When a buyer looks at acquiring a business, they will calculate an anticipated rate of return on their investment.   When calculating their return, they will look beyond the purchase price of the business and will also take into consideration additional money they will need to invest in working capital, improvements, and capital expenditures.  If the anticipated capital expenditures are significant, it may result in a lower value and less marketable company simply because of the impact capital expenditures will have on a buyer’s return on investment.

If your business is in need of significant capital expenditures, should you go ahead and make them before selling?  There isn’t an easy answer to this question, and you should always consult your business sale advisors to discuss the specifics of your company’s situation, the type of asset(s) in question, the level of investment, whether financial performance can be maintained without the investment, and the short-term impact on cash flow.  If such decisions are made without consulting advisors, a seller may be shocked by the impact on their ability to sell.

While having aging payables may seem like somewhat of a positive as it indicates the ability to conserve cash, payables that are aged beyond 30 days can cause concern for a business buyer.  The reasons for this concern include: 

1. It may be an indication of a cash flow issue that is preventing the business from paying its bills in a timely manner;
2. Accounting and bookkeeping processes may be inefficient or loosely managed;
3. This may be a clue that there is a problem with the vendor or its quality that is causing the business to delay payment until the issues, billing disputes, claims, or warranty items are resolved;
4. The company may end up with (or may currently be getting) worse pricing from vendors because of a slow payment history;
5. The company might be at risk of a vendor only providing products or services C.O.D.; or
6. The business might be at risk of losing a supplier because of slow payment, and if so, will there viable alternate vendors with equal or better pricing, terms, and quality?

In preparing for a business sale, a buyer will perceive less risk if your company’s aging payables are the greater of 30 days or the maximum stated terms that creditors provide.  If this is problematic it may indicate that accounts receivables management needs to be improved to increase cash available for payables, a line of credit is needed or should be increased, or the company’s payables management system needs to be improved.

One of the most critical mistakes I've seen business sellers make is selecting the wrong attorney to handle their business sale transaction. Sometimes a business seller will insist on using a friend who is a business litigator or an attorney who helped them with other business or real estate issues but who has limited experience with business sale transactions.

Here are a few things to consider when selecting an attorney for a business sale transaction:

1. An attorney will usually get paid whether the deal closes or not.  Since they typically bill at an hourly rate, their financial interests are not aligned with yours.  The greater number of time-consuming issues they can bring up that need to be resolved, the more money they make.  Good attorneys who are experienced at business sale transactions realize that if enough transactions fall through, it could impact their firm’s reputation and business development activities. Nevertheless, I have been involved in transactions where attorneys create mountains out of molehills and create enough issues that the deal has almost died unnecessarily, while racking up billable hours and creating significant angst for both the buyer and the seller. When selecting an attorney you will want one who not only is experienced at representing business sellers and buyers, but also who has a strong track record of getting transactions closed.
2. The attorney’s specialty can have a dramatic impact on the outcome.  An attorney who primarily does litigation may have a strong, competitive, abrasive, win-lose orientation that is antithetical to the cooperative, pragmatic, positive, win-win approach that most successful small business transactions require. Likewise, a general business attorney who isn’t experienced at business sale transactions may not be knowledgeable about, or skilled at, dealing with even the most common issues that arise in a small business sale.
3. Some attorneys believe that they should be the primary person negotiating the major business deal terms rather than being a supporting member of the deal team. While some attorneys may be effective at leading negotiations, a skilled business broker or investment banker should usually be the one primarily negotiating the major deal terms. Your business broker or investment banker has taken the time to develop a deeper understanding of the business as well as the market and the acquirer. This knowledge will help the broker or investment banker gauge how hard to push for certain terms, at what point the buyer will likely walk, and whether if the deal falls apart there are likely going to be acceptable alternate buyers.  The role of the attorney should be as a team member - providing input, bringing up issues and risk factors to consider, negotiating the legal points of the documents (for example, representations and warranties and indemnification language) and making sure that the legal documents used in the transaction accurately reflect the business terms that have been negotiated and provide necessary protections.
4. Some attorneys do not have a strong knowledge of finance.  A lack of financial knowledge can be detrimental if the attorney is actively negotiating the deal terms. For example, I was working on the sell-side of a transaction where the buyer’s attorney was negotiating terms of a seller note. Later, as he shared with me his monthly payment and balloon payment calculations, it became apparent that the attorney didn’t have a clue about how to calculate an amortized loan with a term that was shorter than the amortization – in fact, he didn’t even know how to calculate a fully-amortized loan! Using bizarre methodology, he calculated monthly principal and interest payments that were 24% higher than they should have been, and the balloon payment he came up with was 20% less than it should have been. Without understanding the financial implications of the transaction, he was not the appropriate person to be negotiating the basic terms of the deal.  Whether you are relying on an attorney for help with negotiating the deal or not, it is good to use an attorney who has a strong understanding of business and financial issues. It may even be worth considering using an attorney who has an accounting background, an MBA, or who has owned a business.
5. An attorney's risk tolerance may be mis-matched with your level of risk tolerance. In general, attorneys will be far more risk adverse than entrepreneurs. This is good because their advice can prevent you from doing stupid or overly risky things, but sometimes it will cause an attorney to push for deal terms that are unrealistic and inconsistent with how most more-risk-tolerant business owners would proceed. For this reason it is important to make sure that you are listening to and considering your attorney’s advice, but that you are still the one making the final decision. If you perceive that an attorney will be resistive to, and fight you on, making final decisions based on your personal risk tolerance level, then you don't have the right attorney. 

