For business owners, many succession plans ultimately lead to the sale of their business. How this looks can depend on your business structure, entity type, and ownership. Although preparing for the sale of a business can be a complex and time-consuming process, here are some of the steps that will come up as you prepare for the sale of your business.
Determine your business’s value
Before you start looking for buyers, you need to determine the value of your business. A business valuation, also known as a company valuation, is the process of determining your business’s economic value. During the valuation process, all areas of a business are analyzed to determine its worth and the worth of its departments or units. It will provide a starting point for price and negotiations and might also help you identify areas that need attention before you begin to market your company.
There are three common methods to evaluating the economic worth of a business. These categories are:
- Income-Based Approach: The income-based approach focuses on the potential income or cash flow generated by the business. This method typically considers the company's historical financial statements, projected future earnings, and the overall risk associated with the business.
- Market-Based Approach: The market-based approach considers the market value of similar businesses or comparable transactions. This method relies on analyzing the prices at which similar companies have been sold in the past or current market conditions.
- Asset-Based Approach: The asset-based approach focuses on the company's net asset value by considering the value of its tangible and intangible assets. This method is commonly used when the company's assets are significant and its income generation is not the primary factor in its value.
Business owners should work with their valuation experts to understand which valuation approach is most likely to apply to their business. Understanding the key inputs and drivers to the valuation methods used can help management teams determine the best strategy to increase value over time.
Prepare for due diligence
In addition to a business valuation on the front end, a buyer will often request a due diligence engagement–such as a Quality of Earnings engagement–during negotiations. The goal of these engagements is to confirm the historical performance of the company along with providing a basis for assumptions made in its future performance such as projected revenue, earnings, and working capital. You will likely be asked to provide a calculation of your company’s EBITDA (Earnings Before Interest, Income Tax, Depreciation and Amortization) as well as relevant supporting documents.
Advance preparation will help ensure a smooth. Give special attention to:
- Personal expenses: Do the expenses on your company’s books include personal items, such as non-business-related travel, meals, entertainment, utilities and vehicle expenses? These types of expenses should be added back to adjusted EBITDA.
- Non-recurring items: Do revenue or expenses include business-related non-recurring items, such as capitalizable costs that were expensed, deal-related transaction costs, or non-recurring income such as Paycheck Protection Loan forgiveness? These types of non-recurring items should also be excluded from adjusted EBTIDA.
- Fixed asset accounts: Has depreciation been properly recorded, or are there any assets you no longer own and should dispose of on the books? Are assets properly classified according to their useful lives?
- Cash: Are your cash accounts reconciled? Is all interest accounted for? Are there any negative cash balances? Follow up with customers on any outstanding invoices.
- Accounts receivable: Does accounts receivable include legacy balances that are not expected to be collected? If so, old balances should be written off or adequately reserved.
- Inventory: Do your inventory levels accurately reflect what is available to convert to cash at the time of your valuation? Are all gains and losses recognized in the appropriate reporting year?
- Accrued liabilities: Do your monthly balance sheets include the appropriate estimates of accrued expenses to properly capture the correct costs each month?
Establish accounting policies and procedures
If you do not already have them in place, you should establish accounting policies and procedures moving forward to align with your organizational goals. Part of these procedures should include organized monthly, quarterly, and annual financial statements. You should also:
- Start tracking your sales pipeline,
- Develop a financial forecasting model, and
- Organize your current and historical tax documents.
Having easy access to your financial information and taking the time to record adjustments now will provide the most accurate picture of your business, reduce risk, and help eliminate any surprises during deal negotiations.
We’re here to help
While the specifics vary greatly, there is one universal: get help. In order to ensure a smooth, efficient, and profitable transaction, you should bring your network of accountants, financial consultants, bankers, business brokers and lawyers together. Investing in the right advice early on will pay dividends. If you have questions about this process—no matter where you are in the process—contact us today.