To prepare a business for sale, owners should organize their financial records, document legitimate earnings adjustments, identify and address major risks, develop supportable financial projections, obtain an independent valuation, and assemble an experienced advisory team. Ideally, this process should begin well before the business is presented to potential buyers.
Selling a business can be an exciting opportunity, and may happen only once in a business owner’s lifetime, but the process is often more demanding than initially expected. Sellers must be prepared for open access – and scrutiny – of every aspect of their business.
Prospective buyers and their advisors will want to understand the company’s financial performance, operations, risks, and future prospects before moving forward with a transaction. Preparing this information in advance can make the due diligence and valuation processes more efficient, reduce avoidable concerns, and help the owner enter negotiations with realistic expectations.
Organize Your Financial and Business Records
A potential buyer will typically request several years of financial statements and tax returns, along with current interim financial information. Other requested documents may include customer and vendor contracts, leases, employee information, debt agreements, insurance policies, and corporate records.
These materials should be complete, consistent, and easy to understand. Significant differences between tax returns, internal financial statements, and other company records will likely lead to additional questions.
Owners should also be prepared to explain unusual expenses, changes in revenue, recent investments, and other events that affected the company’s historical results.
Identify Owner-Related and Nonrecurring Expenses
Many privately held businesses include expenses that may not continue under new ownership. These might include above-market owner compensation, personal expenses paid through the business, related-party rent, or one-time legal and professional fees.
This is especially important in businesses with only one owner, or with multiple owners who are family members. For such companies, the owners’ personal lives and business lives are often very closely intertwined, making it difficult to separate the two financially.
A qualified business appraiser will need to properly identify and justify any expenses which are not truly required for operating the business. These expenses may be added back into operational earnings – hence their nickname, “add-backs.” They may also be called normalization adjustments.
These adjustments can materially affect the company's indicated earnings and value. In a sale context, many proposed adjustments are add-backs that increase normalized earnings. However, the adjustments cannot simply be made based on the owner’s word. They should be reasonable, clearly documented, and supportable.
A buyer or appraiser will not necessarily accept every proposed adjustment. The buyer may feel that some expenses are regular business expenses which are required for continuing the historical revenues. For a potential business seller, preparing the supporting records in advance will make it easier to distinguish legitimate adjustments from ordinary operating expenses.
Identify Risks That Could Affect Business Value
Owners naturally focus on the strengths of their businesses, but buyers will just as naturally want to examine potential risks. These may include customer concentration, dependence on the current owner, limited management depth, expiring contracts, outdated equipment, pending litigation, or reliance on a small number of employees or suppliers.
Identifying these issues early gives the owner an opportunity to address them. For this reason, business advisors and valuators often recommend beginning the sale preparation process two or more years in advance. However, in the event that time does not allow for remediating risk factors, the seller can, at a minimum, prepare to document and explain how the risks are being managed.
The more heavily the business depends on the selling owner, the more important it may be to develop documented procedures, strengthen the management team, and establish a realistic transition plan.
Develop Supportable Financial Projections
Business valuation involves a fundamental marketplace paradox: buyers look to historical performance for evidence of a company’s earning capacity, but ultimately base their offers on the future benefits they expect to receive.
Forecasts should be based on reasonable assumptions supported by the company’s historical performance, existing capacity, customer relationships, backlog, industry conditions, and planned investments. Aggressive projections without adequate support may create skepticism rather than increase perceived value.
Management should be prepared to explain how projected revenue, expenses, capital expenditures, and working capital needs were developed.
Consider an Independent Business Valuation
Business owners are often emotionally and financially invested in their companies, which can make it difficult to assess value objectively. An independent business valuation can help establish a reasonable expectation before negotiations become serious.
The valuation may also identify the factors having the greatest effect on value, including profitability, growth, risk, management depth, and the company’s dependence on individual customers or employees.
When machinery, equipment, real estate, or other tangible assets represent a material portion of the transaction, separate appraisals of those assets may also be appropriate. The need for these additional valuations will depend on the nature of the company and the intended structure of the transaction.
Assemble an Experienced Advisory Team
A business sale can involve legal, tax, valuation, financing, and operational considerations. Depending on the size and complexity of the transaction, the owner’s advisory team may include an attorney, accountant, tax advisor, business appraiser, and investment banker or business broker.
These professionals can help the owner evaluate offers, understand the proposed transaction structure, respond to due diligence requests, and avoid decisions that may have unintended consequences.
Begin Preparing Before a Buyer Arrives
Preparing a company for sale should ideally begin well before a potential buyer submits an offer. Waiting until due diligence is underway can place unnecessary pressure on the owner and increase the likelihood that incomplete records or unresolved issues will disrupt the transaction.
Organized records, supportable earnings adjustments, realistic forecasts, and an objective understanding of value can help the owner approach the sale process with greater confidence. They can also give prospective buyers a clearer picture of the business and reduce uncertainty during negotiations.
Business Valuation Specialists provides independent business valuations for owners, buyers, lenders, attorneys, and other professional advisors. If you are considering the sale of a business and would like to better understand its value, contact us to discuss your valuation needs.
Common Questions
How far in advance should I prepare my business for sale?
Ideally, business owners should begin preparing for a sale two or more years before they expect to enter the market. Starting early provides time to organize financial records, address business risks, reduce owner dependence, document earnings adjustments, and resolve issues that could affect business value.
What financial records will a buyer need when purchasing a business?
Business buyers typically request several years of financial statements and tax returns, along with current interim financial information. They may also request customer and vendor contracts, leases, debt agreements, employee information, insurance policies, and other records needed to evaluate the company’s financial performance and risks.
What are add-backs when selling a business?
Add-backs are expenses included in historical financial statements that may not continue under new ownership. Examples may include above-market owner compensation, certain personal expenses, related-party expenses, and legitimate nonrecurring costs. Buyers and business appraisers generally expect proposed add-backs to be reasonable and supported by documentation.
Should I get a business valuation before selling my business?
A business valuation can help an owner establish reasonable expectations before entering negotiations with potential buyers. It may also identify factors that increase or reduce business value, giving the owner an opportunity to address significant risks before beginning the sale process.
What factors can reduce the value of a business before a sale?
Factors that may reduce business value include customer concentration, dependence on the current owner, inconsistent earnings, limited management depth, expiring contracts, deferred capital expenditures, outdated equipment, and dependence on a small number of employees or suppliers. Reducing these risks before a sale may make the business more attractive to prospective buyers.