How to Prepare Your Business for Sale - The Ultimate Guide
Your business may be your most valuable personal asset, as many owners grow their companies over decades. The prospect of selling your business can feel overwhelming, and you want to receive a fair price for the assets you’ve worked so hard to create.
A business sale also requires extensive preparation, and you should take action to prepare for a potential sale now. Use this guide to prepare for a business sale and get the price you deserve for your company.
The more organized and accurate your accounting records are, the easier it is for a potential buyer to assess your company’s value. This section explains how you can prepare for a sale with accurate accounting records.
Accounting Rules of the Road
It’s important that you use a well-defined accounting process to post transactions and to generate your financial statements.
A potential buyer needs a clear picture of your financial condition, and that includes accurate financial statements for past years. When someone buys your firm, they need to integrate your accounting data into their systems, and your accounting transactions must follow industry standards.
Your accounting processes must be used consistently each month, so that you can generate accurate accounting data. Assume, for example, that you post loan interest expense on the last day of each month, based on a report produced by your bank. If you follow the same procedure each month, you’re more likely to record the correct amount.
Accurate accounting data helps a potential buyer identify trends in your business results. A purchaser, for example, can review your interest expense to determine if the expense is increasing, as a percentage of sales. If interest expense climbs from 2% to 5% of sales, your firm’s total debt is also increasing.
Finally, a reliable accounting system makes it easier for a CPA firm to complete an audit of your financial statements. If an auditor is analyzing interest expense in the income statement, for example, your consistent process for posting the expense makes your financial statements more reliable. As a result, the auditor may spend less total time gathering audit evidence to support their audit opinion.
A potential buyer will also be more likely to rely on your financial statements if he or she feels that your accounting processes are nailed down.
Accounting and Business Software
Business can work far more productively by leveraging technology, and the same concept applies to your accounting system. To operate more efficiently, move away from Excel and Word documents and start using more accounting software tools. Software helps you to work faster and avoid mistakes that lead to errors in your financial statements.
You can also use a number of applications that integrate with your accounting software. Payroll software, for example, uses your employee data to calculate each worker’s net pay, pays employees using direct deposit, and handles your tax reporting.
Payroll can tie up a lot of your time, so make the effort to automate the process.
You can also find useful software to automate your fixed asset accounting, and accounting for inventory purchases and sales. Any number of business processes that you have can be supported by software, and the new Cloud SaaS models have driven down prices that even small businesses can afford.
The more automation you use, the easier it is for a purchaser to take over your business and minimize the time required to learn your accounting and business processes.
Procedures Manual: How you do what you do
What makes your business valuable to a potential buyer?
One component of business value is your ability to operate efficiently and consistently, which helps you to make smart decisions that allow you to outperform your competitors. It’s a part of your firm’s “secrets sauce” that make your company successful.
A procedures manual documents each routine task you use to operate your business, who performs the work, and how often. Creating and distributing a manual to your staff clearly states how you do business and eliminates confusion. A procedures manual is also a great training tool for your employees.
Assume, for example, that you set up an automated system that allows customers to submit orders using an email template. Your manual explains who receives the emails, and how the orders are processed.
Using a procedures manual makes your company more attractive to buyers, because you provide documentation that a purchaser can use to operate your business successfully.
Accrual vs. Cash Accounting: Why accrual is recommended
Generally Accepted Accounting Principles (GAAP) require businesses to post accounting activity using the accrual basis of accounting, and a purchaser will expect you to produce your financial statements using the accrual method, so that your results can be easily compared with similar companies.
The accrual basis requires a company to match revenue earned with the expenses incurred to generate the revenue. This concept is also referred to as the matching principle, and it presents a more accurate picture of a company’s profitability.
Consider this example: If you sell an inventory item in March that was purchased as inventory in January, you match the January cost with the March revenue.
Some small companies use the cash basis of accounting, which posts revenue when cash is received and expense when they are paid in cash. The cash basis presents a distorted picture of your financials and should not be used.
Adjusted Trial Balance
A trial balance is a report listing each account used to post transactions, and the current account balance. Accountants frequently review the trial balance to verify if a particular transaction was posted, and to quickly assess the current financial condition of the business.
To comply with the accrual basis method of accounting, business owners post adjusting entries. For example, assume that a company pays $3,000 representing three months of insurance premiums on 11/30/18, and increases the prepaid insurance account in the balance sheet.
On 12/31/18, the company must recognize one month of insurance expense by reducing the prepaid insurance account by $1,000 and posting an expense. This adjusting entry records the expense in the month that the insurance coverage was provided (December). Note that the expense is recorded when incurred, not when cash is paid.
After posting adjusting entries, the adjusted trial balance is used to generate the financial statements.
Normalizing Adjustments to Financials
Most small business owners keep their set of books based on the tax impact. They minimize their profit in order to minimize their tax burden. However, when you prepare to sell your business, you need to show as much profit as you can.
