The decision to sell your business may be the most important professional decision you ever make, because there’s a lot on the line. You build your business for years- maybe even decades. In addition the huge amount of time you’re invested, you’ve also plowed company earnings back into the business, rather than take a larger distribution of profits as income. A company sale is your chance to recoup your original capital investment, and profit from the growth of your business. Use these tips to prepare your company for sale and maximize the price you receive for your business.
What a buyer wants
If your business looks attractive, several types of entities may be interested in buying your firm. You may get inquiries from a competitor that is looking to grow market share, for example. Private equity firms also buy companies, and these firms raise money from wealthy individuals and institutions that can leave assets invested for long periods of time. When a private equity firm invests, they attempt to manage the company and improve the results for three to five years, then start to liquidate their holdings in years six to ten.
Investors want to buy a business that keeps doing what they’re doing. If, for example, a business generates a 15% profit margin on $10 million in annual sales, a buyer wants a management team that can maintain those results or improve on them. With that in mind, consider these four steps to prepare your business for sale.
RidgeTop Clothing makes clothing and other gear for hikers and outdoor sports. The firm generates $20 million in sales a year, and produces a 15% profit margin ($3 million). RidgeTop’s customers are U.S. retailers that focus on the outdoor market. Jane, the founder of RidgeTop, owns 50% of the firm, with the other 50% owned by a group of retired businessmen who serve as mentors to Jane.
#1- Identify and reward senior managers
No business can operate for long without good managers, and potential buyers recognize the value of senior management. A buyer wants to know how long each manager has been with your firm, and how much industry experience they have. The purchaser also wants to know how they can get management to stay after a company sale. After all, a talented manager may get job offers from competitors.
To prepare your business for sale, consider setting up financial incentives to motivate your senior managers to stay, even if your firm is not sold. One idea is to set up a retirement plan that provides vesting over a period of years. Vesting refers to the retirement assets that are owed by the worker. A four-year vesting schedule, for example, means that your employees earn 25% of the retirement assets each year.
You can also set up a stock option program, which grants your managers the ability to purchase company stock at a specific exercise (strike) price. If the business continues to grow sales and earnings, the stock price will increase, and the manager can exercise the stock option and sell the stock for a gain.
Assume, for example, that a manager is granted to right to buy 1,000 shares of stock at an exercise price of $30 per share. The manager must be employed for three years after the options are granted to exercise the options. If, four years later, the stock is trading at $50 per share, the manager can buy the stock at $30 and sell the shares at $50, which generates a $20,000 profit.
The purchase price of your business may include additional compensation that motivates managers to stay. If your company already has some incentives in place, you’re more likely to keep senior managers and continue to grow your business.
#2- Maintain a good credit rating
Cost of capital is an important factor for any business, because a high cost of capital can limit your firm’s ability to grow. Assume, for example, that RidgeTop Clothing has a 5% line of credit, and that the outstanding balance averages $500,000 over a year. That means that the firm pays about $25,000 in annual interest. If RidgeTop’s credit rating declines and the bank increases the interest rate to 7%, the business will pay $10,000 (2%) more in interest each year.
In addition to higher lending costs, a poor credit rating may also limit the dollar amount a company can borrow. When the bank analyzes the lower credit rating, it may decide to reduce the line of credit amount available to RidgeTop.
To prepare your business for sale, minimize the amount you need to borrow to operate your company. Make sure that you pay your bills on time, and check your firm’s credit rating periodically so that you can correct any errors.
#3 Implement a formal budgeting process
I know it’s just one more thing you have to do, but invest the time to create a formal budget for your business- and do it before year-end. If RidgeTop Clothing budgets for $20 million in sales and a $3 million profit, for example, the company will incur $17 million in costs to make and deliver the product. Some of those expenses are direct costs (materials and labor), while other costs are considered overhead (legal and accounting costs, for example).
$17 million is a lot of money, and the budgeting process is your opportunity to take a hard look at those costs and decide if they are justified. If RidgeTop buys denim for a supplier, can the firm negotiate a lower cost, based on the amount they purchase? Instead of paying an outside law firm an hourly rate, can RidgeTop switch to a fixed monthly retainer to save costs? These are the conversations your firm needs to have in a budgeting process, because the process can lower costs and generate higher profits.
There’s another payoff, if you’re preparing your company for sale. A formal budgeting process shows a potential buyer that you’re a serious business owner who makes informed business decisions. In other words, you’re not flying by the seat of your pants when it comes to business- you’re a grown-up.
#4 Use a set of management reports
I had a chance to meet a former CFO of a Fortune 500 company a few years ago. He was (no surprise) an accountant by training, but engineers managed the business. The former CFO told me that the reason he was successful was that he created a set of accounting reports that senior management found useful and easy to understand. Once he determined what the engineers wanted, he supplied the same set of financial reports every month.
In the same way, every well-managed business has a set of critical management reports that the firm relies on to make decisions. Jane, the founder of RidgeTop Clothing, may really need to see the accounts receivable aging report. In order to manage cash effectively, Jane needs to review the oldest invoices and follow up with customers who have not paid. A clothing manufacturer may also need a constant update on the number of items in inventory and the amount of monthly production required to fill customer orders.
Implementing these four steps may require a great deal of time and effort on your part, but there are two big payoffs that you should keep in mind. If you’re considering selling your business, these steps will increase the value of your enterprise. Even if you don’t sell your business for years, these concepts can help you generate more sales and profit, which can mean a larger income for you.