by Peter C. King, VR Business Brokers/Mergers & Acquisitions, CEO

In a perfect world, business owners sell their companies when banks are anxious to lend, the economy is strong, their industry is booming and the business is enjoying record profitability, with the future looking even brighter. Naturally, a perfect convergence of all these variables would enable you to maximize the value of your business allowing you to sell it at the highest price and on the best terms.

But most business owners don’t sell when market conditions are perfect. Instead, they make the decision for more personal reasons, such as retirement or to free up cash to pursue other investment opportunities. Unfortunately, many businesses are sold when the owner dies unexpectedly or is otherwise unable to run the business. These unplanned events increase the chance that the business will realize a lower selling price than it would in better circumstances.

QUESTIONS TO ASK

Before you make the decision to sell, you need to ask yourself several questions. First, how motivated are you to sell? Selling a business is an arduous process that can take a year or more from the initial valuation to finding a buyer to finalizing the deal.

Second, have you adequately prepared your business to be sold? Most experts agree that owners should plan for the sale of their business at least three years in advance. You may even want to plan for an eventual sale as you’re still establishing and building your business.

But even if you have no current plans to sell, managing your company as if it will be sold is likely to result in a more efficient, financially viable business. For example, your business plan whether a formal or informal document should evaluate growth opportunities, market position, and business goals, and explain how progress in reaching these goals will be measured. Not only is your business plan an important tool in unlocking the current value in your company, but it also serves as initial prospectus for prospective buyers.

INTERNAL AND EXTERNAL FACTORS

Keeping an eye on economic cycles and how they affect the merger and acquisition market is important. The market for privately owned companies can be just cyclical as that for publicly traded companies. Economic recessions, for example, generally mean there are fewer buyers. General economic weakness can also result in a drop in your business’s profitability and a perception among buyers that your business is a risky acquisition.

Also be aware of your business’s growth cycle and plan to sell when sales growth has reached a peak. Of course, this isn’t always easy to calculate, and typically requires the help of outside advisors. Further, you are better positioned to sell if your company boasts valuable patents, brands, proprietary products or a lucrative market niche.

Businesses are typically valued on a multiple of earnings. Your business’s earnings, therefore, must be transparent and documented. Many deals are funded with bank debt, and most lenders won’t finance a transaction without stable cash flows that can be verified through solid financial statements. Buyers also usually look for breadth of management because it reduces the company’s dependence on the departing owner and allows the buyer to learn the business from an experienced management team.

There are also a number of relatively minor things you can do to enhance the perceived value of your company and make it more attractive to purchasers. Cleaning up and organizing the office, factory and warehouse space is an inexpensive enhancement. Repairing or replacing equipment may cost a bit more, but will help you attract buyers seeking a turnkey operation. Finally, consider disposing of unproductive assets or old inventory that buyers don’t want to be burdened with.

MAXIMIZING YOUR SELLING PRICE

Selling your business can be time-consuming a complex process, but you’re likely to maximize your selling price by planning the event well in advance and by engaging qualified advisors to assist you. While a deal can often be put together quickly, maximizing value means that selling your business may take time. Remember, you don’t want to feel pressured to take the first offer, or to accept terms that are less favorable.

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The very best time to sell your business is when someone wants to buy it. While it can be tempting to continue to grow your business forever – particularly when things are going well — that decision comes with a significant downside.

Take a look at the story of Rand Fishkin who started his entrepreneurial journey when he joined his mother’s marketing agency as a partner:

When Fishkin realized how much his Mom’s customers were struggling to get Google to display their company in a search, he immersed himself in the emerging field of Search Engine Optimization (SEO).

He began writing a blog called SEO Moz, which led to an SEO consulting and software company. By 2007, Moz was generating revenue of $850,000 a year when Fishkin decided to drop consulting to become solely a software business.

The company began to grow 100% per year and by 2010, Moz was generating around $650,000 in revenue each month, attracting the attention of Brian Halligan, co-founder of marketing software giant HubSpot.

HubSpot wanted to buy Moz and was offering $25 million of cash and HubSpot stock – an offer almost five times Moz’s $5.7 million of revenue in its last complete financial year.

But Fishkin wasn’t satisfied. He believed a fast growth Software-as-a-Service (SaaS) company was worth four times future revenue and was confident Moz would hit $10 million by the end of that year.

