How Saleable is Your Business?
BY: JOEL LUBER
Ready to Sell?
As an attorney whose practice includes estate and business succession planning, I often assist my clients with the sale of their closely held business. On those occasions, it also becomes my job to (i) determine whether my client is at that point in his or her business life cycle where he or she is ready to sell and (ii) whether the business is ready to be sold. Both questions cannot always be answered in the affirmative.
James Laab, author of The Business Sale System: Insider Secrets to Selling Any Small Business, has a 10 question quiz that can provide a very good indication as to whether you and your business are ready to sell.
With scores from 0 to 5 (0 = strongly disagree; 5 = strongly agree); these are the statements:
- I have a clear idea about what I want to do with my life after I sell my business
- If the price is acceptable, I am prepared to take half in cash and the balance over a term of up to five years
- Overall, I would say my business and I are in pretty good shape
- I have 10 to 20 hours per week that I can dedicate to selling my business
- There are no pending tax or legal problems
- Without me, my business is not worth nearly as much
- Sales or profits have been stagnant or declining recently
- I have a specific price that I will sell for, not a penny less
- I feel uncomfortable giving out a lot of financial details about my business
- I’m worried about new competition or changes in laws pertaining to my business
To score, add the points on statements 1 to 5; subtract the points on statements 6 to 10. The highest possible score is 25. If your score is over 15, you’re on the road to sale; 12 to 14, close to ready, with some fine tuning required; 11 or lower, not ready without significant preparation.
You may have thought the term “business life cycle” a bit odd or out of context. The truth of the matter is that every business and its owner has a natural life cycle, a journey that begins with hope and potential, is then propelled by success, is slowed by adversity and eventually comes to a conclusion. There are only two outcomes for every business: be acquired or to close the doors and liquidate. No owner wants to close the doors, but the undeniable fact is that only 20 percent of businesses on the market actually sell.
A business owner may decide to sell because of life-changing events (death in the family, divorce of spouse or business partner, and illness); changes in the marketplace that cause a loss of revenues or profits; or a desire to pursue other business ventures. The most common reason a business owner decides to sell is he or she has lost the enthusiasm that created the initial spark and ultimately successful enterprise. The business can be as wildly successful as could have been imagined at the outset, be poised for even greater growth. But, if the owner is no longer willing to put in the 50, 60 or 70+ hour work weeks, to tolerate the myriad issues that CEOs must, or has lost the motivation to get up each morning to fight the new fight, it is time to sell.
The Long Vacation
You scored yourself on Laab’s quiz on page one (or have come to the decision by way of alternative analysis), and you are ready to embark on the mission of sale. As you search for a business broker of good repute, the first question you should be asking is: “Do you really own your business?” This question has nothing to do with the stock or membership certificates that represent the ownership interests in the enterprise. Let me explain:
I represented a contractor, a very skilled craftsman, who did exceptionally fine, customized millwork. It started with the owner working out of his basement with a nice set of power tools, an idea and a whole lot of determination. Due to his hard work, the business grew over time. Eventually, the owner hired part-time assistants who became full-time employees and then an administrative person to handle all the office work. As the business began to grow, the owner moved the business out of his basement and into a more spacious commercial building. Soon, the business grew from 10, to 15, then 22 employees. To an outsider, the business looked very different from the company run out of the owner’s basement. Yet, on the inside, it hadn’t changed a bit. The owner was still doing all of the estimates, every job was customized, and the specific knowledge that was required resided only in the owner’s head. When unforeseen circumstances required him to sell the business, he could not find an exit because he did not own a business. He only owned a job; it was a very profitable job, and one with 22 assistants. But, still, it was just a job. Buyers do not want to buy a job; they want to buy a business.
The lesson is clear. For a business to be transferable (salable), the owner’s job responsibilities must also be transferable. Any business must be able to stand without the owner. Revenue must continue to flow after the owner exits the business. You wouldn’t expect your business to grind to a halt if you take a vacation; a sale should be viewed as an extended vacation by the owner. Look, again, at statement 6 in the quiz. If your answer was a 5, you have a serious impediment to sale, one that will drive down the sale price seriously below what you estimate the value of your business to be using any set of applicable industry metrics.
Creating Salability
How do you avoid falling into this very common trap? The key is to make sure your role, as owner, is primarily general management, developing and implementing long-term strategies and growth objectives. You should not be immersed in day-to-day details of operations.
Those duties are best left to the employees who will probably stay with the business after new ownership comes in. A general tenet of all successful businesses is the “Rule of Two.” Each job in your organization should be able to be handled by at least two people. The owner who spends time making sure that he or she is not the only employee performing critical functions can usually sell the business for a premium.
If you really “own” your business and not just a job, it is a matter of preparation and timing to create salability and extract the highest price from a willing buyer. Some of the key factors are:
Solid Statements. Formal (although not necessarily audited) financial statements must be available for at least three years; five years is better, with applicable tax returns. The financial statements will need to be “recast” to accurately reflect the owner’s “perks” and other intra-family transactions so revenues and expenses can be restated to show what the firm will provide to a new owner.
Eliminate Weaknesses. Weed out obsolete and outdated inventory; eliminate a product line if underperforming or not profitable; sell assets (like real estate) that are not contributing to earning power.
Pay Day. Take a hard look at the financials and compare them to what you expect (or require) to be paid for the business. If the financials do not support your expectations, one or the other needs to be adjusted. This may take some time.
The Selling Memorandum. Prepare a “selling memorandum.” This is the key document offered to carefully screened and qualified buyers. It should be prepared with the assistance of a business broker and your accountant with the owner playing a major role.
Curb Appeal. Spruce up the business – clean, paint, reorganize – anything that will make it more appealing to visitors. A neat, clean, organized place of business tells buyers the company is well run.
You have a great business in which you have invested your blood, sweat and tears, and now it’s time to move on. You have carefully prepared. So, what’s next? There is no decision more important in any business owner’s life than the sale of his or her business. You were successful in creating the asset. You, therefore, are the most important factor in its successful sale. This transaction requires the assistance of trained, experienced professionals. They will not only market your business, they must be intimately familiar with the financial results of the business operations and know every detail of any major contract to which the business is a party.
Very simply, you need to rely on your business broker (investment banker), your accountant, and your attorneys. After careful consultation with all three, you will be able to say you really have a business that can be sold and that your expectations of the price and terms for that sale are realistic. Good luck!
This article is part of the Business Advisor Quarterly newsletter from Offit Kurman. You can view the entire newsletter here.
Joel Luber is a Philadelphia based trust and estates attorney who concentrates his practice in sophisticated estate planning for high net worth clients, estate administration, and general corporate and income tax planning. He can be reached at jluber@offitkurman.com.