“My business is my pension” has been repeated time and time again by Business Owners over the years!
However, very few business owners build a business that is capable of being sold and even fewer achieve a sensible and rewarding price in the marketplace. There are many reasons for this and what is clear is that a business will have little value unless the business owner specifically builds a model that will be capable of a reasonable valuation and a business that would be attractive to other potential purchasers. There is another old adage which says “a business owner spends more time getting his car ready for sale than his business” and potential purchasers of businesses identify this time and time again as a very good reason why they lose interest in businesses or offer unacceptable purchase proposals.
It’s interesting that over 75% of businesses advertised for sale never go through to completion.
Some of the more common reasons as to why a business may not be saleable are as follows:-
- Unrealistic valuation by the vendor.
- Lack of profitability.
- Lack of a cohesive team within the business.
- Lack of reliable financial information.
- Evidence of a “lifestyle business” where family members and friends are employed or involved in the business who may prove to be difficult for the purchaser to remove.
- Absence of a unique selling point.
- Insufficient customer loyalty.
- Outdated pricing policies.
- Lack of taxation strategy which may result in the purchaser potentially being responsible for future taxation liabilities.
- Unattractive arrangements relating to business premises such as onerous leases and property commitments.
- Insufficient investment in modern fixed assets and information technology meaning that any purchaser would have to embark on a significant investment program to obtain the best out of the business being acquired.
- Onerous supplier contracts or outdated supplier and customer terms and conditions.
- Lack of liability on the value of major assets particularly stock and work in progress.
The list above although by no means exhaustive clearly shows there are major pitfalls for a business owner who does not plan to build a business that can be passed on to a purchaser as quickly and cleanly as possible whereby extracting the maximum value. The business owner therefore needs to “clean” the business and one of the advantages is that there is greater likelihood of more of the sales consideration being paid up front with less “deferred consideration” or “earn out” than a business that has not attended to all the relevant constituent parts that can affect the valuation. A business valuation can also be enhanced if a business can be disposed of which operates completely independent from the business owner. Many business owners attempting to dispose of their business are effectively trying to get the purchaser to buy the owners job and anticipate them paying the previous owner an income for several years.
How can a business owner enhance the value for the potential sale of the business? Some of the most important matters to do that are as follows:-
- Take at least two to three years to get the business ready for sale.
- Demonstrate a reasonable position in the chosen marketplace.
- Demonstrate that reasonable gross profits can be generated in line with or exceeding industry averages.
- Demonstrate that business overheads are under control and in line with the bench mark in the relevant marketplace.
- Ensure that there is a consistent and if possible increasing profit record of at least three years before the intended sale. Profit is generally accepted to be earnings before interest, corporation taxes, depreciation and any abnormal items.
- Ensure that all fixed assets are properly owned by the business, in use and properly valued.
- Ensure that all current assets, stock and work in progress, debtors and other amounts owed to the business are valued accurately or are collectable.
- Ensure that all current liabilities are fully disclosed in the accounts and that any potential liabilities, such as taxation and legal matters, are disclosed at an early stage.
- Ensure that all commitments to the crown such as Pay as You Earn, Value Added Tax and Corporation tax are correctly calculated and up to date.
- Ensure that there are no onerous restrictions relating to long term liabilities such as business loans, commercial leases, hire purchase contracts or equipment leasing etc.
- Ensure that terms and conditions with customers are reviewed and brought up to date.
- Ensure that all supplier contracts are reviewed and brought up to date.
- Ensure that all contracts of service for employees including directors are up to date with current employment law and fully adhered to. Taking over existing employees often causes the purchaser great difficulty or can seriously affect the business valuation.
What is clear is that if a business is going to attract maximum value it needs to be presented to a potential purchaser with all matters as clean as possible and with the minimum of liability passing to the potential new owner. The potential purchaser will assess the transaction as relatively low risk and provided that he can see that there is potential in the market place and a reasonable profit stream he will then be happy to pay a price at a higher end of expectations. Furthermore the vendor will have greater armoury for discussing the method of payment particularly the resisting further consideration for future earn outs as these almost always seem doomed to failure or end up in litigation.
It is also usual for the vendor of a business to indemnify the purchaser for any potential liabilities that may occur during the time that the vendor owned the business. It stands to reason therefore that if the vendor has spent a good deal of time preparing the business for sale, the likelihood of a major liability arising should be significantly reduced and therefore indemnities to the purchaser can be minimised.