Preparing your business for sale is phase 2 of the process that Ziggy Frankenfeld outlines in this 3-parts series “How to Sell Your Business – Frank Advice From A Broker”. This phase includes 4 steps focused on managing some real risks.
To read Part 1 of the series, click here “Thinking About Selling”
STEP 4: ELIMINATE THE KEY PERSON (ESPECIALLY YOURSELF)
A key person is anyone the business relies upon to operate smoothly; It may be a manager or even a subcontractor. Most often it’s the owner – you! The risk is obvious: what happens to the business if that key person leaves? Such risk reduces the attractiveness of the business to a buyer, and therefore the price any buyer is willing to pay.
Preparing your business for sale starts with implementing one of two possible solutions: the preferable one, which is to address the issue and reduce the dependence; and the one which is often the only option: That is to have a contract that ties the key person to the business, at least for a period. Typically during that period the new owner will be attempting to fix what you couldn’t or didn’t).
How much of the business is you? One massive clue is the name – if it’s Pete Smith Electronics, what happens when Pete Smith sells to Paul Jones?
STEP FIVE: PUT ALL THE REVENUE THROUGH YOUR BOOKS
In the past, some owners have considered it smart not to put all the revenue through the books, in order to avoid paying tax or to have some extra spending money on the side. Notwithstanding the very serious negative consequences of an ATO audit, failing to reflect the full value of income and profits in the accounts will, of course, have a negative effect on the sales price.
And think about it for a moment. Imagine a business owner finds himself or herself saying something like, “And there’s massive hidden potential here” (nudge nudge, wink wink). What do you imagine that person’s credibility will be? It’s what the potential buyer can actually see that will be reflected in the offer. To avoid this, make sure your accounts are right, and that they balance back to your BAS returns. That way, your business is “due diligence”-ready; and it has a set of credible, reliable financials and related back-up schedules ready for a robust review by the buyer and advisors.
STEP SIX: GET SERIOUS ABOUT THE PRICE
A business is worth what the market is willing to pay for it. Value is determined through supply and demand; if supply is abundant, value will be low; and if demand is high, value will be high.
A buyer will typically look at return on investment (‘ROI’), and this can range from as low as 100% (one year’s earnings) to a high of, say, 20% (five years’ earnings) for a larger, more sustainable, medium-sized enterprise that is growing significantly year on year.
The key variable is risk: the lower the risk, the higher the return. A childcare centre, for example, is considered low risk. That is because it’s thought to be relatively safe, with government support, a growing customer base and trading hours of five days a week. Such a business is likely to command an ROI of 20% (five times earnings), whereas a coffee shop earning $100,000 for the proprietor is likely to sell for just that amount, 100% ROI.
And it’s a harsh reality that a business in a rural area is likely to be worth less than the equivalent in a capital city, just because it’s unlikely to grow as fast.
The most complex assessment is the value of goodwill in the business. Goodwill is the difference between the sale price and the Net Asset Value (NAV). Goodwill comes in many forms, including commercial, location and personal goodwill – this last being the least valuable, because it dissipates the moment the seller leaves.
As always, you must get professional help in valuing your business. Be wary of assumptions or informal advice offered by friends or family, or even someone you know who’s sold a business – every business is different, and the differences can materially affect the valuation.
STEP SEVEN: SECURE YOUR TENURE
In effect, you’re selling three things:
- Future maintainable earnings;
- Tangible assets, such as plant and equipment, stock, debtors, fixtures and so on, and
- Intangible assets, specifically goodwill and intellectual property.
The reliability of those earnings needs to be demonstrated. And one way to do that is to ensure there is a secure lease agreement with enough time left on the lease to help ensure the revenue stream; this is particularly true of a retail business. The best result, of course, is to maximise your tenure before or at the point of selling your business.
There are many benefits for independent businesses in owning the land and buildings from which they operate. Not least is the potential benefit when it comes time to sell, and the consequent impact on future maintainable earnings. This is a discussion you should have with your tax advisor or accountant.
For the final steps, read the final post of the series PART 3 “The Final Steps In Preparing Your Business For Sale”
Thinking About Preparing Your Business For Sale?
It is worth getting an independent perspective from a reliable business advisor and broker. Call Ziggy Frankenfeld or CONTACT ZIGGY HERE