Marketing Plan Pt 2

NL6

Step 5: Preparing the Business for Sale Part 1. (Part 2 is Preparing the Sale Documentation)

Sounds like work doesn't it, preparing the business for sale? When you think about it, you have been preparing your business for sale ever since you opened its doors.

Now that you have decided to sell (Step 2), determined the realistic price (Step 4), and selected your intermediary (Step 3), you need to organize the business to present to prospective buyers.

Preparing a business to increase its sale value can be one of the most profitable exercises a business owner can undertake. Here are some actions you can take to enhance the value of your business.

Physical Plant

Pick-up, fix-up, paint-up. My experience is that good housekeeping is a profitable policy even if the business is not for sale. Sloppy work habits and sloppy maintenance of assets creates costly inefficiencies. Good housekeeping gives crispness and appeal to the business. It helps to condition the buyer to fall in love with the business. A buyer in love will work hard to complete the transaction.

Many businesses have storage areas (bone yards) of equipment, patterns, raw materials, overruns and just plain junk. Sort it out, keep the usable items and list them if they are not on the books. Get rid of the rest as a part of your fix-up, paint-up and housekeeping program.

Administration

Tidy up your operating and management procedures. Make sure your employee manual is up to date. Formal documentation of all procedures will give the buyer assurance that you and your employees have a system that works.

Review your contracts. Document any informal or verbal contracts. Review your real estate and equipment leases to be sure that they can be assigned or transferred.

Review your compliance with regulatory agencies such as OSHA, ADA and EPA plus any others peculiar to your industry. Any non-compliance will detract more from the value of your business than the cost of abatement.

Clean up any disputes with the IRS. Try to end any on-going legal actions. A buyer will not accept your legal and tax liabilities.

Management Personnel

A buyer does not want to buy a one man band, particularly when the one man is leaving. In a company dominated by one person, the closer to the retirement of

that person, the less the company is worth. Many such companies end up being liquidated at auction with the value of the goodwill and intangibles lost.

You should pay particular attention to staffing the key management slots. Sales, operations and financial functions should be clearly delineated and appropriate managers appointed or planned for. It is important to convince the buyer that the business can run profitably without your personal attention. Don't elaborate on your personal achievements in the company. It is much better to elaborate on the personal achievements of the staff. After all, they are staying with the business. On a recent buyer search, I had two prime buyers reject the deal because there was no replacement trained for the top spot. (The seller planned to leave after a short transition period.) The lack of a trained replacement meant there were two less bidders for an otherwise outstanding company.

t's almost trite to say, "Have good management." Just good management is not enough. The company in the selling situation above was one of the

best-managed medium-sized companies I have run across--it just didn't have a replacement trained for the top spot.

You must have strong replacements in place to move up when you or any of your key managers are no longer available. This doesn't mean redundant personnel; it means people in the next tier down trained to do jobs both laterally and vertically, even your job--especially your job.

Financial Records

Privately held businesses organize their books to show minimum earnings, thereby minimizing taxes. There is nothing illegal about minimizing taxes within the law. As Judge Learned Hand wrote in a landmark decision, "Nobody owes any public duty to pay more tax than the law demands."

The buyer needs to see the true earnings of the business. You don't need to show higher earnings (and pay more taxes). You need to keep adequate records to allow the buyer to go back over the books and determine the true historical cash flow (recasting).

Keep in mind that the buyer projects cash flow to determine return on investment (ROI). If there are assets in the business that the buyer can use as security for loans, then the buyer's cash investment will be lower, and the ROI on the project will be higher. The buyer recasting process will include both balance sheet items to project the borrowing capability of the business and profit and loss statement items to project the cash flow. Typically, buyers want to see a minimum of five

year's records.

Following are nine record related actions that you can take that will make your business more valuable to a buyer:

1. Maintain Detailed Records of Recastable Expense Items.

Expenses can't be recast if the buyer doesn't know they exist. For example, five trade show trips (read vacations) buried in selling or manufacturing expense may not be discernible to the buyer as an owner perk. You should fully document all potential recastable items with full explanations and segregate them for ease of identification. The buyer might agree that only one trade show was necessary and that the expenditures for the other four were discretionary, and the cost of them could have gone to the bottom line as profit.

