Before putting your business on the market, you need to get ready for the due diligence phase.
It's an appealing fantasy: You launch a business, work hard to make it successful, and then sell it and retire to a tropical paradise.
However, selling your business is not that simple. In reality, the voyage to that lush, distant island can be long and perilous. You might have to navigate everything from key employees jumping ship, to waves of unexpected demands from the prospective buyer, to strong headwinds from lawyers vetting your company for things like product-liability issues. And when you finally reach your island paradise, you might find you can't afford to live there because you made a lot less money from the sale than you thought you would.
How do you avoid that nightmare scenario? It starts with setting realistic expectations — and being fully prepared to sell your business long before the letter of intent comes in.
The Pool of Businesses Changing Hands Isn't Very Deep
The first mistake many business owners make is assuming there's a large pool of potential buyers out there, and it's a simple matter of finding the one that offers the most money. But the number of businesses that actually change hands each year is fairly small.
If we eliminate the "single shingles" — sole proprietorships and so on — from the equation, about 5 million companies operating in the United States in a given year have one or more owner and five or more employees. Of those, only about 150,000 bring in $10 million or more in annual revenue. And of those, only about one in 10,000 on average gets sold each year.
In other words, buying (or selling) a business is a relatively rare event. And in most cases, the seller is more eager to sell than the buyer is eager to buy. That means you'll be largely at the buyer's mercy and have to jump through a lot of hoops to complete the deal.
What's Your Business Worth?
That's a surprisingly difficult question to answer, and it can have an enormous impact on your decision. The range of valuations for your company can vary by up to 1,000%, depending on the methodology. And what seemed like smart business decisions during year-to-year operations can come back to bite you when you decide to sell.
Let's say you consistently drive down your EBITDA — or earnings before interest, taxes, depreciation and amortization — in order to decrease your tax burden. So if you subtract, say, $500,000 in expenses from your $2 million EBITDA, you'd pay taxes on just $1.5 million. You could end up saving a couple hundred thousand dollars a year in taxes by doing that.
But guess what? When it comes time to value your company for sale, using the standard multiple of EBITDA of 6x, your valuation would be just $9 million (6 x $1.5 million) instead of $12 million (6 x $2 million).
That's one of many reasons why you need to start planning to sell your business well in advance. You want the numbers on the books for your most recent operating years to produce the greatest potential valuation.
Passing the Stress Test
Need more reasons to start planning your sale well in advance? Selling your business is a long, exhausting process, and you need to be mentally prepared to endure the strain. When you exchange a letter of intent, it can feel like you're approaching the finish line. At that point, it's natural to start mentally checking out.
That's a mistake. It can take six to nine months from the time you exchange that letter of intent until you close the deal (if you close the deal). Many business owners are shocked by the depth and breadth of the due diligence process during that interval. The prospective buyer wants to minimize their risk, and they'll thoroughly vet your company for anything from possible environmental issues to ambiguity over intellectual property rights. Any friction they encounter has the potential to drive down the sale price.
Meanwhile, your expenses continue to rise in the form of lawyers' fees, consultant costs and possibly even employee overtime as your staff works to meet the buyer's demands.
Chart a Safe Course
The bottom line? If your ultimate goal is to sell your business at some point, then you should start preparing today. That means establishing financial controls and company-wide best practices that will stand up to the scrutiny of the due diligence phase of your eventual sale. It also means building a network of professional services contacts, including lawyers, bankers and CPAs.
Do whatever you can today to ensure the voyage to your retirement paradise will be smooth sailing — and that it ends with a nice lawn chair on a real beach and a drink with an umbrella in it.
As a Partner at B2B CFO, Sal Burd focuses on increasing the value of privately held companies before they're sold. This blog post was adapted from his presentation, "What to Expect and How to Prepare for Selling Your Business," at the virtual Business Bootcamp conducted by Dawn Hershik, Managing Director of Supporting Strategies | Chicago Far West Suburbs.