Preparing Your Business For Sale – 10 Ways To Increase Your Business’ Value

“Failing to prepare is preparing to fail.”

The above quote is one of our firm’s favorite and summarizes the importance of preparation when it comes to selling your business. Most accountants and wealth advisors dedicate a lot of time educating business owners on tax and wealth planning however business and operational planning is just as important if not more as it has a direct impact on increasing the value of your.

“I need to grow my revenues to increase my company value right?”

The most surprising part is that we frequently hear business owners say that “selling more” is the single path to increasing the value of their business and its not true! The same business generating the same revenues and profits can be sold at very different levels of valuation based on qualitative factors. The three core non-financial factors to focus on to drive additional value are i) reducing the buyer’s transition risk, ii) delegating key responsibilities to staff to reduce owner involvement and iii) document processes and collect data accurately. To achieve these things, we recommend focusing on 10 areas of your business to increase the overall value of the company pre-sale.

Value Driver #1 – Cosmetic Improvements (<6 months before sale process)

Similar to a job interview or date, first impressions are critical when selling businesses to private investors who need to envision themselves in the owner’s shoes. There are three common cosmetic improvements to pursue 6 months before going to market to raise your brand and overall appearance:

• Revamped Website & Branding – If you don’t have a website, build one. If you have an antiquated website, invest in a refreshed redesign with new photos of the products/services your deliver and some background on your facility, history, team. The first thing investors do is they look your business up online and check your google reviews and online presence. Start off the relationship right with a positive first impression through a clean website.

• Clean Your Facility/Warehouse – Investors will usually tour the business before they buy it. Things like dirty bathrooms, dusty reception desks, messy lunchrooms and poor landscaping limits an investors enthusiasm when attempting to envision themselves in your role. Repaint and keep commonly used areas clean.

• Clear Out Dead Inventory or Equipment - Do some heavy spring cleaning and get rid of dead stock and unused machinery that is taking up space in your warehouse. Freeing up space shows two things 1) room for growth and 2) potential cost savings as the company doesn’t use all of its current space and therefore its physical footprint can be downsized.

Value Driver #2 – Financial Statements and Due Diligence Information (2+ Years Prior to Sale)

Business buyers are reliant on accurate financial information to make investment decisions. Upgrading and investing in your company’s financial standards and systems is critical to ensuring that a business is not only desirable but sellable. The quality of the financials will be scrutinized not only by the buyer but their investors and lending partners. There are a few things to focus on in this area:

• Hire a qualified CPA Accountant – Some businesses choose to stick with their longtime accountant while they have grown in size and most likely outgrown their accountant’s expertise. Several years prior to selling, it is worthwhile to evaluate the quality of your CPA accountant to ensure that you are working with a credible firm who is preparing your annual financial information correctly. Relying on non-CPA bookkeeping firms can result in ill-prepared financials or misfiled tax returns which undermines your negotiating position when going to sell the business.

• Review Engagement Statements – Another common issue is that most business owners, choosing to save on accounting fees, only prepare notice to reader (NTR) financial statements. The challenge is that most banks looking to lend to business buyers require review engaged financial statements. By upgrading your statements to review engaged prior to selling the business, investors can more easily finance the transaction which speeds up the time to close.

• Accurate Inventory Counts – A common area of focus during investor due diligence and working capital negotiations is the business’ inventory balance. Some business owners may choose to avoid counting their inventory on a monthly basis or even manipulate their year end inventory balance to reduce taxable income. When preparing to sell, its important to “invest in taxes” and try to go by the book in order to properly reflect asset balances like inventory. This ensures a more accurate historical number for diligence and negotiations.

Value Driver #3 – Back-Office Processes (2+ Years Prior to Sale)

Financial investors pay a premium for businesses that are well organized and have documented policies in place. Why? Because it reduces the buyer’s transition risk and makes due diligence easier to complete. With poor controls and a lack of operational information, buyers can become frustrated and they may lose confidence in the accuracy of the statements made by the seller. Poor information and controls can put the overall deal at risk or at the very least result in the purchase price being renegotiated to mitigate some of the buyer’s concerns. Here are some common areas business buyers focus on during their due diligence:

• Revenue & Cost Information - Keep track of your segment and division revenues & direct costs based on customer, products/services sold and units/hours sold. The more granular the sales and cost information is, the easier a buyer is able to learn about your business and trust the statements made during the sale process.

• Pricing and Quotes – Does the business solely rely on the owner to price new work? Are there any formal policies or pricing models that can be developed to explain pricing in clear detail to speed up a buyer’s education process? The underlying benefit is that once pricing controls are in place, it can be more easily delegated to staff which frees up the owner’s time and reduces the time to train the new owner once the transaction closes.