Codiligent has worked with a number of excellent business sale transaction attorneys, and would be happy to make introductions.  

Codiligent is marketing a developer of a SaaS business model medical billing software used by the behavioral health industry. 

Listing Number: 1000010614
Price:     $17.3 million
EBITDA: $1,554,322 (12 months ending 8/31/15)

Link to more information: intro package for 1000010614

The following video from the Kauffman Foundation exposes some myths about entrepreneurship but they excluded one of the most significant myths: 7 out of 10 businesses fail in the first five years. This tired old misperception stems from confusion about the difference in the definitions of "non-survival" and "failure". Non-survival isn't the same as failure. Many businesses that don't survive are far from being failures. Contact Codiligent business brokers if you'd like to learn the truth about business failure rates (which are significantly lower than commonly perceived).

Many of the small and lower-mid-market companies that I interact with (under $25 million in annual revenue) have done little to prepare for a business sale. There seems to be a common belief that preparing for a business sale just means extra work and greater expense, with only an incremental difference in outcome. If done correctly it will actually save most business owners substantial time, result in a far higher purchase price, prevent costly mistakes, and may even make the difference in whether the business will be sellable.

How does being better prepared for a sale save a business owner time? 

• It will be easier, more efficient, and more effective to attract the right buyers and get them to move forward. 
• It may increase competition for your business, keeping the process moving more quickly and with fewer delays by a buyer. 
• It reduces the probability of having a deal terminate with one buyer and having to start over with another. 
  
• The time spent preparing for a sale will reduce the time required during formal due diligence (in essence, you are compiling due diligence information prior to marketing the company - so it's not more time that is required, rather it's a shift in when time is expended).

How does preparing for a business sale increase the probability of a higher price?
The most basic components of the most commonly used valuation approaches are: 1, cash flow; 2, risk factors; and 3, expected growth in cash flow. If through better preparation you can impact these factors, you will increase the probability of achieving a higher price.

To illustrate how this can impact price let's look at a basic capitalized earnings approach to estimating value. This  approach involves dividing projected operating free cash flow (OFCF) by a capitalization rate. The capitalization rate is equal to a discount rate minus the expected long-term growth rate of the business. The discount rate is a risk-appropriate expected return on investment. So, let's assume that a business was projected to have $1 million in OFCF in the coming year, and the discount rate was 18% and the expected long-term growth rate was 2.5%, for a capitalization rate of 15.5%. If you divide the $1 million in OFCF by the 15.5% capitalization rate, the estimated value would be $6,451,613.

Now suppose that because of better preparation a buyer perceives less risk and greater growth, and so rather than an 18% discount rate, a 17% rate is used, and instead of a 2.5% long-term growth rate, a 3% rate is used. This would result in a 14% capitalization rate and the value would be $7,142,857. Would being able to achieve a price that's nearly $700,000 more make greater preparation worthwhile?

