Questions for Business Owners

Are you diversified? A major problem with small companies is that their business is often focused on one or two major customers or clients, or their inventory comes from only one supplier. A rule of thumb is that no more than 10 percent of one’s business should be derived from one customer or client. Expanding …

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Two Pricing Challenges

1. What all should be added back? When normalizing a financial statement, it is easy to get carried away. After all, the more items that are added back, the more profitable the business appears. It is quite easy to add back the cost of a new roof for the factory or a new fancy neon sign …

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“How Much is My Business Worth?”

This is the most often asked question by business owners when a business intermediary asks them if they are interested in selling their business. Often times, it is also a no-win question. If the suggested price is too high, the seller may be satisfied for the moment, but that satisfaction will end when the business fails …

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The Three Ways to Respond in Negotiations

Basically, the various ways of responding during a negotiation fit into three different categories.   1. Take it or leave it. The simplest way to respond in a negotiation is with a “yes” or “no” to the proposal.   For example, whether the buyer makes an offer or a seller makes a counter-offer, the other party has …

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Building Value in Your Business

Below you will find a number of suggestions to consider in order to build value in your business.   The role of the owner One difficulty in selling many small businesses is the role of the owner. Too many times he or she is the “one man band.” A new owner may have difficulty filling that …

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Questions for Business OwnersTwo Pricing Challenges“How Much is My Business Worth?”The Three Ways to Respond in NegotiationsBuilding Value in Your Business

Questions for Business Owners

Are you diversified?
A major problem with small companies is that their business is often focused on one or two major customers or clients, or their inventory comes from only one supplier.
A rule of thumb is that no more than 10 percent of one’s business should be derived from one customer or client. Expanding to new markets, adding new products, or finding new customers without deviating too far from the business’s core activities helps to build value.
Is there an area where you need to change course?
A big advantage of small business is its ability to quickly change direction, to rapidly react to changes in the economy or the marketplace, and to take advantage of new opportunities. Now may be a good time to evaluate any changes that need to be made.
How is your documentation?

Paperwork is not usually high up on the list of things to do for small business owners. Yet, the value of a business could depend on proper paperwork. Are contracts signed and available? Are the books and records up to date? Are all company agreements in writing?
Are your assets protected?
Many small business owners fail to trademark the name of a service, product or anything else specifically unique to their business. Proprietary written material should be copyrighted. If the name of the business is unique or important, it should be registered. Check Walt Disney or Kleenex – both have a small ® behind it showing that the name is registered. Secret recipes, brand names, etc. should be registered, copyrighted, trademarked, etc. – they are all part of building value.
Are you operating “lean and mean”?
Many larger companies outsource their logistical needs, their accounting, the sale of their products – even their manufacturing. Many smaller businesses outsource their accounting, their payroll, and their legal. Outsourcing can allow small businesses to focus on what they do best.

All of the above questions can help a business owner discover ways to increase the value of a business. Small business owners should keep in mind that creating value is critical to the long-term (and short-term) success of the business. And, sooner or later, most business owners decide to sell their business.

Two Pricing Challenges

1. What all should be added back?

When normalizing a financial statement, it is easy to get carried away. After all, the more items that are added back, the more profitable the business appears. It is quite easy to add back the cost of a new roof for the factory or a new fancy neon sign on the basis that these are one-time expenses. However, an operating business always has some expenses like these each year and to add each and every one of them back as “one-time expenses” can be quite misleading.

 

2. What’s the right multiple?

Likewise, the multiple can be very subjective. It is created by weighing and assigning a numeric value to such areas or factors as location, number of years in business, industry trends, sales trends, competition, or even such factors as the length of lease remaining, whether the owner will finance the sale and the reason for sale. In larger businesses, management stability, customer concentration, and geographic distribution are also considered.

 

A business intermediary can provide assistance in selecting which items to add back and what multiple to use in order to create a realistic listing price for your business.

“How Much is My Business Worth?”

This is the most often asked question by business owners when a business intermediary asks them if they are interested in selling their business. Often times, it is also a no-win question. If the suggested price is too high, the seller may be satisfied for the moment, but that satisfaction will end when the business fails to sell for the inflated price. On the other hand, if the suggested price is too low, the intermediary may be promptly escorted to the door.
So, how does the business intermediary come up with a price? The business intermediary will generally review the financials and add back certain items. This is often referred to as “normalizing” the financial statements. This is done by pulling out the proverbial non-cash deductions such as depreciation, interest, amortization and taxes (if shown on the statement) and either adding these amounts to profit or subtracting them from a loss.
The resulting figures are commonly referred to as Earnings before Interest and Taxes (EBIT) and Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA).
For smaller businesses (for example, under $3 million in sales), the figure most often used to determine the sale price for a business is Seller’s Discretionary Earnings (SDE). This is essentially EBITDA plus the seller/owner’s benefits and salary/earnings.
Once the SDE, EBIT, or EBITDA figure has been established, it is usually multiplied by a multiplier. This multiplication then creates a suggested or recommended asking price.
The numeric values used as a multiple of SDE can range from 0 to 4 or even 5 in some cases. Typically, a small business will sell for between 1.8 and 2.5 times SDE although many businesses can fall under or over. Larger businesses can range from 3 to 8 times EBIT or EBITDA, but again can fall much lower or higher depending on the business.
While the process above creates a good starting point, it is important to remember that, ultimately, the price of a business is determined by what someone is willing to pay for it. In other words, price is determined by the marketplace.