Fishkin counter offered, saying he would be willing to accept $40 million. HubSpot declined.

New Plans Ahead

Instead of selling Moz, Fishkin raised a round of venture capital and started to diversify away from SEO tools into a broader set of marketing offerings. The further Moz veered away from its core in SEO, the more money his business began to lose.

By 2014, Moz was in full crisis mode, and Fishkin had begun suffering from a bout of depression. He decided to step down as CEO, describing his resignation as a “lot of sadness, a heap of regrets and a smattering of resentment.”

Fishkin became a minority shareholder in a company he no longer controlled where the venture capitalists had preferred rights in a liquidity event.

A Lesson Learned

In the ensuing years since turning down Halligan’s offer, HubSpot went public on the New York Stock Exchange and had been worth nearly 20 times as much.

Fishkin revealed that today, his liquid net worth is $800,000 – much of which he was about to spend on elder care for his grandparents. The Moz stock he holds may or may not have value after the venture capitalist get their preferred return. At the same time, Fishkin estimated HubSpot’s offer of $25 million in cash and HubSpot stock would now be worth more than $100 million (based on the increased value of HubSpot’s stock).

Fishkin’s tale is a cautionary reminder why the best time to sell your company is when someone wants to buy it – a story that is shared in his book Lost and Founder: A Painfully Honest Field Guide to the Startup World.

What if an offer was made for your business today? Would you be ready to sell? Would you regret if you said no?

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The value of your business comes down to a single equation: what multiple of your profit is an acquirer willing to pay for your company?

profit × multiple = value

Most owners believe the best way to improve the value of their company is to make more profit – so, they find ways to sell more and more. As experts in their industry, it’s natural that customers want to personally engage with them, which means spending more time on the phones, on the road and face-to-face to increase sales.

With this model, a company can slightly grow, but the owner’s life becomes much more difficult: customers demand more time and service, employees begin to burn out, and soon it feels like there are not enough hours in the day. Revenue flat lines, health can suffer and relationships get strained – all from working too much. Does this feel familiar?

If you’re spending too much time and effort on increasing your profit, you could find yourself diminishing the overall value of your business. The solution? Focus on driving your multiple (the other number in the equation above). Driving your multiple will ultimately help you grow your company value, improve your profit and redeem your freedom.

What Drives Your Multiple

Differentiated Market Position

Acquirers only buy what they could not easily create, so expect to be paid more if you have close to a monopoly on what you sell and/or are one of the few companies who have been licensed to provide the specific product or service in your market.

Lots of Runway

Most founders think market share is something to strive for, but in the eyes of an acquirer, it can decrease the value of your business because you’ve already sopped up most of the opportunity.

Recurring Revenue

An acquirer is going to want to know how your business will do once you leave – recurring revenue assures them that there will still be a business once the founder hits eject.

Financials

The size and profitability of your company will matter to investors. So will the quality of your bookkeeping.

The You Factor

The most valuable businesses can thrive without their owners. The inverse is also true because the most valuable businesses are masters of independence.

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This article is provided by Brent Beshore, courtesy of Axial.net.

The following is an excerpt from investor Brent Beshore’s recent book, The Messy Marketplace: Selling Your Business in a World of Imperfect Buyers. Beshore is founder and CEO of adventur.es, a Midwestern-based permanent equity firm. 

As a seller, it can be easy to fixate on the numbers. “My business is worth X. I’m going to get Y cash at close.” These figures will represent some of the largest you’ve seen in your lifetime. The focus on valuation is understandable, but remember that structure and terms are equally important in negotiation.

When negotiating with a qualified and trustworthy investor (a.k.a. the type of buyer you probably want), you should take advantage of their expertise. While this may seem counterintuitive, they have spent their careers understanding creative ways to structure a deal, from responsible options and uses of debt to how to properly incentivize existing leadership to ensure a smooth transition. Your best path is to tell them what is important to you and why, and also what you recognize to be the risks in the deal. Then let them explain what options may satisfy both parties best. To be clear, I’m not suggesting blind trust in a buyer regardless of reputation, or your intuition. Always approach a proposed solution with open-minded skepticism.