What type of mistakes can be prevented by preparing for a business sale?
The types of mistakes that a business owner may make are numerous, so I'll provide just a few examples:

• A business owner has a family member on payroll in a marketing position. The person has not been effective and should be terminated, but the business owner doesn't want to rock the boat and figures that paying $60,000 per year to avoid family conflict is worth it and believes that a buyer can terminate that employee if desired. The problem is that it may be difficult to prove that this family member is not adding any value. If the employee is showing up at work, a buyer is going to assume that they must be adding some value. Consequently, many buyers will be reluctant to add back that person's salary (or a portion of it). Yet, if this employee truly isn't adding value, and terminating them would cause their salary to drop straight to the bottom line, it could significantly impact value. If a business sold for 6x Earnings Before Interest Taxes and Depreciation (EBITDA) that could mean a $360,000 lower price. A business owner who understands this would be wise to terminate this employee two years in advance of a sale so that a track record of performance can be demonstrated without that staff member.
• A business owner fails to negotiate client contracts in a way that will increase the marketability and value of the business. For instance, there may be a non-assignability clause that could prove problematic when a business owner is ready to sell and buyers are not confident that clients will enter into new contracts with them post acquisition.  
• Financial statements have not reliably been prepared in accordance with GAAP, which will cause buyers to be uncomfortable relying on their accuracy.
• As part of a growth strategy a business owner focuses on growing sales from its largest client which already represents 20% of revenue. A seller may appreciate the ease of dealing with fewer clients, but buyers will perceive greater risk associated with less diversification.

"I don't really need a high price for my business. Maybe preparing for a sale doesn't really matter - as long as I get a reasonable price."
Selling a business is far more difficult than many business owners perceive. In fact, many businesses - particularly those that have not adequately prepared for a sale, may not successfully sell at all. Research from various sources show that only 5%-30% (depending on which study you look at) of all small businesses that are marketed actually end with a completed sale. Consequently, it's important for business owners to do all that they can to ensure success which includes not only adequately preparing for a sale, but also using professional representation.

How to prepare for a business sale
In Michael Schwerdtfeger's article "Expect the Unexpected: How to Prepare for a Transaction" he offers three pieces of advice on preparing for a sale:

1. Define your goals
   
2. Address tax and estate issues
   
3. Hire an intermediary
   

Out of these, I would suggest that hiring a quality intermediary is probably the most important step. The business broker or investment banker can then help guide you through the steps necessary to best prepare for a business sale. At Codiligent we offer a free Marketability Assessment which provides business owners with feedback on issues that may impact marketability and value based on a focused interview and high level review of recent financial information.  For business owners who want to have a deeper level of preparation we offer a program called Always Ready To Sell which involves doing a comprehensive analysis of the company that utilizes multiple years of financial data, a variety of approaches to estimating value, and a deep dive into qualitative and strategic information.

Do you have the knowledge and skills needed to fully realize the benefits from owning your business?

Beginning October 6, a new season of SPBO (Strategic Planning for Business Owners) Workshops will commence, offering business owners knowledge and tools to optimize the performance of their businesses, achieve more work-life balance, and prepare for retirement. These low-cost interactive 2-hour workshops, led by experienced professionals, are designed to efficiently provide education on critical business management elements often misunderstood or ignored by business owners.

Register here for the first workshop in Portland, Oregon: "Creating a Strategic Plan", scheduled for Tuesday October 6 from 7:30 AM - 9:30 AM and emerge from the session with an outline of a realizable strategic plan for your business and the tools to actually make it happen.

BENEFITS OF ATTENDING
You will leave this workshop equipped with the knowledge and tools to help you:

• Identify critical company challenges and develop a plan to address those challenges
• Establish realistic benchmarks and accountability measures
• Maximize your team's time efficiency and productivity
• Move away from the day-to-day aspects of operating your company and focus on maximizing company success and value
• Focus efforts to lead your company to its full potential

Subsequent workshops will include topics such as cash flow management, determining and optimizing the value of your business, marketing consistent with your strategic plan, how to recruit and retain the right employees, mitigating risk, and more.

Seats are limited for this unique opportunity for business owners. Check out the SPBO website for detailed information.