How to Get Ready to Sell a Business

How to Get Ready to Sell a Business

It doesn’t matter if you’re the fifth owner of a business or if you’re the entrepreneur who started the company. At some point you may want to step away from your business. It could be to do something else or just retire.

Many business owners believe there is only one option for their business – work as long as they can, then shut down the company. However, with some prior planning and help, there are other options.

Maybe there’s a partner you can sell your shares to. For businesses with enough employees and an owner who doesn’t mind a transfer that will take a few years, an Employee Stock Ownership Plan (ESOP) may be a good alternative.  

However, the vast majority of business owners are running a shop where they are the key employee and manager. Many of these people believe that their business could never be sold because once they leave, the whole operation would die. In many cases they are correct, but they don’t have to be. This is where good planning comes in.

Value is in the Profitability

There is a very simple formula used to determine the value of a business or almost any other investment. It is expressed as Value = Income/Risk. The difficult part is determining what the actual income generated by the business is. The risk rate is basically a return on investment and different buyers accept different levels of risk, so we will focus on the Income aspect. The higher the income number, the greater the concluded value.

Caution Needed Regarding Taxes

The most common operational strategy among small business owners is to minimize taxes. This is not a secret. Often business owners will write off expenses that reduce their taxable net income, This sometimes happens even though those expenses were not needed for operations. Perhaps, the company did not necessarily need a new truck that year, or the rental cost for the office space also owned by the business’ owner is higher than it would be for a third party, or perhaps there are paid employees who never actually set foot on the premises. There are many strategies used to write off non-operating expenses and thus reduce taxable income. (Please note that some of these strategies could be construed by the IRS as tax fraud.)

An unfortunate side effect of reducing taxable income is that it also reduces the numerator in the simple equation mentioned above. The lower the Income is, the lower the eventual sale price. To increase the amount a buyer would be willing to pay for a company, one simply needs stop trying to minimize taxes and instead operate with the purpose of showing exactly how profitable the business is.

Buyers of businesses and lenders providing capital for business acquisitions, require at least three years of tax returns for review as part of the process. Both buyers and lenders get excited when tax returns show increasing profitability. That makes obtaining underwriting approval much easier. However, most of the time the opposite is true. The tax returns show very little in the way of profits, or even show losses instead, and the seller spends an inordinate amount of time trying to explain where all the money went and why this business is really a great deal. Sometimes the explanations work, but most of the time a seller ends up having to either take a lower offered price, or accept that the business will not sell.

If those tax returns showed every dollar of income, neither the buyers nor the lenders could argue about profitability. Also, consider every dollar is taxed at rates of up to about 40%. That counts towards an eventual sale price at least two to four times! Sometimes even more! Is it worth it, to pay $0.40 to the government in order to obtain $2.00 to $4.00 three years later? Multiply these numbers times the net income figures showed on your latest tax return. And then consider what the value range would be if all your profits were reported clearly.

Consider a Business Broker

You’re an expert in your industry and have years of experience helping your customers accomplish their goals. And there is a whole industry devoted to helping business owners sell their companies. They’re called Business Brokers and they have years of experience helping their clients accomplish their goals. Most of them work on a commission basis, which means you pay them upon a successful sale of your business.  

A good business broker can also help you plan for an eventual sale in the future. There are so many details and strategies to consider to increase a potential sale price. Some may take a couple of years to thoroughly implement. With prior planning and the help of a good business broker, a liquidation sale need not be the final scene for your business.

Shawn Hyde is the founder and owner of Canyon Valuations. See Shawn Hyde's full bio here.