Some common expenses that may be recast are: personal use of the company car; life, disability and buy/sell insurance; unnecessary boats, condos, airplanes; country and health club memberships; personal expenses on the company credit card; excess (or sub-market) salaries to the owner and owner's family; owner's portion of pension or profit sharing plans; royalties; non-recurring expenses or revenues; and any other item that was not necessary to run

the business.

2. Account for All Inventory at Cost or Market, Whichever is Lower.

Pay particular attention to inventories. Overstated inventories can be deal breakers. Make sure you include all inventory: raw materials, work in process, finished goods and supplies. Understated inventories can cost you money. The true value of the inventory becomes apparent at the close of sale as a result of a closing physical inventory. Even when this true value is known, buyers find it hard to recast because understatements may involve several fiscal years. In such cases sellers may not know exactly which years the inventory understatements occurred and by what amount in each year.

In a stock sale, understated inventory causes the buyer to become wary. A tax audit may show the inventory discrepancy and the corporation (now owned by the buyer) may have a tax liability as a result. The buyer will reduce the purchase price to pay for potential IRS fines. On the other hand, if the inventory is overstated because of theft, damage, obsolescence or other reasons, the operator of the business needs to know so corrective actions can be taken. Your best management procedure is to set up routine physical inventory cycles or to establish a perpetual physical inventory system. This will assure control and allow any discrepancies to be promptly corrected on the books.

Talk to your accountant about any adjustment that may be required. Let the potential buyer know about the adjustment and how you plan to handle it.

3. Report Rents at the Market Value.

When the owner of the business is also the owner of the real estate, frequently the rents charged the business are above market rate. The business should not be penalized because the owner chooses to distribute some income of the business to rent.

On the other hand, the income a business enjoys as a result of an under market lease reflects the value of the lease--not the business. A buyer will recast the lease expense to show the cost at the market rate.

4. Appraise the Assets.

If fixed assets are a substantial part of your balance sheet, you should appraise them. Most of the time it is not necessary to have a formal appraisal. In my experience, owners know the value of their fixed assets within 10%. You may find that you have under utilized assets that are not required for the business. You could sell these separately and not affect the sale price of the business.

When the buyer plans to use the fixed assets as security for a loan, the lender will require a formal appraisal.

5. Clean up the Balance Sheet.

Many privately held business owners could make more money if they sold the assets and liquidated the business.

I know of a chain of lumber yards that owns real estate, free and clear, worth $6 million. The business returns $300,000 pretax per year. If the owner sold the real estate and gave the business away, he could invest in tax-free municipals and have an income free of tax equal to what the business is returning.

I did an evaluation of a business a couple of years ago that had $600,000 in cash and $400,000 in other assets. The cash was earning 8% and the other assets were earning 20%. The ROI was higher without the excess cash!

Most of the time you will be better off by removing non-productive items from the balance sheet before offering the business for sale. On the other hand, make sure that you don't sell the business for less than the market value of its separate assets.

6. Set Realistic Depreciation Schedules.

Use the most advantageous depreciation for tax purposes and the estimated actual depreciation for management purposes. Design book depreciation schedules to reflect actual depreciation as near as you can estimate.

Depreciation is a real expense. Artificial tax

depreciation allowances skew the management decision making process. For example, if you have a crane that you know will last 15 years, depreciate it over 15 years for management purposes. Depreciate it over a shorter time as allowed by the IRS (maybe even accelerated depreciation) for tax purposes.

7. Capitalize Properly.

Some businesses charge improvements and major repairs to expense. This practice reduces book profits and taxes in the year of the occurrence. It also keeps an asset off the books that should have been there with the result that book value is understated.

Also, the cost of a major capital repair may be booked in several expense accounts, making it difficult to recast.