Value Driver #4 – Managing Bad Debts & Customer Accounts (2+ Years Prior to Sale)

One common indicator business buyers look out for is historical bad debts. If the bad debt expense of a business is sustainably high or is increasing, buyers will question the overall quality of your customer base. Controlling bad debts starts with formalizing a clear accounts receivable collection policy and delegating those responsibilities to sales staff or client-facing employees. Furthermore, offering various methods of collection (credit card payment, EFT wire transfers, etc.) and requiring deposits to cover material costs upfront speeds up the collection cycle of the business and reduces the amount of AR financing provided to customers. By speeding up collections, the required net working capital levels of the business decline which results in higher net proceeds to the seller when the business is ultimately sold.

Value Driver #5 – Close Out Lawsuits and Open Litigation (<1 Year Prior to Sale)

Open litigation or disputes of a material manner will undermine the value of your business as buyers are naturally pessimistic when pricing in risks. In most instances, the expected cost of settling and the ongoing cost of legal representation will be factored into their offer which begs the question, why not settle now and eliminate the threat of a purchase price reduction? Buyers and their counsel will run searches on the corporation and probe into several legal areas when doing due diligence. If there are active disputes, its more cost effective to settle prior to selling the business.

• Customer lawsuits/Disputes – Being sued by a customer is one of the quickest ways to lose buyer interest, it communicates either 1) you have poor customers that are litigious or 2) you are delivering a poor product/service. Resolve these disputes quickly via out of court settlements or AR discounts and future credit discounts.

• Employee Terminations/Pay Disputes - Current employee disputes illustrate internal unrest and poor morale which increases the perceived buyer transition risk. Focusing on reducing employee turnover and settling disputes is critical. With the labor market being so competitive, most business owners are increasing their wage rates to compensate staff and reduce turnover.

• Environmental Contamination – If there are environmental lawsuits relating to your property or adjacent properties in the neighborhood, buyers will not only demand a full environmental guarantee of future losses incurred as a result of this environmental contamination but they will also factor in an inflated cost of remediation into the purchase price. Addressing the environmental concerns upfront by paying for the remediation yourself is the best approach, it eliminates buyers attempting to low-ball the business and allows you as the seller to control your remediation costs.

Value Driver #6 – Building A Middle Management Team (2-5 Years Prior to Sale)

The more an owner is able to delegate their day-to-day activities, the more valuable the business is to an investor. Key owner risk is such a prevalent risk in small and medium-sized businesses that investors are willing to pay a premium for businesses where middle management are independently running the day-to-day operations. This ultimately reduces the transition risk of the business for the new buyer. There are several best practices to implement several years prior to selling the company.

• Promote Senior Staff – Organizations where all employees/divisions report directly to the owner create significant buyer risk. Promote veteran employees to middle management roles to create a buffer of senior staff that can help support a buyer’s transition process.

• Delegate Owner Tasks – Focus on delegating responsibilities like payroll, invoicing, inventory purchasing and inside sales responsibilities. Critical functions are more difficult to delegate however admin functions can be supported by back-office staff and are among the first things delegated by the buyer once they take over the business and implement these same principles.

• Invest In Key Employee Retention – Most organizations have one or several key employees that lead critical functions in the business (VP of Production, Purchaser, Sales Rep, etc). Focus on setting up a bonus plan for this employee rewarding them for future profit growth. If the employee is paid below market wages, focus on raising their salary closer to competitive levels. Having a key employee depart while trying to sell the business can derail your efforts very quickly.

Value Driver #7 – Employee Contracts (2-5 Years Prior to Sale)

For businesses dealing with critical intellectual property (IP) like product designs, software, leading-edge services or manufacturing processes which are not patented, ownership must legally plan to protect these items and target key employees who either participated in the design of the initial IP or who are involved in its delivery. This a sleeping giant in M&A transactions as most owners pay little attention to their employee agreements when building the business however professional buyers scrutinize such agreements especially when there is significant customer concentration or IP that generates value for the business. This helps ensure buyer protection in a transition scenario. Consider the following agreements:

• Non-Compete Agreements – For key staff, having a non-compete agreement ensures that these employees do not leave the company post sale and take key customers/suppliers with them.

• Non-Disclosure Agreements – For key staff and designers working on products manufactured by the company or under design, NDA documents are a commonplace agreement to ensure IP protection and prevent leaks if employees leave the company.