To illustrate, here are a handful of scenarios:

QUICK EXIT: You tell the buyer that you will only consider an offer that provides all cash at close because of grave health concerns. Immediate liquidity is priority number one. You are asking the buyer to assume all responsibility and liability for not only the future prospects of the organization, but also the transition post-close. The buyer will apply a discount and the resulting valuation will likely be substantially less than a deal with more structure over a longer time period.

MARKET-BASED EXIT: You tell the buyer that you have a target valuation range, providing research that backs up why you believe it is reasonable for your business. The buyer will compare your research against their own, and also the circumstances of your company. Sellers sometimes bring forth research on industry-relevant com- panies unrelated in scale, leadership depth, and earnings history, which a buyer will quickly disregard. If the research is valid, how- ever, the buyer will likely calculate a similar valuation range (it may not be exactly the same, but they’ll tell you why) and focus on structure and terms. What percentage will be earned out to ensure performance? What guarantees will be outlined about key employees and customers?

BRIGHT FUTURE EXIT: You tell the buyer the company is set up for future growth, you have confidence in the projections provided, and, while you need some immediate liquidity, you want to share in the upside. The buyer will structure the deal to share risk and reward.

Valuation and terms for each of these exit scenarios will be varied, and that’s a good thing. They’re creative solutions. It’s key to remember what’s important to you and evaluate the options against those criteria. And above all, communicate your interests clearly.

There are no hard rules in valuation. A buyer doesn’t have to match another buyer’s offer, accept your presented adjustments, or meet your demands on timeline or payment structure in their offer. And, you don’t have to sell. Every value and formula is negotiable.

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Source: FeelPic/iStock

Takeaway: Take control of your financial statement by learning how accounting policies can positively impact EBITDA.

This article written by John Carvalho, president and founder of Stone Oak Capital Inc., an M&A advisory firm, as well as a co-founder of Divestopedia

EBITDA is a commonly used metric for the valuation of mid-market businesses. Now, the appropriateness of using EBITDA can be debated, but the fact is that most estimates of business value start with this number. So needless to say, increasing EBITDA will increase the value of a business.

Most often, business owners of privately held companies are motivated to minimize taxes. They will try to expense as much as possible and even defer recording revenue to reduce taxable income. Business brokers or investment bankers will often normalize the results of a vendor’s financial statements for nonrecurring or one-time costs. These normalizations are scrutinized by potential buyers and often rejected as legitimate adjustments. On the other hand, EBITDA (before normalizations) calculated from financial statements that are prepared by an external accountant receive much less scrutiny from the prospective buyer.

To this end, business owners should consider how their accounting policies are impacting EBITDA. The truth is that business owners can choose between various accepted accounting methods to show higher EBITDA on their externally prepared financial statement and thus positively impact business value. Some people may consider this to be financial engineering, which carries a negative connotation. I consider it to be smart exit planning.

Selection of Accounting Principles

Accounting principles are rarely black and white. There is a significant amount of gray in determining how to record a transaction. Let’s thank Luca Pacioli, the father of accounting, for the double entry system of bookkeeping that has been used for over four centuries. In its simplest form, cash outlays can be recorded as an expense on the income statement or as some sort of assets on the balance sheet. Comparatively, cash inflows can be recorded as revenue or some sort of liability (or equity) on the balance sheet. There is significant judgment and flexibility that goes into recording each transaction. This, of course, can have a material impact on the EBITDA of a business.

Here are five common accounting policy selections that can be managed to increase EBITDA:

Capital Leases versus Operating Leases

One on the biggest knocks against EBITDA as a valuation metric is that it is supposed to reflect a company’s cash flow, but it does not consider the requirement for capital expenditures. Warren Buffett, in his criticism of EBITDA, is credited as saying, “Does management think the tooth fairy pays for capital expenditures?” Regardless of your stance on EBITDA, capital asset expenditures are not considered in the calculation of EBITDA, but depreciation and amortization is added back.

If your company is capital intensive, recording equipment leases as capital versus operating will improve EBITDA. For operating leases, rental payments are expensed on the income statement and therefore reduce earnings. On the other hand, if a lease is recorded as a capital lease, the assets are recorded on the balance sheet and depreciated over time. The related liability is recorded as debt on the balance sheet and the interest is expensed on the income statement. Payments toward the capital lease are not expensed and instead are recorded against the liability which would not impact earning. Also depreciation on the asset and interest on the debt are added back, therefore EBITDA would be higher.

