New job applicants get haircuts, shine their shoes, and practice their interview skills while preparing to hopefully land a position. Those seeking to sell a home often repaint inside and out, primp the landscaping, and clean from top to bottom before hosting an open house.
And a business owner who hopes to receive a fair price for his or her company would be wise to engage in such “dressing up” activities as well. While it may go without saying, putting your best foot forward is always the best strategy to maximize the value of any sale.
The Importance of Seller Objectivity
Achieving a sale at the price you want means that you should look at your company as objectively as possible, problems and all. This prepares you to counter any buyer’s objections or degradation of your company’s value, and allows you to maximize assets and minimize (or at least be prepared to handle) flaws.
Recognize that it is easy to get an inflated sense of importance, especially when a stranger comes calling with an interest in buying your company. After all, starting and running a successful company is not an accident, nor a matter of luck. Long-term business success requires a combination of intelligence, guts, and hard work.
As a consequence, many owners assume interested buyers understand the business opportunity and profit potential of their company. They presume that an acceptable offer will be forthcoming, only to be surprised when the would-be buyer tells the owner that their baby – the company – is ugly.
Getting the highest price for your business requires a thorough understanding of the opportunities and threats facing your business. Potential buyers focus on the future of a business, not its past. Accordingly, why would any potential buyer be interested in your company? Does it offer unique products or services? Does it dominate its geographic and industry markets? Does it have capabilities and capacity that are difficult or expensive to replicate?
Buyers are most interested in those companies whose products and services are in growing markets with unrestricted pricing flexibility or obvious expense reduction possibilities. They seek under-utilized – but valuable – assets that can be exploited, especially by the potential purchaser. Similarly, any threat to the business must be identified, quantified, and strategized.
Before engaging in discussions with potential buyers, you should be familiar with the following:
- Mindset of a Potential Buyer. Why is a particular potential buyer interested in your company? What advantages does he or she see in a purchase? Are the advantages to be gained unique to him or her or any potential purchaser? What concerns might he or she have in agreeing to your price? The difference between an acceptable price and an over-the-top valuation is the degree of emotional commitment of the buyer. Simply put, a seller seeks to negotiate with a purchaser more anxious to buy than the seller is to shed the company. Presenting your company in a way that triggers the potential buyer’s positive emotions can lead to a higher price, a quicker closing, and fewer conditions.
- Knowledge of the Marketplace. Do you know whether any companies in your industry have changed hands in the last three years and the values at which they traded? Do you know of companies with comparable revenues in your geographic markets that have sold in recent years? Has your potential buyer purchased other enterprises similar to your company in the past? Do you know the details of the transactions? It is immeasurably easier to get the price you seek if buyers have paid similar prices for other companies in the past. Knowing the history of past sales enables you to receive a premium if you can point out the superior benefits of your company. Remember, if you can’t justify the price in your mind, you are unlikely to convince a skeptical buyer to pay a premium.
- Negotiation Skills. A successful transaction leaves both parties feeling like winners. Successful negotiators understand that some conditions are more critical than others, and are willing to give ground on lesser points to win on those issues more important to them. For example, a seller might agree to extended payment terms in return for a higher price. In negotiations, objectivity is more important than passion.
Dressing Up the Company for Sale
Smart sellers take the necessary steps to make their company look as positive as possible, being sure to remain truthful and open about their activities. Here are several common items needed to produce a favorable image of your company.
1. Reviewable Financial Records
While audited financial statements are ideal, they are not required if they have been prepared in accordance with accounting standards and can be reviewed by qualified accountants. The lack of valid and reviewable accounting records is usually the kiss of death for a potential buyer.
2. Recast Income and Cash Flow Statements
Privately owned companies often reflect extraordinary expenses for the benefit of the owners. For example, owners typically take compensation that includes their salary and any company profits to avoid taxation at the corporate and personal level. Similarly, there may be liberal allowances for such owner expenses as travel and entertainment.
