Given the unusual economic environment, now isn’t the best time to sell a company. But it’s the perfect time to plan to sell one.
Your bottom line for the last couple of years probably isn’t anything to brag about. And that isn’t just a problem for your checkbook. The selling price for a small business is typically based on an average of three years performance. So if 2010 is when the turnaround starts, if you can ride the wave of the recovery for the next three years, now is the time to start planning to sell in 2013. There’s lots you can do between now and then to maximize how much you take to the bank when you finally sell your company.
Step One: Research
There are lots of complicated ways to figure out what your company should be worth — discounted cash flow and capital asset pricing to name two. But the simple fact is that most small businesses sell for a multiple of some indicator of what they’re going to make in the future.
Three to five times earnings (net income) before interest and taxes, is one typical indicator, for example. Other common multipliers are based on owner’s discretionary income, gross revenue, assets, or even book value if there is one.
In other words, if your earnings average, say, $200,000 for the next three years, your business will likely go for somewhere between $600,000 to $1,000,000. But that’s a broad range, so find out what's typical in your industry. Ask the owners of recently sold businesses, check with industry associations, your accountant and lawyer, and talk with several experienced business sales advisors.
Incidentally, companies that see a strategic match may be willing to pay more for your company than a typical multiple. A strategic purchase is one where the other company sees that you offer customers, reputation, in-demand talents, location, intellectual property, diversification, market penetration, financial savings, better processes, a distribution network, or other vertical/horizontal avenues for growth. The most likely strategic buyers are your customers, vendors and even competitors.
Step Two: Do the Math
Once you have a general idea of what your business is worth, put a spreadsheet together to figure what you may walk away with after taxes. Federal, state, and local taxes can total between 15 to 46 percent of the sale. How big a bite they take will depend on the percentage allocated to capital gains (and taxed at a lower rate), your state tax rate, whether you cash out all at once or in installments, and other factors.
Then run a sensitivity analysis based on different sale prices, sales formats, and installment vs. cash sale. Be sure to factor in the effect of depreciation recapture, loans you’ll have to repay, set asides the buyer may require, etc.
Now you have the information you need to plan how you operate and keep your books for the next three years.
Step Three: Plan Your Work and Work Your Plan
Running the business specifically to sell it may require that you do things differently than you have in the past.
If you're hiding cash income — stop. Even if you can convince your buyer that your income is 50 percent higher than it appears, your buyer's banker won't be impressed and you could wind up with a visit from the IRS. If you mix business and personal bank accounts, credit cards, cash — stop. You don’t want the due-diligence package to include details of where you buy your Valentine’s Day gifts or for whom.
Plan from the Courtroom Backwards
Given that one out every 250 people in the U.S. is a lawyer (two if you live in New York), you need to be extremely careful not to misrepresent, exaggerate, understate, or fail to disclose anything that could lead to a courtroom if the business doesn’t perform as well as the new owners hope. Even if they’re incompetent, maybe especially if they’re incompetent, they’ll blame it on you and try to find a way to prove you misrepresented what the business could do.
Your best protection is honesty. Your second best protection is documentation. A seller memorandum must disclose the good, the bad, and the ugly about your business — every last bit of it. An exhaustive list of exhibits should back up what you’ve said too. In fact, you’ll probably work harder to put together everything you need for the sale than you ever have in the business. If you keep track now; it will be a lot easier than going back to compile the details later.
Document Non-Recurring Events
Most buyers will accept reasonable add-backs such as discretionary owner spending (a luxury car, expensive camera), one-time expenses (a trade show that was a flop), and unusual revenue or expense hiccup (a road closing that drove business your way, or a TV ad that didn’t). But keep good records to back up your claims. It’ll be difficult to identify and document every potential add-back, but keep in mind that at a 5x multiple on every $200 dinner you write off could be worth an extra $1,000 in the selling price.
A one-person operation is harder to sell and worth less than a business that can operate on its own. Put the systems and procedures in place to allow the business to function without you. If you or your personality define the business, it will be hard to sell. Take steps now to make the brand about something other than you.
Hire Competent Advisors
Your accountant and lawyer will play a key role in the sale of your business. If they're not experienced in business transfers, find ones who are. Their advice now can save you big money when you sell.
Find a good intermediary. Business brokers dominate the $1 million and under market, while mergers and acquisitions (M&A) specialists lean toward bigger transactions. But watch out, the bottom of the market is populated with bottom feeders; they’ll try to charge you a small fortune to put together a sale package. Legitimate brokers and M&A companies, by comparison, earn their income as a percentage of the sale rather than from upfront fees.
Run the Business
Don't become so focused on selling the business that you neglect to run it, become disenfranchised from it, or alienate your staff, suppliers, or customers. The sale's not over until it's over — and maybe not even then. Run the business with your full attention until all the contingencies are met and the money is in the bank.
Grow Your Net
Do everything you can to increase your earnings, but make sure whatever you do is sustainable. If you artificially grow your bottom line it's bound to trigger a court visit if things don't go well for the new owner.
Step Four: Take a Cruise
You’ll probably be disappointed with what’s left after fees and taxes, but now’s the time for high-fives, a bottle of champagne, and maybe even a cruise. Don’t forget to give yourself a good pat on the back for making money the old fashioned way — you earned it.
Tom Harnish is a serial entrepreneur. Always on the bleeding edge of technology, he learned what works (and what doesn't) when raising money by spending countless (and often fruitless) hours in front of lenders and investors.