Cashing Out? Be Prepared

By John Weikert

Maybe you started it, maybe you bought it. Either way, you’ve invested a lot of yourself in the business. You’ve made sacrifices. You’ve worked 24 hours a day. You’ve juggled schedules, tried to find operators/employees to handle the phones on Monday mornings when one or more of your staff called in sick, or worse, quit without notice. You’ve even bought a four-wheel drive vehicle just to pick up employees in bad weather, and much, much more. Indeed, a business you’ve owned has taken your time, effort and financial investment, and selling often is a bittersweet proposition. The challenge is to find an effective way to sell your business in a reasonable amount of time and on the best possible terms.

A word of caution. Once you decide to sell your business, it’s usually wise to keep your plans confidential. If word gets out that you plan to sell, your competitors will have a field day, and your employees and customers may become wary. Both situations could adversely affect your ability to continue in business and ultimately affect your selling price.

Selling a business can be very time-consuming. It can be an emotionally charged experience, as it is typically one of the most significant events in a business owner’s life. There is a lot to be said for planning to sell your business. In fact, if you are planning to sell in one to three years, now is the time to start planning for the sale.

After assessing your business, you should begin a preliminary calculation of your company’s value. Selling a company is hard work, and you will not want to proceed unless you are confident that your company’s value meets your expectations.

A common misconception is that valuation is an exact science. While the use of formulas in a valuation implies exactness, it is very difficult to set the worth of a company at a single figure. In the TAS industry we hear that bureaus are sold at a multiple of monthly revenues. These multiples range anywhere from three times to fifteen times. We also hear that another formula is used based on profit performance. However, don’t be fooled into thinking that’s all there is to it.

Another misconception is that value equals selling price. The final selling price can be either higher or lower than the estimated range of values for the company, depending on the eagerness of the buyer to buy and the seller to sell, the demand for the type of company, the form or consideration paid, the negotiating skills of the parties, etc. In fact, the selling price of a company sometimes does not seem to have much relation to its estimated value.

Unfortunately, too many TAS sales are handled poorly by business owners who don’t have a good understanding of the buy/sell process, and by incompetent intermediaries who should know better.

The following will take you through the key steps of the buy/sell process and explain each one. It will also point out some of the more common mistakes and pitfalls inherent to the process.

Start Preparing Financial Statements for Selling Purposes, Recast the Numbers

No, I’m not advocating an illicit set of books. However, financials prepared for tax purposes are designed to show income as low as possible within the confines of IRS regulations. Large corporations typically prepare a set of financials for the IRS and another for in-house analysis. You should begin this practice too and you should begin far in advance of the sale. It is much more effective than having to prepare a so-called restructured set or “normalized” set of financial reports years after the fact. It is very effective though if you have done it on a regular basis for several years.

In valuing a business, some typical financial adjustments may include the following:

  • Excessive management salaries.
  • Salaries paid to individuals who can be replaced at much lower salaries.
  • Retirement and health plans that provide better benefits than the plans of other companies in the industry.
  • Excessive perks, such as company cars, trips and club memberships.
  • Beneficial leases.

Personnel Changes: In an industry not noted for its depth of management, buyers are afraid that key employees might leave after they take over the company. If they are prepared to remain with the company through the transition, fine. If the employees are thinking of leaving, it is better that they leave sooner than later. This will allow ample time to train replacements who will remain with the company through a transition. In any event, it might be prudent to have all employees sign a non-compete agreement and keep it on file. This way a prospective new owner will have a higher level of confidence that the employees are more apt to remain with the business.

Talk to Key Employees: If you haven’t discussed your plans with key employees, do so now. They will hear of your plans anyway, so it is better that they learn from you and get the straight story. Also, you will need their support in assuring prospective buyers that the transition will be a smooth one.

Examine Contracts: Many TAS owners have contracts with customers and telcos. Take a close look at these. Those that would be beneficial to a new owner should be kept and extended if possible. However, if there are contracts that you are renewing because of habit, or for other reasons that are not financially prudent, now is the time to do something about them. Contracts that are harmful to a buyer will certainly lower the value of your company.

Review your Real Estate Lease: If yours is the type of business that depends on location, make sure that you can assure a buyer that he/she will be able to stay in that location for a reasonable period of time. Above all, make sure that your lease isn’t set to expire and be re-negotiated while you are actively selling your company. Negotiating a lease when you are all set to sell is like negotiating with a gun to your head.

Likewise, if your location might be inappropriate for a buyer, consider moving now.

Renewal options are generally better than long commitments because they give the buyer maximum flexibility to stay put or to move. At the very least, make sure you have a consent clause in your lease that permits you to assign your lease to a new owner without being reasonably withheld.