As a consequence, the financial records, while accurate, do not reflect the operations of the company as it would be managed by a new owner. Many sellers prepare pro forma statements supplementing their actual financial statements to provide a more realistic view of the company as it might appear under new ownership. Pro forma statements are analytical devices prepared without using generally accepted accounting principles (GAAP).
The purpose of a pro forma statement is to eliminate extraordinary or one-time expenses that might mislead potential buyers about the probable results in typical conditions. For example, the actual books might reflect an owner’s total compensation of $250,000 and travel/entertainment expenses (T&E) of $80,000 per year. However, the recast statements might reflect a $100,000 salary and a $50,000 T&E expense, which is more indicative of the results a new owner might expect. Recasting an income statement is generally for the purpose of demonstrating more pretax income.
Recasting the salary and T&E expenses can better reflect the likely pretax profits that a buyer might enjoy, as demonstrated on the following table:
Similar adjustments may be made to reduce the impact of accelerated depreciation or the seller’s practice of expensing, rather than capitalizing, real assets. It is important to notify prospective buyers that the financials have been recast with specific adjustments documented and disclosed. Sellers should also recognize that buyers usually create their own versions of pro forma statements to reflect the target company’s operations as they might appear under the buyer’s policies and procedures.
3. Modified Balance Sheet
Old, unused, or obsolete equipment should be sold prior to the sale, as it is unlikely that the buyer will pay for such questionable assets. Specific accounting conventions that affect the balance sheet may require adjustments – for example, contra-accounts such as provisions for bad debts (which may be intentionally high) to protect cash. Similarly, use of accelerated depreciation schedules can artificially deflate the value of fixed assets as can amortization of intangible assets or depletion of natural resources assets. Private company balance sheets frequently include debts to the company due from the owner that would be liquidated upon sale, as well as other obligations that will not be assumed by the purchaser. Many owners engage independent valuation firms to establish current market values for depreciated and depleted machinery and equipment when book values do not reflect the real values.
4. List of Intangible Assets
The value of assets such as patents, customer lists, trademarks, websites, or licensing or franchise agreements may not be accurately reflected on the balance sheet. However, these assets should be listed and considered in the price negotiations. For example, a favorable long-term lease may be a significant asset that is not usually reflected in the financial records.
At the same time, potential liabilities should be fully disclosed – but it is not necessary to create a reserve for such items if they do not appear in the historical records. Buyers are capable of quantifying such risks, and will arrive at their conclusions about the extent and possibility of liability.
5. Critical Employees Agreements
Key employees should have employment and non-compete contracts with the company to assure any potential buyers that they will remain with the company following the sale. Informal compensation or bonus arrangements for employees should be formalized or eliminated. Sellers are often required to warrant the maximum level of liabilities, including informal employee benefits.
6. Blue Sky Projections
Many sellers prepare three- to five-year projections predicting financial performance based on the implementation of their market and operating strategies in the future. They are invariably positive, hence the term “Blue Sky.” As long as such pro forma statements are clearly identified as projections with the printed caveat that they may not be achieved, their use is acceptable and may be useful to potential buyers.
Blue sky is the “sizzle” in the sale, and helps engage the emotions of potential buyers. Remember, optimism is acceptable; fantasy is not. Few companies, other than startups, grow at a rate of more than 20% per year. The more aggressive your projections, the less likely they will be taken seriously. It is never appropriate, nor wise, to guarantee or warrant a projection.
Selling your company may be the culmination of a career or an unexpected reward for smart management. The process is often time-consuming and almost always frustrating, and negotiations are not always successful.
Establish a value for your company – what it is worth to you – before embarking on a potential sale process, since your evaluation may not be shared by a potential buyer. If you cannot come to an acceptable price with the buyer, be prepared to walk. As the owner of the company, you control the sales process – don’t be afraid to exercise your power.
What additional tips can you suggest to prepare a company for sale?