Do You have an Exit Strategy for your Small Business?
There will be some point in the future when you may want to “get out” of your business, that is, exit it. Too often, I see genuine hardworking people who have struggled and persevered to build up a good, successful business become disappointed and confused when they realize, following the sale, that they failed to reap the richly deserved benefits of all their hard work.
The mistake these common business owners make is that they do not start thinking about their exit strategy early. Even though the sale may seem far off, thinking about it now can allow you to have time to work with professionals to develop a proper plan. The degree of care and effort you put into the sales process could have a huge impact on the price you receive and how long it will take to complete that sale.
When selling, business owners may not know what to do or where to start. Without this knowledge, often a business fails in being presented effectively to potential buyers. Even if you are not yet intending to sell, reading about this mistake will not only give you a better appreciation of your own business, but will also expose you to some pertinent principles
There are a number of things that you should be doing to improve the value of your company. Because these things take time, the ideal situation would be to start working on them three years before the sale, since most buyers will want to see three years of financials on your business before making an offer or completing a sale.
Improve your business’s income. One of the first questions that a buyer will typically have is “what is the revenue and net income of your small business?” The most vital step you’ll want to take is to clean up your income statement. You can have your accountant recast your financials to reflect the way the company should look with new owners. This may mean simply increasing your advertising expenditures, hiring another salesperson on a commission basis, or keeping your business open for an extra 8 hours per week to generate more revenue. Also, take a hard look at your expenses to see whether you can reduce them. You may also want to have your accountant capitalize certain items that might otherwise have been expensed, and review your depreciation and inventory reporting methods.
Improve your business’s assets. Assess the assets of the business. You’ll want to sell off or dispose of any unproductive assets or inventory that isn’t selling. The buyer won’t want to pay for them, and they will only drag you down — better to get what you can from them now, and write off any losses that may result. The business may own assets that you will want to retain after the sale (the most common example is a company car). Now is the time for you to “buy” the asset from the business, perhaps at the current book value. If the business owns real estate, you might consider removing it and placing it in a limited liability company so that it will not be transferred in the sale. You can continue to lease it to the new owners, or to someone else, and retain an income stream. This is a judgment call — for some businesses, the real estate provides the main appeal to buyers and you won’t get much for the business without it. Your business broker, if you have one, should be able to tell you whether this is true for you.
Another move you may want to make is to replace any machinery that’s nearing the end of its useful life, and do any necessary repairs and upgrades. The average buyer wants to purchase a turnkey operation, meaning that all they have to do is walk in, turn on the lights, and the business will operate with no immediate need for investment on their part.
Clean up potential liabilities. You should make an effort to clear up any pending or potential legal problems, such as product liability claims, employee lawsuits, CRA audits, insurance disputes, etc. A buyer who purchases only the assets of your business (instead of corporate stock) generally won’t get stuck with inherited legal problems; however, the very existence of lawsuits or other problems may raise red flags in a potential buyer’s mind. One concern that buyers increasingly have is whether there might be any lurking environmental problems on your property. When problems turn up, it’s possible that any and all former owners can be held accountable by the government for very expensive cleanup costs.
If real estate will be part of the sale of your business, you should make every effort to ensure there are no leaking underground storage tanks, asbestos, lead paint, hidden hazardous waste, or other nasty surprises around the property. If it’s reasonable to conclude that problems are unlikely, an environmental transaction screen conducted at your attorney’s direction may be all that is necessary. This is one area where your lawyer’s advice will be very important.
If you are like most small businesses, you have probably shown lower profits to minimize your annual tax burden. While that strategy may be excellent for tax purposes, it could be harmful when determining the value of your business. To obtain the highest price for your small business, you will want to make your company look as profitable as possible to prospective buyers.
The best way to do this is to have your accountant recast the profitandloss statements to reflect adjustments for what the business owner takes out of the business in terms of compensation and fringe benefits. This can be especially useful when dealing with a buyer who would operate the business himself.
The next thing is to take these recast financial statements and prepare projected financial statements for the next five years. Remember that the prospective buyer is looking at the future potential growth and profitability of your business and your projections could serve as an important basis for the prospective buyer to pay top dollar for your business.
Unfortunately, most business owners who sell their business end up getting pennies to the dollar and get the short end of the stick because they didn’t properly plan the sale.