Thinking about selling your business? Then be ready!
Someone once said that luck is nothing more than preparation meeting opportunity. When it comes to selling your business, It stands to reason, then, that opportunity meeting neglect, disorganization and a lack of preparation will surely deliver the opposite of luck. We’ve recently had the privilege of working with several companies in various stages of the sale process. One was thinking about retiring, another received an unsolicited offer (every entrepreneur’s dream, right?) and the other was transitioning to the next generation of management.
Though different in circumstance, each reinforced several concepts that, while basic, can very easily be forgotten or ignored all together:
- The value of your business is determined by the market, not by YOU. In rare cases the value of your business can be more than what you think, but more often it is less. What a related business sold for is interesting, but each business has its own unique value drivers. When you hear that a competitor sold his business for 2X book value or 5 times earnings, don’t waste time running to the calculator to figure out what that means to you. First, rumors and misinformation are common in sale situations. Second, deal structure can have a huge impact on price. Third, maybe you don’t have the same intangibles that drove up the price of the other business…maybe yours are better, maybe not.
- Timing’s not everything…it’s the only thing: That unsolicited offer may come in tomorrow; you may have a health crisis that forces a quick sale of the business. On the other hand, you may be ready to sell now but the market is not buying, at least not at a price acceptable to you.
- Numbers don’t lie: More often than not your business will be sold in an asset sale, not a stock sale. In an asset sale significant focus will be placed on EBITDA: earnings before interest, taxes, depreciation and amortization, and adjusted EBITDA will reflect items that would be different to a potential buyer than they have been historically. Say you are selling the business but not selling the office building. In that case, one of the adjustments would be to reduce historical EBITDA by the amount of rent you plan to charge the buyer. On the other hand, if you are paying yourself a higher salary than a new buyer would need to pay someone to do your functions; you would show that difference as an increase to historical EBITDA.
The lesson of these realities: You always need to be in a position to consider the sale of your business.But what does that mean specifically? Here are a few thoughts:
- You cannot control value but you can be aware of trends in your industry. EBITDA multiples, types of buyers, what they are looking for, etc. And get this information from sources that are familiar with the broad range of deals in your industry and in business generally. The data received from an industry group or an investment banker with strong ties to your industry is a lot more valid than cocktail party chatter. Stay in the loop but don’t overreact to a single data point.
- You cannot control timing but you can have a plan in place if you are unable to preside over the future of your business. This can be in well-defined legal format, like your estate documents telling your heirs to sell the business. It can also be in the form of a board of directors or advisory board in place to assist your heirs in making decisions about the future of the business. What better gift could you leave them?
- You can envision what the “Adjusted EBITDA” schedule will look like to a potential buyer. Is the business loaded with all sorts of non-operating expenses that need to be added back to arrive at the true cash flow of the business? Salaries to relatives in excess of their contribution to the business, personal expenses run through the business to get a tax deduction, numerous related party transactions? All businesses will have some EBITDA adjustments, but as the list gets longer the believability of the numbers get lower. Remember…you are trying to convince the potential purchaser that you run a clean operation, and that the books and records can be relied upon. The more explaining of exceptions you have to do, the less believable you are. I recall being told by a colleague that during negotiations to buy a business, the owner told him that there was $100,000 of vendor rebates that he took personally in cash so they would not be found on the books. My colleague’s immediate reaction was “If he is cheating on that what else is he misrepresenting?” The deal never happened.
My recommendation is to prepare, or have your CFO, consultant or accountant prepare an annual rolling 3-5 year ADJUSTED EBITDA schedule. Show all of the items that you would want to add back to EBITDA for purposes of a sale. Explain to yourself, or better yet, explain to a trusted advisor what all of the adjustments are and why they are necessary. How do they sound? Do they have a valid business purpose…“We are adding back real estate taxes on our investment property since that property will not be included in the sale.” Or do they sound sleazy…”We are adding back $100,000 of the salary that we are paying my nephew to manage the shipping department, but he really doesn’t run the shipping department, that is just to keep my sister happy, so you wouldn’t have to incur that expense.”
This exercise has multiple benefits…..knowing your Adjusted EBITDA makes you more informed when reading about or discussing your industry with knowledgeable parties or in the case of an unsolicited offer. It also provides your heirs or successors with important information about the core business with all of the noise removed. Finally, it allows you to do an annual trial run of your Adjusted EBITDA calculation, which will hopefully lead you to minimize required adjustments in the future.
Try it, and let me know how it works. Connect with Doug Jones: d: 804-955-4427 c: 804-921-2445 e-mail: djones@fahrenheitfinance.com