Some businesses expense indirect supplies and direct raw materials on receipt. If inventories of these are significant, set up your books to expense them as used, not as received, to reflect their true cost to your process.

Make sure you define all assets not on the books. The buyer will not give value to such things as: trademarks, samples, demo units, patents, software, trade secrets, secret formulas and recipes, unless you identify them.

8. End Skim and Other Illegal Practices.

Record all cash sales in the books. Record as sales all products purchased from the business for the owner's private use.

If incidental vending machine revenue is a part of the on-going revenue, record it. If scrap sales revenue is a part of the on-going business revenue, record it. A buyer will not consider skim when evaluating a business. If the buyer offers four times annual recast cash flow for the business, each annual dollar skimmed will reduce the offer by four dollars. Skimming is bad economics.

If there is some unrecorded cash that you took out of the business in the deep dark past, don't tell the buyer about it; don't tell me about it; don't tell your intermediary about it. Let it be your secret mistake. If the buyer sees tax cheating, it jeopardizes the integrity perception of the seller and the records of the business.

9. Consider Having an Annual Audit.

Audited statements have benefits to a company even if no sale is imminent. The auditors, as part of an experienced third party financial group, will look at the business and make suggestions for improvements in financing and controls.

Most owners of private businesses throw up their hands at the thought of an audit. Audits are costly. However, audited statements significantly reduce the closing costs and the due diligence period for the buyer. As a result, the buyer can afford to pay more for the business. One experienced buying group told me that they would pay 5% more for a company that had audited statements.

Changes in the tax laws in the past few years have made stock sales more attractive to sellers. You may find your buyer insisting upon audited statements if the transaction is a stock sale. In my judgment, improved financial controls and the enhanced value of the business justifies the cost of audits.

Business Planning

For the sale of your business, you need to prepare or update your business plan. The buyer's perception of the future cash flow stream is the single most important factor in the value of your business. How does the buyer determine the future cash flow? By preparing a business plan. If there is nothing better to go on, the buyer will extrapolate historical cash flows into the future.

Every buyer will prepare a business plan and project cash flow--always! Yet, in most transactions, the buyer has the least amount of information. The seller has been running the business; the seller knows the markets; the seller has a pretty good idea what sales and costs are likely to be in the future. The seller should prepare the business plan!

The buyer will still prepare a business plan and project the cash flow. But, the basis of the buyer's projections can be your plan--not just assumptions pulled out of thin air.

Ideally, the seller should have prepared a business plan from the beginning of the business and updated it on a regular basis. A business plan with a record of met projections is a powerful sales tool. The buyer perceives such a plan as realistic. It lowers the risk factor thus lowering the ROI requirement and increasing the value in the buyer's mind.

The business plan should show what the business has done and what it will do in the future. It should have enough detail to convince the buyer that it is real, practical and doable. The plan should include a narrative description of the business, its markets, competition, management, personnel, strategic goals and mission statement. It should include plans to achieve the specific goals and tell how those goals relate to revenues and profits. It should include past three and future three years pro forma financial data showing sources and applications of funding, capital equipment requirements, break-even analysis, income projections and cash flows.

A business plan will document the future and improve the value of your business to a prospective buyer.

Conclusion

It is work, preparing a business for sale. But, the work of organizing the business to present to a prospective buyer will uncover hidden gold.

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Tip of the Month

Inadequate records will result in an inadequate selling price.

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Next Month

Next month we talk about Step 5, Part 2 in the Exit Strategy Process, Preparing the Marketing Documents.

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Disclaimer

This publication is intended to help the reader understand the issues involved in selling a business. It is designed to provide information reflecting the experience of the editors and writers in helping sellers of businesses. It is prepared and presented with the understanding that the publishers, editors and writers are not engaged in rendering legal, accounting or other professional service. If legal accounting or other expert advice is sought, it should be acquired from competent professionals. The reader would be well advised to seek such professional assistance in the early stages of any consideration of the sale or purchase of a business.

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