We have included tips in the more common areas based on dealing with thousands of businesses that have embarked on this journey of preparing their business for sale.
We have found through experience that many businesses have reduced the profitability of the business for tax reasons and, if this is the case, the true value of the business will not be clear from the financial records. This creates a significant problem when the business is being valued for sale, especially if the business is being sold on a multiple of profit.
Many small business owners argue they are too busy running the business to implement costly internal systems and procedures. With powerful and affordable accounting and management software products now widely available, even a micro business can produce detailed management information in a simple and timely manner. More automated businesses are more valuable businesses.
If a business does not appear in order, the business value goes down, therefore it is important for entrepreneurs thinking of selling to implement systems that will have the added benefit of increasing productivity and profitability in the lead up to the sale.
During the due diligence phase, buyers begin tentatively but then quickly form a judgment about whether all the information provided is credible and whether the business has a good chance of continuing the income into the future.
The sale process will be delayed if the necessary documentation is not in place. Here are some tips to help you to get ready for this process:
Tip #1: Human Resources
A buyer looks for evidence that the business has a team of people in place who are capable of running and growing the business without the involvement of the previous owner. This makes strong human resources systems vital to a sale.
Many small businesses are only as good as their management and staff, and prospective purchasers know this. Where the business is a service industry, the value of trained and committed staff is a major component of the deal, and it is important the workforce is motivated and accountable.
Businesses also shouldn’t appear as if they are too heavily dependent on the involvement of the owner. If this is the case, more responsibility and autonomy should be given to senior staff as you prepare to sell, so that when you step out of the picture, the business doesn’t fall apart. A business will be more attractive to prospective purchasers when it can show its owner is not critical to the operation.
The business should have job descriptions that include key performance indicators (KPIs) for each role within the business. A job description covers why a job exists, what skills or qualifications are required, what are the mandatory and supplementary functions of the job, what the objectives of performance measurements of the job are and how they link to the management goals for the company. Setting KPIs for each employee means the business owner can better monitor performance.
There should be a signed contract with each employee and evidence of performance reviews and their outcomes on file.
All intellectual property developed within the business should be signed off by employees and contractors.
Company policies and procedures should be documented and a procedures manual becomes a useful document when inducting new employees. There should also be a current management chart showing the title of each position and connecting lines showing who is accountable to whom.
Other HR issues a buyer will consider are staff turnover, how employees will react to a sale, whether management is respected and employee morale.
An owner should create a succession plan that looks at all tasks he/she performs in the business and identify people who could take over, and what level of training they would need to do so. New salary and commission packages should be considered for people taking on new responsibilities and a time frame calculated for the delegation of the owner’s areas of responsibility.
Tip #2: Marketing Plans and Systems
When a potential buyer looks at a business, it will be evaluated on the basis that he or she can replicate the business model to continue making profit in future years. Potential buyers will ask about the customer acquisition process. They will need to be assured that the current business owners don’t personally generate all the income. Therefore, having good marketing and sales systems that can be demonstrated to win new clients is essential for a good valuation.
Small businesses often market in an ad hoc manner and fail to measure the success of their activities, so comprehensive sales and marketing forecasts, lead generation, conversion and churn rates are an asset when negotiating. As is a good marketing plan.
A marketing plan should encompass market research, marketing objectives, marketing strategies and monitoring and control processes. Fundamental to a successful marketing plan is understanding the needs of the business’s customer base. This includes characteristics such as gender, aspirations and an ability to pay. A marketing plan needs to outline the size of the market, where it is located, and how it is being impacted by technology, attitudes and social and economic trends. The market can be further segmented into customers with similar attributes like ethnicity or gender.
A marketing plan should include their product offering, their reputation, their strengths and weakness and pricing. A competitor’s website is often a good starting point for competitive intelligence. Marketing goals cover what products or services a company offers to different market segments, the key benefits a company offers, what the company’s competitive advantage is, and what targets need to be met. Marketing goals need to be specific, measurable, achievable, realistic and time bound. They should encompass ‘The Four Ps’ – product, price, promotion and place.
Most importantly, business owners should create a portfolio of past sales letters and what response they elicited. There should also be a portfolio of advertisements with information on where they were placed, the inquiries they generated and how many of these were converted into a sale.
CUSTOMER RELATIONSHIP MANAGEMENT (CRM)
The driver of any business is sales. Today, many small businesses use Customer relationship Management (CRM) software to keep track of the entire sales process, including forecasts, sales pipelines and sales. It is also an effective way to keep a sales force accountable.