Every seller should consider the answer to one question: “What would you pay for your business if you were going to buy it?”

The Three Ways to Respond in Negotiations

Basically, the various ways of responding during a negotiation fit into three different categories.

 

1. Take it or leave it.
The simplest way to respond in a negotiation is with a “yes” or “no” to the proposal.

 

For example, whether the buyer makes an offer or a seller makes a counter-offer, the other party has the option to accept or reject the offer exactly as proposed.

 

2. Split the difference.
Another valid response is to split the difference or find middle ground between two positions.
For example: A buyer and seller may elect to split the difference between what the seller is willing to accept and the buyer is willing or pay. This is an oversimplification, but this method is often used.

 

3. Trade-offs.
The third way to respond is to offer or ask for a trade-off in one area in order to hold one’s ground in another area. The parties have to know what is really important to them. Many of these trade-offs are non-monetary and involve personal issues.
For example, the seller may want his son to be able to stay with the company or may want a guarantee that the buyer will not move the company. In either of these situations, the seller may accept a lower price offered by the buyer as a trade for accepting such a condition.

Building Value in Your Business

Below you will find a number of suggestions to consider in order to build value in your business.

 

The role of the owner
One difficulty in selling many small businesses is the role of the owner. Too many times he or she is the “one man band.” A new owner may have difficulty filling that role. While a business owner may not be considering selling, the time will come, sometimes unexpectedly. It pays for owners to work at making their businesses less dependent on them. One solution is to get one or more employees more actively involved in the role of the owner.
Important customers and suppliers
Too many “one-on-one” relationships with major customers and suppliers may also make a business harder to sell.  An owner will want to work with more than one contact at important customers or suppliers so the personal relationships are not just one-on-one and more easily transferable to a new owner.
Loyal Employees
Happy and loyal employees create a strong business. Keeping employees involved in the business, creating transparency in business decision-making, and providing good employee benefits can go a long way in keeping employees happy and loyal, thus increasing the value of a business.
Growth
Small businesses tend to stay small because the owner wants to keep it that way for many reasons. The owner may want to maintain control, or maximize his or her own benefits. But, in order to build growth and subsequent value, the owner has to build new services, market share and/or new markets.
A business intermediary can help business owners consider other ways to increase the value of their business before the time comes to sell.

Top Four Factors in Closing a Deal

  1. The assurance of a prompt closing – Deals that are allowed to drag are more at risk of falling through. Sellers, buyers, and the related professionals should all be motivated to keep the process moving.  This does not mean glossing over issues and concerns in order to close the sale, but dealing with each step of the process in a timely manner. A professional business intermediary can be a big help in keeping the momentum of a sale moving forward.
  2. How the deal is structured – This includes such things as cash, stock, contingencies, earn-outs, representations and warranties, etc.
  3. Full price and/or other considerations
  4. Legal and/or governmental issues – Obviously, the presence of such issues can be a hindrance to the successful closing of a deal. A business owner will want to address these issues before placing a business on the market.

Exit Planning Mistakes

There are a number of common exit planning mistakes. Below are just a few.
Procrastination
  
The first and worst mistake is failing to develop an exit strategy long before one is needed. Unfortunately, too many owners don’t even think about exit planning until circumstances make it imperative that they sell.
Reactive vs. Proactive
 
Once a business owner decides to sell, he or she must be proactive, not reactive. Selling a business is not like waiting for Publisher’s Clearing House to knock on the door and hand over a big check. That’s why it pays to build the exit strategy long before it is needed.
Failing to Consider All Options
 
It is also important to consider all options. An outright sale is obviously the most common. However, other options may involve a sale to management, an ESOP, a recapitalization, an intra-family sale, etc. Owners should consider what they desire from the sale of the business and which option or options best meet those desires or the needs of the business owner.
 
Unaware of the Company’s Actual Value
As part of the exit planning strategy, knowing what the company is worth is critical. Ideally, this should be evaluated every year.  Only by knowing the value of the business can business owners decide if the value coincides with their “exit” requirements. A professional business intermediary can assist in this process. Keep in mind that market conditions greatly impact value.
Failing to Plan Life After the Business

 

Many business owners place their business up for sale and only then, for the first time, give thought to what they are going to do if it sells. This often results in panic after an offer has been made and the business owner then begins to seriously consider what he or she will do after the sale and how that will be financed. Many owners in this situation actually abort a pending sale or withdraw it from sale. This thought process about what life will look like “post-sale” should be done long before considering selling.
Going Solo

 

Another mistake is failing to take advantage of the outside professionals that are available. Attempting to be a sole practitioner in the selling process is a big mistake. Business owners also need to make sure these outside professionals have transaction experience. Starting with a professional business intermediary is a good start.

