The sale of a business can be one of the most critical and lucrative events in someone’s life. However, the execution of this process is subject to many moving parts, so proper planning is vital to the overall success of the sale.
We recommend that business owners begin planning for the sale of their company at least two years prior to exposing it to the open market, as strategies to maximize the selling price will take time to execute. It is also important to start the process early to ensure the company is structured tax efficiently to provide the most after-tax dollars on the future sale. Similar to “home staging” in the real estate market, where a home is made more appealing to attract the highest price, there are various tactics a business owner can deploy to make their business more attractive to potential buyers, and therefore increase its selling price.
The following are some of the key considerations that should be involved in planning for a sale:
1. Recent financial performance
A company’s financial performance in the years immediately preceding a sale have the most significant impact on price to a prospective buyer. Sellers tend to benefit where they have demonstrated growth in both revenues and cash flows, and where there is a reasonable expectation that growth will continue. In addition, sellers should focus on sustainable revenues rather than one-time contracts. In the years leading up to the sale, sellers should undertake measures to increase cash flows, either through cost control measures and/or increasing revenues.
2. Balance Sheet Management
In most business transactions, the buyer inherits the balance sheet as part of the purchase price. Balance sheets values are subject to negotiations and can have a significant impact on the final price that is ultimately paid. Buyers prefer to deal with “clean” balance sheets. Therefore, sellers should remove non-operating or redundant assets and liabilities, which includes assets and liabilities that do not contribute to the operations of the business (e.g. real estate, portfolio investments, related party/shareholder loans, etc.).
Removal of the net redundant assets can usually be accomplished on a tax deferred basis, which can increase the seller’s after-tax proceeds. In other situations, such as when a seller’s company owns real estate in which the business operates, it is often beneficial to segregate the real estate in a holding company and enter into a lease agreement with the operating company. Some of these strategies require implementation well in advance of a sale to ensure the transaction can be completed on a tax deferred basis.
Real estate has different business risk than that of an operating business, so segregating these assets simplifies the valuation process. Furthermore, some purchasers may not want to invest in real estate, which allows the seller to retain a future income stream after the sale, by way of a lease of the premises.
3. Working Capital Management
The amount of working capital conveyed to the buyer upon the sale is usually negotiated with reference to recent industry norms. Therefore, to the extent that a seller can better manage working capital in the years prior to the sale (e.g., reducing the average length of accounts receivable and increasing inventory turnover), the seller will benefit from effectively generating additional cash and value from the business.
4. Qualitative Factors
While the previous tips focus on quantitative measures, there are also qualitative considerations to consider when planning for a sale.
Diversified Customer or Supplier Base
When selling a business, the customer base has a major impact on its price. A diverse customer base with revenues from many customers is more valuable than those from a select few customers, because it lowers “concentration risk”. This occurs when a business is particularly reliant on certain customers to survive, because they comprise a large percentage of sales and receivables. This could pose problems if such a customer were to face financial hardship, or if they did not want to conduct business with the new owner. A general rule of thumb is that, where it can be accomplished, no single customer should account for more than 10% of total revenue, which can be achieved through differentiation of customers or even through distinct revenue streams.
Similarly, a diverse supplier base ensures that the business can adapt to changing prices, logistical issues, and other concerns that may be elevated when reliant on one or few suppliers.
In a broad sense, a competitive advantage can refer to factors that allow a business to generate profits more efficiently than its competitors, either due to the perception of higher quality products and/or services, which influences pricing, or its ability to produce goods or services better or more efficiently than its rivals. In either case, the business can generate additional revenues and/or higher margins than its competitors.
A company should understand and emphasize the sustainability of its competitive advantage(s) in the marketplace, as a prospective buyer will pay more for a business with competitive strengths that cannot be easily duplicated by competitors.
Financial Foresight and Controls
Financial controls allow a business to properly monitor financial and other resources effectively, which provides a framework for managing operations, as well as cash flows. Proper financial controls should provide financial data on a timely basis and allow for forecasting to enhance profitability and improve accountability. During the due diligence phase, a potential buyer is typically focused on accurate and efficient financial information and processes. These can influence the price paid, depending on how effectively these are established by the seller.
At GG LLP, our experienced professionals can assist you throughout the entire process by providing tax planning, valuation, and other support services. We would be delighted to discuss how your business can increase its price, and to guide you through all the necessary steps. Do not hesitate to reach out for more information.