Examine Equipment Leases: If you are leasing equipment and the lease will remain in place after the sale, look at the rationale of the lease(s) from a buyer’s perspective. If a lease will have the effect of saddling the buyer with an interest rate well above prevailing rates and any tax advantages have already accrued to you, the lease may hurt your company’s value.

Formalize Your Records: Suppose your policy is to give customers terms of net 30 days. Suppose you’re like most TAS owners and make exceptions to most policies. Perhaps your brother’s wife and your college roommate are allowed to wait as long as they need to pay. The person who buys your company is not going to want to hear about preferential treatment for your brother’s wife or your college roommate, nor will he/she want to be the one to have to cancel the exceptions. It is better to enforce policy now to make the transition smoother. If that’s not possible, at least document the exceptions so the buyer is not hit with surprises.

Systemize Operations: Many TAS businesses rely on a mix of clearly documented procedures, and procedures that exist only in the owner’s head. Your company will be more salable if procedures are clearly systematized and documented so that a competent manager or new owner can take over with minimal training. Get it out of your head and into a procedure manual. Make sure the procedures are tested and refined before the sale.

Separate Real Estate: It sometimes makes sense to own real estate as a company asset. But when it comes time to sell, including it as part of a business sale can increase the complexity of the sale and make a business less attractive. Sophisticated buyers like to transact real estate separately from the business itself. Also, if real estate is separate, you can start showing rental to the real estate owner as a regular line item expense for the company, making it more clear and acceptable for a buyer to assume the expense.

Ownership Structure: If you are operating as a sole proprietorship or a partnership, now may be a good time to incorporate for two reasons:

First, it is better to have the corporation liable for payables and other debts. Otherwise you might find yourself responsible for the new owner’s liabilities or liabilities that he agreed to takeover. Make the change now because it takes time for creditors to change things over in their own records. Incorporating just before a sale to distance one’s self from obligations is not foolproof. In fact, if you wait too long, you may have difficulty meeting IRS filing requirements and other bureaucratic requirements that are notorious for taking too long.

Secondly, a corporation provides a clean vehicle for transferring a company in part rather than a whole. A buyer could purchase the proportion of the firm’s stock (at the agreed price) that would give him the agreed proportion of the company. If this sounds complicated, it is. I suggest you check with a good tax specialist.

Documentation: Entrepreneurs are not known for their fastidiousness in keeping records and documentation. In preparing to sell a business, you first must gather documentation. Audited statements prepared by a reputable accountant, while rare to the TAS industry, will help establish your business credentials. Tax returns also offer proof of business performance. Generally, three years of financial records will serve to establish where the business has been and its profitability. Among the items you’ll need to gather are:

  • Income statements.
  • Balance sheets and income tax returns from the last three to five years.
  • Records of accounts receivable and payable.
  • Bank statements.
  • Copies of any notes or mortgages owed.
  • Existing contracts with employees, customers or suppliers.
  • Detail ESOP, 401K and any other retirement plans in place.
  • Present lease.
  • List of equipment owned or leased and any maintenance contracts or other obligations associated with such assets.
  • Corporate books (if incorporated) or partnership agreement (if partnership).

Banking Connections: Bankers don’t like surprises. It is a good idea to tell your banker that you plan to sell the company in the near future. Don’t be afraid to ask him about the possibility of financing a buy out, or partly financing it through receivables, but don’t expect a firm commitment.

Review Terms and Structure of Sale: Terms are as important as the price. Decide the range of owner financing that you’ll consider and the degree of security you’ll demand. Remain flexible though, so as not to limit your options. A buyer may present you with a reasonable but unexpected financing package. There are as many ways to structure financing as there are businesses for sale. Also, all buyers are not equal. You may be happy to finance one buyer for 50% of the sale price, while another you might not trust for 5%.

In evaluating prospective offers, sellers should investigate the prospective buyer’s (1) credentials and track record, (2) creditworthiness, especially if a portion of the purchase price is deferred or is paid in notes or stock, (3) management style, and (4) integrity.

Selling a business is not and should not be a simple transaction. For example, you can sell all of the business or part of the business. You might sell your interest in a corporation to another corporation or an individual. Or, your corporation may sell its assets. It is not unusual for a business owner to sell the business but retain ownership of the receivables for the purposes of security. There are even instances where a business is essentially leased with an option to purchase.

In the final analysis, your company is worth only what someone will pay for it. Generally, a potential buyer’s offer will be influenced by how soon he or she expects to see a return on the initial investment.

If it is planned for in advance and done wisely, the sale of a business may be among the most rewarding moments in a business career. You have, no doubt, recognized the need to plan your business’s future. It’s never too early to consider and plan your future.

For instant information on J. Weikert & Company, LLC, you can access their fax-on-demand line by dialing 800-227-5638; ext 137.

[From Connection Magazine – September 1998]

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