Preparing Your Business for Sale
In this newsletter, we outline some key elements that should be considered to effectively prepare oneself a few months or even years prior to a sale process in order to maximize value.
Selling a business is usually one of the most impactful decisions in an entrepreneur’s career. We are often asked how one should prepare a business for sale.
Early decisions – Two to Five years prior to launching a process
No matter whether they are strategic or financial players, one of the first things prospective buyers will examine is how you’ve mitigated business risks.
Sellers who plan a few years ahead and address the larger potential issues will have a distinct advantage over those who opted for the status quo. The most common issues include:
Key-man risk: Make sure you are dispensable and not perceived as a “one-man band”. Too many times, we come across owners who single-handedly control all aspects of their business. This can include controlling key customer and/or supplier relationships, acting as the de facto CFO, being the only person with possession of recipes and production methods, etc. Ask yourself, can my company run without me for several months? If it cannot, potential buyers will realize that too much of the value is attributable to an individual who won’t be there for the long term after the sale. Strategic roles held by close family members or partners who will leave the company after the sale will have the same negative impact.
Having proper management to ensure that the business can survive the owner is fundamental to getting the most value down the road.
Improve your financial reporting: While you may not require audited financial statements for your current reporting needs, having quality financial information and reporting is fundamental when the time comes to selling your business. Since an acquirer will require several years of historical financials and consistent accounting practices over time, the best time to start a cleanup would be at least 2 years prior to selling. A reliable, disciplined and detailed accounting system is worth as much, if not more, than a review engagement or audited report. Such a system should adhere to strong and consistent accounting policies and practices such as treatment of doubtful receivables, inventory valuations, revenue recognition, accurate accruals and liability recognition, etc.
A well-managed system will save you a lot of grief down the road. We also highly recommend beefing-up internal controls and procedures as well as having well-defined KPIs.
Clean up your tax reporting and government regulations: As a small business you may be willing to take more risk in declaring revenues, passing expenses, filing properly and/or on a timely basis, adhering to sales tax, employment, or other government regulations. You wouldn’t want a prospective buyer’s due diligence review to reveal a potential exposure to additional taxes, penalties and interest, the sum of which might represent a substantial portion of the purchase price. While you may be comfortable taking risks, be aware that most prospective buyers are not, and they will uncover these risks during their due diligence, or worse, later. The result can be a material reduction in the value of your business, failure to sell, or future litigation.
Cleaning up your exposure to government rules can take several years; therefore, unless you plan to never sell your company, or only sell its assets (keeping the exposure to yourself), we strongly recommend starting five years ahead of planning for a sale.
HR issues: Build an effective management team by surrounding yourself with the best resources to ensure your company provides a safe, equitable workplace. Companies with low employee turnover are typically more attractive. This is especially the case post-COVID where recruiting and keeping good employees has become even more critical.
Environmental issues (for industrial operations): Whether you own or rent your facility, you should be aware of any issues. If no environmental audit was ever done, or if it is more than five years old, you should at minimum get a Phase I audit done on the property. Hopefully, no material issues will arise, however, if they do, then a Phase II and any required remediation will take time. Waiting until you have an interested buyer to clear this up may cause serious delays, kill the deal or result in a material price reduction.
At the very least, we recommend you apprise yourself of your situation ahead of any transaction.
Mitigate business specific risks that are under your control: These risks can take several forms; here are but a few examples:
- Client or supplier concentration; while gaining new clients can take time, preparing a few years in advance to lower client concentration can prove very rewarding financially as concentration will affect business valuation at exit. One way to address these risks would be to enter into long-term agreements.
- Locking leases for a long duration at a pre-negotiated price can prove useful, especially in an inflationary environment.
- Ensuring your long-term debt can be repaid with a limited prepayment penalty could also provide more money in your pockets.
Business Plan: Have a clear path to growth by identifying business development opportunities and acquisition targets.
Fiscal Planning: Having your tax expert review your fiscal planning in advance can prove very useful as well. For certain transactions, including claiming CPCC capital gain exemption or Family Trusts participation, a 2-year vesting period is necessary to ensure all the fiscal attributes can be obtained so a business owner has to plan accordingly. Redundant assets should be removed from the business earlier.
The Year Before
In the year prior to launching your process, you should assemble the team that will help you execute the transaction smoothly. We outlined this process in our newsletter Key steps to selling your business.
Here are the concrete roles that each team member will perform to prepare your company for sale:
Investment Banker: while we wrote about this in greater detail in our newsletter the process of selling your business, the investment banker’s role prior to launching is to provide you with a realistic value of the business, prepare the Confidential Information Memorandum, and lay out an effective strategy to market the company.
Lawyer: Prior to launching a sale process, it is important to have your lawyer review (and correct) important information such as:
- Minute books: identify and correct irregularities in the minute books;
- Material agreements: They can also review material agreements to monitor if some clauses, like change of control clauses in certain contracts, might affect the sale process and subsequent negotiations. Getting signed copy of agreements is also recommended;
- Litigation: if applicable, understand current ongoing litigation and how they might affect the sale process and subsequent negotiations;
Tax expert: It is the Seller’s responsibility to provide a tax memorandum outlining how the purchase price is to be allocated and paid amongst the sellers. Start early with your tax advisor to ensure proper coordination with the purchaser’s counsel on contemplated pre closing corporate reorganization and to respect often fairly tight delays down the road in the final negotiations to closing;
Accountant: We wrote in a previous newsletter about the benefits of a Vendor Due Diligence, which can provide a number of advantages in a sale process. Basically, this will allow you to discover any value-reducing issues before the purchaser does.
At the end of the day, even if you have addressed all of the points mentioned above, one cannot lose sight of what makes a company valuable; growth in revenues, growth in profits, healthy EBITDA margins, positive cashflow generation, market share growth, and market positioning, to name just a few.
If you’re interested in planning early for a successful exit, we’d be happy to review and provide guidance on key decisions you should take to maximize your exit down the road. Contact one of our team members today.
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