Preparing to Sell your Business

Considerations for a Successful Business Transaction

Selling a business can be a complex and emotionally charged process for owners. Whether selling to retire or moving on to other ventures, owners should take the necessary steps to ensure the process goes smoothly and yields the best possible outcome. If you are pondering a sale or in the process of preparing your exit strategy, here are four items to consider for a successful transaction:

1. Understand the Goals of the Sale

The most important step is to intimately understand both the personal and financial goals of the sale. Selling a business is a deeply personal process and a potential sale will impact your family, your employees, your business partners and other parties involved with your business. Determine why you want to sell your business, what you hope to achieve from the sale and what your ideal outcome would be, are just as important as the actual sale itself.

Financial objectives such as maximizing the sale price, pulling cash out of the business, minimizing your tax liability, etc. are the primary focus of a sale. However, non-financial goals and objectives are just as important. These may include considerations such as your role within the business after the sale, plans after, retirement plans or other personal or professional goals. Understanding the non-financial goals of the sale is essential to ensuring the transaction aligns with your overall objectives and you can achieve the outcomes that matter most to you.

An experienced advisor will start this conversation to begin crafting the most appropriate transaction to achieve your overall goals. From this conversation, the advisor can begin to model strategic alternatives that will hopefully achieve all parties’ goals in a transaction.

2. Understand the Company’s Value

Understanding the value of your business is the most critical component of preparing to sell it. Not only will it help you set a realistic asking price, but it will also enable you to identify the key drivers of value within your company, identify the right buyer and determine what steps you can take to maximize its value before putting it on the market.

How is the value calculated?

Value almost always comes down to the company’s ability to generate cash flow. This ability is typically expressed as a multiple of revenue, gross profit or earnings. The multiple most commonly used to calculate a sales price is EBITDA (earnings before interest, taxes, depreciation and amortization), which measures a business’s core operating cash flows.

Additionally, capital expenditures and changes in new working capital will impact a company’s free cash flows and subsequently, sales price and/or the amount of cash a seller will pull out of the business. Companies should approach these two items with a “business as usual” attitude – the business should continue to operate as it normally would but should consider holding off on any major capital expenditures that may negatively impact value or are not necessary to achieve the financial projections.

What are the key drivers of value?

When valuing a business, it’s important to identify the key drivers of value that contribute to its overall worth. While these can vary depending on the industry and specific business, common drivers of value include:

• Revenue and Profitability: The revenue and profitability of the business the two most significant drivers of value. Higher revenues and profits generally indicate a more valuable business.
• Market Position: A company’s market position, including its brand reputation and market share, can significantly impact its value.
• Customer Base: A strong and loyal customer base can be an asset for any business, as it can contribute to steady revenue and repeat business.
• Intellectual Property: Patents, trademarks and other intellectual property can be valuable assets that contribute to a company’s overall value.
• Talent: The ability to retain a company’s key management team as well and its top employees will often impact a buyer’s valuation of the business.
• Growth Potential: Investors are often interested in companies with strong growth potential, as they represent the opportunity for significant returns on investment.

Adjustments to EBITDA

• Non-recurring Costs: It’s crucial to consider any non-recurring costs that may impact the value of your business. Non-recurring costs refer to expenses that are unlikely to occur again in the future and can include things such as professional fees, software implementation costs, expenses associated with the development of new products and services, etc. These costs impact the value of the business in the eyes of potential buyers and the removal of these costs will often increase EBITDA. In preparation for a sale, it may be a good idea to cease some of these practices, because a buyer may be skeptical if a large portion of EBITDA is adjusted.
• Accounting-Based Adjustments: Accounting-based adjustments refer to changes made to the EBITDA figure to account for non-cash expenses or revenue.[1] These adjustments may include:
  • Revenue recognition
  • Write-downs of receivables (bad debt) and obsolete inventory
  • Accrued liabilities not presented on the company’s financial statements
  • Capitalized expenditures versus repairs & maintenance
  • Stock-based presentation
  • Depreciation and amortization
• Diligence-Related Findings: Referring to adjustments made to EBITDA based on information uncovered during the due diligence process.[2] These adjustments may include:
  • “Market-based” adjustments: a buyer will want to review expenditures such as rent and management compensation to determine if these expenses are paid at market rates.
  • “Term-based” adjustments: it’s important to identify any revenues or expenses that will be eliminated based on the terms of the sale. We commonly see these types of adjustments related to rent and related expenses, executive-based compensation[3], and personal expenses run through the business.
  • *COVID-related adjustments: Ensure you have communicated to the buyer both the challenges the business enduring during the Global Pandemic as well as all subsidies received during this process. Adjustments for PPP loans, ERTC credits, etc. should be adjusted out of EBITDA. For the companies severely impacted by supply chain disruption: the ability to communicate these implications and how they financially impacted your business can make a substantial difference in the outcome of a sale.
  • Other adjustments: The sustainability of key customers, representations made by management regarding future expectations of the business, or errors or discrepancies uncovered in the financial statements during the due diligence process, can also cause adjustments to EBITDA to account for these changes.