Is Now the Right Time to Sell?

Business owners frequently ask, “Is now a good time to sell my business?” This may sound like an election-year answer, but the answer truly is “yes” and “no.”

 

Let’s address the “yes” first. Yes, there are some current market conditions that make now a good time to sell.

 

First, high unemployment creates new buyers. Many of those who are now unemployed may have desired to own their own business in the past, but not been willing to risk leaving the job they had at the time to venture out on their own. Newly unemployed, they no longer have the security and benefits of a job to hold them back and there aren’t a lot of other jobs available to replace the one they have lost. Many of the unemployed are over 45 and so, very few companies will hire them.  Those who could get hired may just plain be tired of getting laid off, downsized, etc. The more buyers there are, the higher the price sellers will receive.

 

Second, there is a shortage of good businesses, so the good ones will be in demand. Even those that aren’t quite as good will find willing buyers.
Third, the Bush tax cuts are set to expire at the end of 2012 unless legislation is passed extending these cuts.  This means that the long-term capital gains tax rate will increase from 15 percent (for any sale completed in 2012) to 20 percent (for any sale completed next year or later). Business owners who think they may want to sell in the next few years should consider how much they will save by selling in 2012 and put their business on the market early enough to complete the sale before the end of the year.

So, what about the “no” answer? The answer is probably “no” for business owners that don’t have a good reason to sell now or who expect to get the price they may have thought their business was worth before the economic downturn. However, for business owners who have a realistic view of what their business is worth in today’s market, who have been toying with the idea of selling recently, who have been thinking about retirement, or who have been dreaming about another venture, now just may be the perfect time to list.

A Due Diligence Checklist

Here is a brief checklist of some of the main items to consider during the due diligence process.
Industry Structure
Compute the percentage of sales by product line. Review pricing policies. Consider discount structure and product warranties. If possible, check these figures against industry guidelines.
Human Resources
Review names, positions and responsibilities of the key management staff. Find out about any incentive and bonus arrangements. Review employee turnover.
Marketing
Get a list of the major customers and arrive at a sales breakdown by region, and country, if exporting. Compare the company’s market share to the competition, if possible.
Operations
Review the current financial statements and compare to the budget. Check the incoming sales, analyze the backlog and investigate the prospects for future sales.
Balance Sheet
Accounts receivables should be checked for aging, who’s paying and who isn’t, bad debt and the reserves. Inventory should be checked for work-in-process, finished goods along with turnover, and non-usable inventory. Find out the policy for returns and/or write-offs.
Environmental Issues
This is a newer but quite complicated process. Ground contamination, ground water, lead paint and asbestos issues are all reasons for deals not closing or, at best, not closing in a timely manner.
Manufacturing
This is where an operational expert can be invaluable. Does the facility work efficiently? How old and serviceable is the machinery and equipment? Is the technology still current? What is it really worth? Other areas, such as the manufacturing time by product, outsourcing in place, key suppliers, etc. should also be checked.
Trademarks, Patents & Copyrights
Find out if these intangible assets are transferable, and whose name they are in. If they are in an individual name, can they be transferred to the buyer? In today’s business world where intangible assets may be the backbone of the company, the deal is generally based on the satisfactory transfer of these assets.

Seize the Moment — Tips for Sellers (Option A)

Those business owners who decide to take advantage of a favorable market should act quickly to launch the selling process. There are vital steps to take–and crucial realizations to face–in preparing for this all-important transaction.

1. Resolve current problems as soon and as thoroughly as possible. If the business is a partnership, both parties should be agreed about the major decisions to be made in the selling process. Hopefully, in cases where the business is a partnership, a buy-sell agreement is firmly in place.

2. Financial records must be accurate, up-to-date, and impressive indicators of the owner’s business ability. Some buyers may be willing to buy potential, but they don’t want to pay for it. In fact, sellers should be open about all aspects of the business that might affect the sale; otherwise, once the real facts are revealed (as they inevitably will be!), the sale may be lost.

3. Sellers must understand from the beginning that they may have to help finance the sale. The seller’s business broker, in qualifying potential buyers, will also assess their financial credibility and their ability to run a successful business, thus helping to take the understandable fear out of seller financing.

4. Sellers should also seek the advice of a business professional in determining price. The business broker will apply industry-tested valuation methods, and will incorporate those intangibles to be ensure that the business will not be underpriced. At the same time, the business broker will point out to sellers how the price is dictated by the marketplace and that realistic pricing is an absolute must. Most buyers, faced with an out-of-sight price won’t wait for it to drop–they’ll just go elsewhere.

5. In marketing the business for sale, sellers benefit many times over from the guidance of a business broker professional. The business broker who lists the particular business for sale represents the seller and works toward completing the transaction in a reasonable amount of time and at a price and terms acceptable to the seller. The broker will also present and assess offers, and, at the appropriate juncture, he or she can also help in structuring the sale transaction itself. The broker and the seller become a team, involved in a relationship of mutual trust, with the common goal being the successful business sale.

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