Capitalization

Another method to increase EBITDA is to be more aggressive on capitalization of costs, which means moving cash outlays from being recorded as an expense on the income statement to an asset on the balance sheet. This has two positive effects: The first is that it strengthens your balance sheet by showing more assets; the second is reducing expenses and increase EBITDA.

A transaction can be capitalized if it extends the useful life of a capital asset. Significant repairs and maintenance costs are often expensed in privately held businesses to reduce net income and, correspondingly, income tax at the detriment of higher EBITDA.

Costs that have future economic value that can be measured might also be eligible for capitalization. As an example, wages paid to employees for the development of a new software can be added to the cost of that implementation. Capitalization of costs is a gray area that requires just as much qualitative justification as quantitative.

Inventory

Many privately held businesses will hold inventory even though it is fully expensed when purchased. A periodic inventory count can move the inventory still sitting in the shop or warehouse off of the income statement and on to the balance sheet. This has the immediate effect of increasing EBITDA and also, from a financial reporting perspective, presents a more realistic picture of the working capital required to operate the business.

Revenue Recognition

Revenue recognition is an accounting principle that determines the specific conditions under which revenue is recognized or accounted for. Revenues are recognized when they are earned and corresponding expenses are recorded to match that timing. But when is the revenue actually earned?

Many businesses will record revenue when a project is completed, but there are many instances when partially completed jobs will straddle a company’s year-end. If revenue was recognized for the percentage of the work completed on those projects, the profit margin would be recorded on the income statement and increase EBITDA for that period.

Cut-off

Cut-off relates to whether transactions and events have been recorded in the correct accounting period. Moving certain transactions from one period to the next can have a significant impact on EBITDA. For example, delaying major purchases or taking delivery of major items after year-end can push costs to the subsequent year and thus increase EBITDA. The same is true on the revenue side if a company is able to close a major deal or make a large shipment to a customer prior to a year-end.

Own Your Financial Statement

Let me be clear that I am not suggesting perpetrating fraud or any sort of misrepresentation that could mislead a potential buyer; I am merely suggesting that selection and knowledge of accounting policies can have a significant impact on EBITDA and, consequently, the determination of a company’s value during a sale process. I see too many business owners blindly accept the adjustments that are presented to them by their external accountants. Your company’s financial statement are exactly that — yours! You should have significant input into the policies used in their creation and the ending results that they communicate to outside stakeholders.

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One of the biggest mistake owners make in selling their company is being lured into a proprietary deal.

The Definition Of A Proprietary Deal

Acquirers land a proprietary deal (or “prop deal”) when they convince owners to sell their businesses without creating a competitive marketplace. Acquirers running a proprietary deal know they don’t have any competition and tend to make weaker offers with more punitive terms because they know nobody else is bidding.

Many founders become the target of a proprietary deal without even knowing they have been duped. First, someone senior from the acquiring company approaches the founder, complimenting them on their business. The acquirer suggests lunch, and then high-level financials are exchanged. Soon, the owner starts going down a path that is difficult to come back from.

As the parties in a proprietary deal get to know one another, founders often share information with the acquirer that puts them in a compromised negotiation position. The interactions are set up as friendly exchanges between two industry leaders, but many founders reveal key facts in these discussions that end up being used against them when negotiations turn serious. Business owners also become more emotionally committed to selling the more resources they invest in the process and the more time they spend thinking—perhaps dreaming—of what it would mean to sell their business.

How To Avoid Getting Taken In By A Proprietary Deal

Savvy sellers avoid the proprietary deal by creating a competitive process for their company. Take for example Dan Martell, the founder of Clarity.fm, among other companies. When Martell decided to sell Clarity, he knew the likely buyer was one of five New York-based companies. Instead of negotiating with one, he invited all five to an event he hosted in New York. The five CEOs—all of whom knew one another—saw a room full of their competitors and realized that if Clarity went on the market, they would have to out-bid the other buyers in that room.

Hosting the event was Martell’s way of communicating to all the potential buyers that a proprietary deal was off the table and that if they wanted to buy Clarity, they would have to compete for it.

It’s flattering to receive a call from an executive at a company you respect. Just know that if you accept their invitation of lunch, you run the risk of becoming the latest casualty of the proprietary deal.

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