CRM software lets a company use what it knows about its customers to target them using tailor-made marketing to obtain a higher response rate. Today CRM systems can be integrated with accounting software and other programs such as Microsoft Outlook or your email software.
A review of a CRM system will be one of the key ways a prospective buyer will assess the strength of a business’s customer base. The database should correlate with other sales figures provided and needs to be clean and contain unique records.
Tip #3: Contracts
Any potential purchaser is going to want to review all the contracts that the business has signed. If it is a company share transfer, the new buyer will have all the liabilities of these contracts transferred.
These include all contracts that bring money into the business or are part of the revenue obligations. This includes strategic alliance contracts, sale or distribution contracts, product contracts, support/maintenance contracts and warranties relating to plant and equipment.
These include all expense areas such as leases for property, equipment or motor vehicles, insurance policies, web hosting, cost of goods and other suppliers.
Buyers will want to review the potential liability from any warranties. There are four types of warranties. Voluntary Warranties are given by manufacturers, resellers or service providers to demonstrate they stand by their product. Extended Warranties give a manufacturer’s warranty over a longer period. Specified Warranties are those imposed by a state or territory for a particular product such as used cars. Implied Warranties are those imposed by the Trade Practices Act and Fair Trading laws.
Buyers will want to see evidence of insurance policies covering public liability, vehicle, fire, burglary, professional indemnity and sickness.
Tip #4: Financial Documentation
Well-documented financials are critical to a successful sale. Sellers need to have copies (where applicable) of the last three years’ tax returns for the business and up-to-date tax statements. Buyers will also want to check depreciation schedules for equipment and furniture and fittings, and check the book value, market value and replacement value of fixed assets. At the time of the sale, all equipment needs to be in good working order.
Sellers also need to produce a reconciliation that includes ‘add-backs’. Add-backs are all the personal, or one-off expense items that are included in the tax returns. It should also include all payments and wages paid to the owner (and associated personnel). This then provides a net payment of the return to the business owner. Sellers should also add back depreciation that shows the cash return to the owner.
This figure of profit before tax plus add-backs is often used as valuation tool. Most buyers will also demand that a market payment for a business manager also be added back.
When you are negotiating the sale of the business, sales by customers and products and detailed management reports are necessary to demonstrate how the business has been performing at the micro level.
The due diligence process will check that all superannuation obligations have been met and long service leave entitlements may become an adjustment in the final sale price.
MANAGEMENT SYSTEMS AND FORECASTS
Businesses are valued based on the amount of future income they may be able to generate factored against risk. Therefore, the more credible a forecast is, and the more reliable it is seen as a projection for future income, then the higher the likely value of a business at valuation.
It is good to provide a 12-24 month forecast, a five-year forecast and a scorecard. If your forecast is non-existent or seen as non-reliable, then it is likely that a business will be valued on historical earnings and this may lead to a downward valuation.
Tip #5: Company Documents and IP
There needs to be a register of all the business’s trademark and patent documentation.
If it doesn’t exist, the vendor should create an IP Register that details logos, trademarks, patents, software copyright and designs.
If there is a website or websites, there needs to be a list of all the domain names and where they were registered. This is important because when a business is signed over to someone else, the seller will likely be assigning the rights of all the websites, trademarks and patents.
The company incorporation documentation, which includes the Memorandum of Incorporation, the Share Registry, personal details of all shareholders, registered business name and an Asset Register will need to be available for review during due diligence.
Tip #6: Credibility and Branding
TESTIMONIALS & CASE STUDIES
Although a business owner might know how good their company is, this needs to be communicated to potential buyers. A seller should make sure to print out any credible customer testimonials and awards or recognitions, all of which reflect the company has a good reputation.
If the business is actively involved in community programs, this is worth highlighting. Also, a seller should put together some case studies of high-profile companies that have used the business’s product and saved time or money. Case studies can also be placed on a company’s website to create public relations activity.
Although there is a time commitment needed to enter business awards, it does add to the credibility of a company. At the very least, it is worth investigating local business awards.
A powerful, well-known brand increases goodwill. The most common mistake small businesses make is to name the business after the owner. Usually this reduces the attractiveness of the brand to a potential purchaser, as it flags the fact the business is reliant on the original owner.
Prior to going to market, an entrepreneur must look at the business name and product names, making sure the brand appeals and will not limit the business to a segment that in the future may become obsolete.
When the time comes to sell the business, it can be restrictive if the name of the business is linked to a geographical area. This makes it hard for a buyer to move to another location or open multiple outlets in other locations.
Our friends over at Maus Software have been gracious enough to provide us with this information