By recasting the financial statements to comply with accrual accounting standards, a firm determines the true operating profit of the business by adding back discretionary expenses that are not needed to run the business. This “normalizing” process is something a potential buyer will need to evaluate your company.
Financial Statements: Including past years
A potential buyer will want to review financial statements for at least the past three years, and even more, if the financial records are available. A multi-year review helps a purchaser identify trends in your business.
The sooner you can start to generate and store financial statements on the cloud, the more prepared you are for a potential sale.
Goodwill: Defined, how goodwill is created
Goodwill may be an issue when one company buys another firm.
Goodwill is defined as the price paid for an asset above the asset’s fair market value. If a company buys a business, a product line, or intellectual property (patent, copyright), the dollar amount paid over fair market value is posted to goodwill in the financial statements.
If, for example, Acme Manufacturing company buys Standard Manufacturing and pays $500,000 more than the fair market value of the assets, Acme will post $500,000 to a Goodwill-Standard Purchase account.
Tax returns, getting help
Your business tax returns will also be provided for past years, and your returns must comply with applicable tax laws.
A CPA can keep your accounting on track and confirm that your financial records comply with accounting standards and tax laws, so consider working with a CPA from the day you start your business.
Make the effort to comply with these accounting rules of the road, even if you’re not planning on a business sale right away. Making improvements now will make the process much easier down the road.
Preparing you financial statements for a potential buyer
There are several more steps you should take to prepare your financial statements for a potential buyer:
- Reconciliations: Make sure that all of your accounts are reconciled, and that the reconciled balances are reflected in your financial statements
- Categories: Review your financials to ensure that account balances are posted to the proper categories. Cash, accounts receivable, and inventory, for example, should be posted as current assets, while fixed assets are non-current assets.
- Final review: Your firm’s CFO should perform a final review of the financial statements for reasonableness. If you don’t have a CFO position in your company, have your CPA firm conduct the review.
These steps can help you provide accurate financial statements to a potential buyer.
Can your business continue to operate profitably after you’re gone?
This is a big consideration, because no owner can operate the business forever. Planning for succession can help you maintain the value of your enterprise, and ultimately help you sell the company for a higher price.
Planning upfront is important, because an owner may become disabled or pass away unexpectedly. If the unexpected should happen, your plan can put another manager in place and help the business maintain profitability.
The different ways to successfully transition your business
Here are several strategies you can use to transition your business:
- Promote from within: You may identify and mentor someone on your current management team to take over the business when you leave. Promoting from within helps you maintain relationships with customers, vendors and employees.
- Buy/sell agreements: Owners can put an agreement in place with existing business partners, or with an outside potential buyer, and the agreement dictates how the future selling price will be calculated. These agreements speed up the sale process.
- Employee Stock Ownership Plans (ESOP): An ESOP allows company managers and other employees to set aside funds in a trust to eventually buy the business from an owner, and the ESOP agreement typically provides a metric to compute the sale price (multiple of sales, earnings, etc.).
Planning Ahead of Time
A succession plan may require you to train and mentor a successor, and to put legal documents in place. Both of these tasks are time consuming. In addition, employees funding an ESOP need a number of years to accumulate the funds needed to buy out the owner.
For each of these reasons, you should plan for succession as soon as possible.
Putting a detailed plan in place can help you avoid a forced sale. A forced sale occurs when the owner is under pressure to sell the business, or the owner’s heirs are trying to sell the company. The seller does not have any bargaining power and will likely receive far less for the business when the sale is finalized.
Make the effort to put a succession plan in place, even if you’re not planning on selling your business for years.
Increasing Company Value Before a Sale
Your goal is to maximize the price you receive for your business, and you can take proactive steps to increase the value of your company. Generating more revenue and profits while you remain the owner increases the value of your business, helping to justify a higher sale price.
A great starting point is to perform a SWOT analysis on your business. The term SWOT stands for strengths, weaknesses, opportunities, and threats, and you can write down issues in each of those four areas. Get input from people on your staff, share your SWOT analysis with your team, and ask them for feedback.
Once you perform this analysis, you can start focusing on business improvements.
Brand awareness, customer base, cash flow
If you can increase your company’s brand awareness, the number of people who know about your products and services will increase. With more prospects, you stand a better chance of converting interested people into repeat customers. Finally, developing a stable base of repeat customers will improve your cash flow.
To improve company profitability, you also need to analyze your costs.
Make sure that you account for every cost you incur to operate your business and use total costs to decide on sales prices that generate a reasonable level of profit. Consider using multiple suppliers for your key purchases, so that suppliers must compete with each other for your business, which drives down the purchase price for goods and services and improves your gross profit and operating margins.
Finally, if a product line or company division isn’t profitable, consider closing the operation and focusing on profitable areas of your business.
Successful companies often benefit from making strategic investments that pay off down the road. You may, for example, invest in a new technology that allows your firm to be more productive, or spend money to train your staff more effectively.
It may take months or years to show a return, but smart investments can increase the value of your business.
Metrics to Review
Just like the dashboard in your car, well-managed firms use a set of metrics to monitor how the business is performing, and where the company can make improvements.