Sales Price versus Net Proceeds

When selling a business, it’s important to understand the difference between the sales price and the net proceeds. The sales price is the total amount paid by the buyer for the business. The net proceeds, on the other hand, are the amount of money you will receive after all expenses associated with the sale have been paid.

Expenses associated with the sale may include broker fees, legal fees, taxes and other transaction costs. It’s important to take these expenses into account when determining your asking price for the business, as they can significantly impact your net proceeds.

An accurate and proper analysis of how much cash you will walk away with is crucial in determining whether to proceed with a transaction. Your expectations must reconcile with the ultimate amount of money (or other assets) you will have.

Owners should work with an accountant or appraiser to determine the company’s worth. Knowing the value of the business will help you set a reasonable asking price and negotiate a fair deal.

3. Market your Business for Sale

Once you’ve determined you’re ready to sell your business and have a clear understanding of its value, it’s time to start preparing for the sale process. One key aspect of this preparation is effectively marketing your business to potential buyers. Here are some steps to take when marketing your business for sale:

• Identify your Team: Selling a business is a complex process requiring a team of professionals. Owners should seek the help of an investment banker, a CPA, an attorney, a wealth advisor, accountant, attorney and other professionals who can provide guidance and support throughout the process. An accountant can help with the financial components of the deal specifically with the determination of adjusted EBITDA, networking capital and tax planning strategies that can help minimize the tax implications of the sale and most importantly, assist with the supporting analyses and communications between the attorneys, bankers, buy/sell-side representatives concerning the financial information. Utilizing your CPA within this capacity will often result in deal-terms that are advantageous to the seller, fair to the buyer and structured in a tax-efficiently manner enabling the seller to maximize the net proceeds received from the sale. Involve your accountant as soon as possible if you are willing to invest in a team that will work toward generating the best value and experience from this process.

• Create a Confidential Information Memorandum: A Confidential Information Memorandum (CIM) is a document that provides potential buyers with detailed information about your business. This document should include information about the business’s history, financial performance, growth potential, industry trends and other relevant information that can help buyers evaluate the opportunity. The CIM should also include a detailed description of the assets being sold, such as intellectual property, real estate, equipment and inventory. The CIM is a critical component of the sales process, as it provides potential buyers with the information, they need to evaluate the opportunity and make informed decisions. However, it’s important to keep in mind that the CIM should be kept confidential and only shared with qualified buyers who have signed a nondisclosure agreement.

• Prepare Financial Statements: Selling a business requires transparency, so you must prepare accurate and up-to-date financial statements. Financial statements, such as income statements, balance sheets and cash flow statements, provide potential buyers with an overview of the business’s financial health. Work with an accountant to review your financial statements, tax returns and bank statements, and correct any inaccuracies before providing the records to a buyer. In addition to the financial statements, you may also want to provide potential buyers with other financial information, such as customer and supplier lists, accounts receivable and payable reports and inventory reports. This information can help buyers to evaluate the financial health of your business and make informed decisions about the purchase.

4. Other Considerations for the Sales Process

When preparing to sell your business, there are many important considerations to keep in mind throughout the sales process including:

• Clean Up the Business: Owners should clean up the business before putting it on the market. This includes tidying up the physical space, decluttering and repairing any damage. Additionally, you should ensure that the company complies with all regulations and laws. This will give potential buyers a good impression of the business and its operations.
• Prepare for Buyer Due Diligence: This is often an overlooked element of a sale transaction. The buyer’s due diligence team will thoroughly review the company’s financial, legal and operational information to assess its value and potential risks. This can require significant time and effort from your key executives, accounting staff and legal firm.
• Be Willing to Negotiate: Negotiating a sale can be a long and complicated process. Be prepared to negotiate on price, terms and other aspects of the sale. It’s important for you to have a clear understanding of what you want to achieve from the sale and be willing to compromise when necessary.

Questions?

Preparing for a sale in a deliberate manner over time may help ease the financial and time burdens of selling a business. It will also help get the house in order before a third party comes in and starts reviewing all aspects of a business. When the transaction is forced due to unforeseen yet predictable circumstances, the outcome for the selling shareholders may be less than ideal. Early conversations with advisors may improve the likelihood of better outcomes once a process is launched. The Boy Scout motto, “Be Prepared,” is apt, as being prepared for a potential sale can help bring about a successful transaction. Contact an Adams Brown advisor if you need support, including valuation services, developing negotiations, financing strategies and managing due diligence.

[1] Understanding the “basis” of the financial statements (e.g. GAAP) used to determine the sales price, terms, and conditions is one of if not the most important components of every deal.

[2] Note: These are often management-adjusted or accounting-adjusted in nature, but typically found and discussed during the diligence process.

[3] A common mistake made by business owners when adjusting EBITDA is to remove all their compensation from EBITDA. A buyer will take into consideration any additional expenses that the business will incur going forward if they bring on any other executives to replace the owner, and in the process, create an unfavorable adjustment.