For business owners contemplating a future sale of their business, we believe it is never too early to start the process. We recently posted “55 Questions to Ask Yourself Before You Sell Your Business”.
Our “55 Questions” are designed to help owners think about their business from the potential buyer’s point of view. Buyers purchase the future, specifically the future profits and cash flows of the business. Therefore, the current owner’s responsibility is to provide the buyer with a high degree of confidence the business will continue to perform at or above historical levels.
In this Part II of our series, let’s consider general financial matters.
General Financial Questions to Ask Yourself Before You Sell Your Business
- Are my financial records in tip-top shape?
Nothing erodes business confidence faster than messy and disorganized financial records.
In a typical transaction, the seller provides financial statements to the potential buyer, a value and deal structure is agreed upon, and the buyer begins its due diligence process. If the buyer immediately determines the financial statements – the very basis of the valuation discussions – are inaccurate, disorganized, and unreliable, then confidence fades quickly. Transaction value often declines as well. In severe cases, deals fall completely apart because the buyer simply cannot get comfortable with the accuracy of the financial statements.
Financial statements that are accurate and complete are key to the successful sale of a business. It is well worth your time and money to invest in qualified internal or external resources to improve the quality of financial reporting.
- Should I invest in an independent audit of my financial statements?
Yes, in most cases. Having audited financial statements will always improve the due diligence process and provide the seller with greater confidence.
Some business owners try to avoid the cost of having audited statements by waiting until they have a deal in hand and then calling an independent auditor in a rush to audit the last two or three fiscal years of operations. The problem with this approach is it’s too late to correct any errors in accounting practices or record-keeping. The current owner and the buyer will be watching the audit process unfold at the same time, and if the audit reveals material adjustments to previously reported financial results; confidence and transaction value erodes quickly.
On the other hand, if the owner invests in annual audits at least two to three years ahead of a potential transaction, accounting issues can be surfaced and corrected long before the negotiation process begins.
- Do I mix personal expenses in my business records?
Many business owners mix personal and business expenses together in the business checkbook. Even if the business is properly recording these personal expenditures as additional compensation or distributions of profits, we recommend eliminating as many personal expenses as possible from the business records.
In a sale transaction, these personal expenses represent “noise” in the numbers. The buyer must determine the true cash flows of the business, and if the financial results have to be “adjusted” to remove dozens or even hundreds of personal transactions, then the due diligence process is extended and the risk of deal fatigue increases.
- Do I have a solid monthly accounting closing process to ensure each month’s financial statements are materially accurate?
The typical acquisition takes 90 to 180 days to complete from letter of intent to closing. During this period, the buyer will want monthly updates on the financial performance of the company to ensure the business is meeting their expectations.
In many businesses, the accounting books are not closed until thirty days or more after the month-end. Additionally, the closing process may not be well defined and executed to produce materially accurate results for the month.
To instill the desired confidence in the buyer’s mind during the transaction process, we recommend developing a documented closing process that produces solid, monthly financial statements within 7 to 10 business days after month’s end.
- Have I made written or oral promises to key employees about bonuses or other remuneration if I should ever sell the business?
All promises to provide remuneration to staff or any other party in the event of a sale of the company should properly written and signed off by both parties now rather than when an offer is in hand.
Failure to document these promises can lead to a range of problems once an offer is on the table. These problems can range from misunderstanding of the details of the original promise to negative tax outcomes to giving the recipient sufficient power to dictate transaction deal terms.
- Do we routinely cull customers who abuse our employees or place unreasonable demands on our organization?
After the proposed transaction closes, the new owner of your business will need to be focused on maintaining and increasing the profitability of the business. If he or she is instead distracted by having to deal with toxic customers who abuse your employees and have unreasonable expectations, then those future results could be in jeopardy.
Why does this matter to the current owner of the business? In many middle market and small business acquisitions, a significant portion of the purchase price is paid after closing in the form of debt payments or earn-outs based on the post-closing performance of the business. That said, both parties have a vested interest in the business’s performance long after the ownership has changed hands.
Most people are familiar with the Pareto principle, commonly known as the 80/20 Rule.[i] Applying the rule to business, 80% of total profits come from 20% of clients. Conversely, the remaining 20% of profits come from 80% of clients. It’s no surprise that toxic clients fall into the latter category. To take this concept a step further, we run the risk of allowing low-yielding customers to consume 80% of our time. When it comes to positioning your company for success, culling troublesome customers is good for business, whether you plan to sell or not.
In Part III of our “55 Questions” series, we will take a closer look at revenues and profitability.
We recently discussed our “55 Questions” with Gordon Deal on the “Your Money Now” podcast. You may listen to the podcast here.
[i] Kruse, Kevin: The 80/20 Rule And How It Can Change Your Life. Forbes. 7 March 2016: http://www.forbes.com/sites/kevinkruse/2016/03/07/80-20-rule/#77645c151eb5