Preparing your business for an exit
April 07, 2022
Written by Spencer Lamb, CPA, CVA, Manager for Business Valuation Consultants, LLC
You've built it from the ground up and spent years perfecting your trade, but now you're thinking about exiting your business. It's a significant undertaking that requires foresight, thoughtful planning, and an honest look at you and your business. If done correctly, it is one of the most exciting times for a business owner that results in the funds and freedom to begin a new adventure in life.
But there are certain details involved with exiting your business that have to be considered; often, well in advance of the event happening. Studies indicate that more than 70 percent of the 70 million small businesses owned by Baby Boomers are expected to change hands over the next 10 to 15 years. When it comes to exiting your business, what preparations have you made?
Are you ready to leave?
"Are you ready to leave?" is the first question to ask when thinking about exiting your company, and it's both financial and personal.
Financially, a significant amount of your income and wealth is likely tied to your business. Will the sale of your company provide the funds necessary for your next adventure or retirement? Has your business reached maturity, or is it still growing and may be worth more in the future? Before selling an income-generating asset, it's important to project what you may receive for the business versus what you will personally need in the future.
From a personal standpoint, decoupling yourself from your business can be a significant change in your life. Owners immersed in their business may have trouble letting go of the control and responsibility. They may not know what to do with the extra time. And a significant part of their identity may be tied to their position in the business.
Plan in advance
It is ideal for business owners who are ready to sell to start planning 3-5 years in advance. It may sound like a long time, but it will fly for a business preparing to sell. That timetable will enable you to take measures to increase your company's value, make the operations less dependent on your efforts, find the best options for exiting your business and plan for taxes.
Not doing any one of these – or not doing them to the fullest extent possible – will result in an even longer timetable, a lower valuation, and increased personal and professional stress for the entirety of the transaction.
Get your financials and documents in order
It's nearly impossible to value a business or identify opportunities for improvement without accurate financials. You should update all accounting statements, including the income statement, cash flow statement, and balance sheet. Additionally, all asset and liability accounts should be analyzed to ensure accuracy and be adjusted if necessary.
All accounting records should comply with Generally Accepted Accounting Principles and adhere to updated guidance. For example, accounting records should reflect updated revenue recognition (ASC 606) and lease accounting guidance (ASC 842). A professional audit or review of financials may be warranted to ensure the accuracy of historical financials.
Sales forecasts and financial projections should also be updated. Projections can be a powerful tool for making well-informed decisions and showing a suitor the business's future potential.
All corporate documents such as the articles of incorporation, the operating agreement, by-laws, shareholder agreements, vendor, customer and employee agreements, and tax returns should be gathered, organized, and centralized. These items should be organized and accessible, even if you're not selling the business.
Getting your financials and documents in order will help you assess the current state of your business and be ready to engage with a suitor. Having everything in order not only speeds the process but will help build a suitor's confidence in buying the business. A buyer needs to know what they are acquiring, and this pertains to more than just the income of the business. The governing documents have a significant impact on the fair market value of a company.
Discuss valuation and strategies with your CPA
Estimating the value of your company is an important first step. It helps to set your initial expectations, enables you to identify opportunities to increase value, and finally, helps you project the net proceeds from the transaction.
Companies in your industry may be valued based on revenue and income metrics such as monthly recurring revenue, historical revenue, historical earnings before interest, taxes, depreciation and amortization (“EBITDA”), seller’s discretionary earnings, and or future projections. Other metrics such as the number of customers, average customer lifetime value, gross margin, customer acquisition costs, and customer attrition may affect valuation.
You can identify which metrics are important and find industry comparables by researching industry reports. Investment firms, M&A firms, trade groups, and business brokers often publish research that includes metrics on completed transactions. This research can also provide valuable information on industry trends, recent news, and active buyers in the market.
While industry reports help provide valuable information, they are not a replacement for discussing the valuation of your unique business with an expert advisor. An advisor can provide guidance and perform expert analysis of your business.
You may benefit from a professional valuation to better understand what your business may be worth to a potential buyer. There are many reasons why a company might be interested in buying your business, and thus, your business may be worth more or less to different buyers. An expert advisor can help identify the strategic and synergistic value a business may provide to different buyers and adjust the valuation accordingly. This can help you focus on potential buyers who might be willing to pay the most for your business.
Our firm can perform other analyses to help you identify potential gaps or problems and maximize value. For example, a Quality of Earnings report can provide a detailed analysis of your company's revenue and expenses. It can help both the buyer and seller understand the forward-looking performance of the business at a very detailed level. While you can use this report to identify and address problems or gaps, you can also use it to help support your valuation and transaction terms.
Maximize your company's value
Business owners should create a plan for increasing value, and that plan may include short-term and long-term tactics, all depending on the time horizon. Trimming unnecessary expenses, cutting unprofitable customers or low-margin products, investing in sales, and investing in management are all ways to drive value.
Businesses that are dependent on an owner are not as valuable as businesses that aren't. A suitor may decrease an offer, hold back sale proceeds or require that an owner remains with the company post-sale for a certain amount of time. Ideally, the owner should take steps to decouple themselves from operations.
There are also qualitative measures that can increase value, such as having sound internal controls and processes in place at the management and financial reporting levels. Management should document all critical business processes and the resources needed for each. Employees should be cross trained so that no process is dependent on just one employee. Management should also look for and address any single points of failure in all operations and infrastructure. These steps will decrease the risk for a buyer, ensure a smooth transition and thus, increase the amount they are willing to pay.
Plan for taxes ahead of time
Tax planning should not be an afterthought of your sale process. It should be one of the first things you consider. In the beginning, an owner has a significant amount of flexibility in the type and terms of the transaction, but the options narrow as the process moves forward.
Tax optimization strategies go beyond just the business because they must consider both the company and the owner(s). Depending on the situation, there may be steps you should take from an estate planning perspective well before starting the sale process.
The type and structure of the transaction may play a significant role in the timing and amount of income an owner realizes.
Contact our office
Each situation is unique, which is why owners should work closely with their advisors. They can help maximize both the business's value and the net proceeds from the transaction. If you are thinking about selling your business, please contact our office to discuss your situation. Our expert advisors can help provide the guidance needed to maximize the value of your business, minimize your tax consequences and maximize your wealth.
Call us at (800) 241-0151 or fill out the form below and we'll contact you to discuss your specific situation.
Heard, McElroy & Vestal is a team of professionals working to assure the best possible service for you. When you choose to establish a relationship with our firm, you have a wealth of knowledge and resources available to you. Our professional services include Accounting Services, Audit & Assurance, Retirement Plan Services, Tax, and Transition & Exit Planning.
For more information on how Heard, McElroy & Vestal can assist you, please call (800) 241-0151.
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