Some metrics reveal the cost to acquire customers (customer acquisition cost), the lifetime value of your customers (“LTV”), and the recurring revenue generated from clients who pay using a subscription model (monthly recurring revenue or “MRR”).
Metrics can also reveal trends in your firm’s performance, helping you to identify areas of improvement. If you’re analyzing sales by product line, for example, you may use the trailing twelve months or the twelve months moving averages to assess your sales trends.
Some of the most useful metrics are industry-specific. An online retailer, for example, may closely monitor sales returns, because returns both reduce revenue and cause the business to incur more costs.
Create a useful set of metrics, so that you can keep an eye on your business and make changes to increase profits.
Professionals and Their Roles
Selling your business requires months of planning and negotiation, and you will work with a number of professionals to complete a business sale.
A company sale will likely involve your in-house accountant (if you use one), or experts at a CPA firm who may perform your audit, handle your payroll processing, or prepare your business tax returns. You’ll also need an attorney to review your contracts and the sales documents.
Buyers and sellers often agree to retain a Certified Valuation Accountant (CVA) to provide an independent valuation of the business. You may also work with an exit planning advisor who helps you prepare your business for sale and grow your business to maximize your value, and a wealth planner, who can help you invest the sales proceeds.
The professional with the most involvement in your business sale, however, is often a business broker.
To prepare your company for sale, starting finding professionals who can fill each of these roles. Ask your network of business contacts for referrals.
Role of the Exit Planning Advisor
There’s a lot riding on the sale of your business, and going it alone can leave you feeling overwhelmed and frustrated. Preparing your business sales involves two things in particular: 1) growing your company the right way that maximizes your sales and your profits, and 2) positioning your company in the best light to buyers, much like a house is staged by a Realtor before it is taken to market. Sellers who partner with a savvy Exit Planning Advisor can find a guide who helps them maximize the value of their business at exit, and provides them with clarity and a vision of what life will be like after the sale.
Exit Planning Advisors provide a myriad of services, depending on what you’re looking for in a partner.
Wealth Planners help with succession planning,key man insurance, estate planning, tax strategy and more. Typically, each of these services are provided by different strategic advisors, and there are different levels of experience and service, depending on who you go with.
Growth Advisory practitioners who are skilled at helping you grow your business, improve operations and prepare your business for the ultimate sale. Their focus is maximizing the value of the business to attract multiple buyers who present offers that leave the Seller little doubt that they’ve left money on the table post-sale.
Exit Planning Advisors typically work with the owner before the sale of the business and usually throughout the sales process, helping the owner sustain their business value and achieve their goals and objectives. The last thing a Seller wants to see during the sales process is buyers discounting their offers because the business’s performance dips due to “Seller fatigue” or a momentary veering off course due to distractions.
Role of the Business Broker
In many cases, a business broker works with you during the entire sale process. A broker will use a number of metrics to determine a reasonable price for your business, including the business valuation, if one is created by a CVA. The broker will analyze recent sales of companies in your industry and use that information in the pricing decision.
One important role of a business broker is to find buyers, to educate them about your business, and to negotiate a final sale price.
Finding an experienced business broker can make the sale process easier, and help you receive a higher price for your firm.
Finding a Buyer
It can take six months or longer to prepare for a company sale, find a buyer, negotiate a sale price, and complete a business sale. To speed up the process, you need a business broker who can find prospects and understand what motivates the potential buyers.
Who are your best prospects?
Some C-suite executives who are leaving the corporate world may have an interest in buying a business. Another market for potential buyers is industry peers, competitors, customers or suppliers. These people may know your business and the industry well, and may see your business as an attractive investment.
Private equity firms also may be good prospects because these firms create large funds with private investor dollars and use the funds to purchase businesses.
If you do come across a potential buyer, make every effort to determine if they have pre-qualified financing for the purchase. As an example, the C-suite executive may have accumulated wealth from deferred compensation and stock options, or may be pre-approved for an SBA loan.
Pre-qualified financing means that the buyer has the resources to close on a business purchase.
If a potential buyer’s interest is strong enough, you may decide to start a due diligence process with the purchaser. Due diligence allows a purchaser to review an extensive set of documents so the buyer can be fully informed and consider a formal offer for the business.
The seller will provide general information, such as the financial statements, and the company organization chart. You’ll also provide contracts with vendors, suppliers and any lease agreements. If your firm has written agreements with any customers or employees, those are also provided.
The purchaser will also want detail on how you market your product and your recent marketing results. You’ll provide market research and statistics on website visits and social media strategies.
While the potential buyer is required to keep all the due diligence information confidential, the documents allow the purchaser to fully understand your business and to make an informed sale price offer.
Worth the Effort
The thought of preparing for a business sale may be overwhelming, given the hours that you put in simply to operate your business. Getting ready for a sale requires a big investment of time and effort, but the payoff is finding a buyer who will pay a reasonable price. Use these tips to prepare for a sale and get a price that you deserve.
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