• Contractor Agreements – If the company is reliant on contractors (independent sales reps for example), it is critical to ensure that these contractors sign non-compete and copyright protection clauses ensuring that all worked created while working for the company or existing customers of that company are protected under this clause.

Value Driver #8 – Customer Relationships (2-5 Years Prior to Sale)

One of the most significant value drivers is focusing on increasing the “stickiness” of your customer base. This means that your customers are more reliant on your product/service and therefore are less likely to switch to competing options and more frequently purchasing from you. This results in buyers paying a premium for the business as they feel comfortable that the customers they are acquiring will stick around and not leave post sale. The ideal is having customer contracts renewing annually however its unrealistic to assume that all customers will sign contracts. What we recommend is focusing on the underlying drivers of repeat business, this means creating repeat services that are convenient and which people rely on (for example annual maintenance or services to upkeep products and reduce downtime/long-term service costs). This requires studying your customer base to understand what repeat products or services can be supplied to them and grow that division pre-sale.

The second area of focus should be diversification of customer volumes. Even if a major customer account is “sticky” buyers are naturally hesitant when a key customer makes up 20%+ of the business’ total revenues. What if they leave? What if they convert to a new business model? The potential threat of this dependency usually limits their willingness to pay more for the business so focusing on adding new accounts to spread out the revenues is a valuable exercise to mitigate buyer concerns pre-sale.

Value Driver #9 – Real Estate Considerations (1-2 Year Prior to Sale)

If you own the property in which the business operates from, its important to recognize that the business buyer may not be the same buyer for the real estate premises. In most of our firm’s transactions, the real estate is sold to a separate third-party buyer therefore separating the ownership of the business and its real estate post-sale. There are several ways to set up your real estate prior to a sale:

• Real-Co/Op-Co Structure - For sellers, to maximize your tax structure, its recommended that you separate the business into an operating company while the real property is owned in a real estate holding company. This way the sale of the business does not interfere with the separate sale of the real estate and therefore you can sell the shares of the operating company without incurring costs in moving the real estate out of the operating company.

• Charge Yourself Market Rent - Owners have a tendency to charge themselves below market-level rental rates which overinflates the profit level of the operating company as intercompany rent is lower than what would be paid if they were leasing the property from a third-party landlord. When going to sell a business, a buyer will “normalize” this and account for the market rent that is going to be paid rather than the rent that was paid in the past therefore the owner gains very little by keeping rent low in the operating company and only creates confusion around what the true profitability is for the business. To manage your own valuation expectations regarding profit, its best to charge yourself market rent instead of allowing the buyer to normalize for it.

• Invest in a Phase One Environmental Report - Most buyers will want the seller to guarantee that the property is clean and free of any environmental contamination. Making such a guarantee either requires a high level of certainty that the property is clean or, what we recommend, is that the seller invests in a phase one environmental report which definitively confirms that the property was clean at the same of the business sale and therefore any issues that arise in the future are clearly the fault of the new business owner and not the past seller. It’s a worthwhile insurance policy to have to avoid legal disputes in the future.

Value Driver #10 – Outstanding Cash and Debt (<1 Year Prior to Sale)

Most business sales close on a cash-free/debt-free basis meaning that the seller is responsible to settle the cash and debt on the balance sheet. Most owners can save a lot on taxes and banking fees with some proper planning beforehand. To save on tax, you want to avoid having excess cash in the corporation prior to a sale as in certain countries (like in Canada), if the cash balance is 10%+ of the sale value of the corporation, the seller losses their eligibility to benefit from capital gains exemptions for small business sales. Therefore prior to selling, tax efficiently stripping cash funds out of the corporation is critical to your financial planning which should be done by a qualified CPA or tax lawyer.

When it comes to debt, most buyers will finance the business using their own bank therefore any outstanding loans will need to be prepaid by the seller. Prepaying fixed rate loans results in bank penalties which can eat away at your net sale proceeds. Therefore, targeting a reduction in prepayment penalties with your bank and converting your business loans into floating rate loans prior to a sale will reduce the amount of prepayment penalties you will have to pay once you go through with the business sale.

For a more detail discussion on all of these value drivers mentioned above, consider watching FinanceKid's YouTube Video covering the 10 Ways to Increase Your Business' Value Pre Sale. Check out the link below.

About the Author – Robert Bezede is a Canadian-based M&A advisor working with lower mid-market companies valued between $1 to $50 Million in enterprise value working across a broad range of sectors. If you or someone you know is looking to sell their business, please reach out to Robert via LinkedIn or send an email to robert.bezede@robleecapital.ca