While every business sale transaction is different, after being involved in many business sales and purchases, I have noticed a few common pitfalls and traps for the owner/seller. Whether your exit is imminent or 10+ years from now, here are a few to watch out for on your path forward, a list of what not to do.
1. Give Team Raises
We’ve encountered a number of business owners who prior to selling will give raises to their team. There is always a myriad of reasons – no raises in a long time, wanting to reward loyalty before leaving, and as a way to ensure employees are taken care of, etc. All nice sentiments but this can definitely impact a transaction and purchase price.
A raise can be appropriate if it is earned and a part of a regularly scheduled event or if your team are currently being paid below local economic or profession standards. However, any bump in salary that is not planned for with a corresponding increase in revenues will reduce the profitability of the business and therefore it’s value. If you feel you need to reward certain dedicated employees, it’s better to provide a closing bonus to them out of the sale proceeds.
2. Change Your Accounting Methods
It is best to avoid accounting system changes such as moving from cash to accrual accounting, re-categorizing expenses differently than you have done recently, changing accountants who then shift your structure, etc. Buyers and their lenders will analyze a business’s financials and they expect verifiable results. They will assess the cash flow to determine 1) if the value is fair and 2) where risk/opportunities lie. Inconsistencies in expenses and shifts in organization can make buyers and lenders wary about the reliability of the earnings projections. This could result in a lower offer price or worse, it could turn the buyer off the business altogether.
3. Make Significant Change to Employee Benefits
Unless you are reducing the expense to the business, making significant changes in employee benefit plans should be avoided for the reasons provided in #1 and #2 above. Also keep in mind, continuing employee benefit plans is at the discretion of the new owner. Depending on the trend in the benefit costs, it may or may not be sustainable for the new owner post-settlement. Receiving a benefit only to have it taken away could create friction between the staff and the new owner which could set everyone up for failure.
4. Purchase Excess Inventory or Deplete Inventory
Almost all business value determinations include an operational level of inventory in the business price. This means that a “normal” inventory level must be present at settlement, unless otherwise agreed. Most contracts will provide for a physical count of the inventory at settlement. If there is an excess amount or if the inventory has been depleted the settlement may be disrupted and/or purchase price adjustment may be warranted.
5. Purchasing High-End Equipment or Engaging in New Leasing Arrangements
The business earnings (profits) drive the value of the business, period. Purchasing new equipment may increase a practice’s attractiveness to a potential buyer but it is not likely to increase the value of the business – unless the equipment is used to generate new revenues which lead to greater earnings. When you are planning an exit, such investments may make sense if you have the time to produce the return on the investment.
On the leasing side, having lease agreements can create complications during a business sale transaction, even when the lease “pays for itself” through details in the agreement. While there are exceptions, in most transactions, the leases are paid out at settlement, with clear title passing at that time. They do not transfer to the new owner. Just because the lease agreement is transferable or assignable does not mean that the buyer will accept the transfer and the obligated relationship. Entering into new binding agreements during your exit planning should be done cautiously and with great attention to detail.
6. Starting to Coast Before You Exit
The business value is based on what the business is currently doing. Having easy potential to increase revenues by expanding hours, increasing marketing or providing more services definitely adds attractant value for a buyer, but it does not add $$ value. Buyers aren’t interested in paying vendors for the work that they, the purchasers will need to do to make the potential real. Business owners that start coasting (cutting back hours, limiting services provided, etc.) can risk impacting the business value significantly which can make for a very different exit that expected.
7. Not Having Your Business Valued
It is the owner’s responsibility to set the price of the business. Ideally, advice for this would come from an experienced accountant or professional business appraiser. However, an owner is entitled to put any price on their business that they want. Doing so though does not mean a buyer will pay it. While there is still the occasional fool, almost all buyers will test the price with their advisors, lenders and accountants. If the purchase price is not realistic, the negotiations can come to a standstill, with both parties now distrustful of the other. Additionally, for the seller, it’s a poor way (and poor timing) to find out that their business (a major retirement asset) is not worth as much as they thought. We also find that an unrealistic price put on a business when first listed for sale results in a sale price much less than what would have been achieved had the seller been realistic with their price in the first place.
Related to this is sharing the business financial and operational data with the possible buyer before your valuation is complete. As the owner/seller, it can be challenging to commit to a transaction before you have all of the details involved in your decision. Value the business first, commit to an exit and then begin the process with your buyer. Resist jumping ahead in the sequence.
8. Ignoring Facility and Equipment Care & Maintenance
Whether the premises are going to be leased or sold, the buyer will most likely have a building inspection performed and will test all of the equipment. When multiple issues surface a buyer can start to wonder about the conditions of things that are not so visible. It can be overwhelming to a potential buyer to realise that not only will they have the new challenge of business ownership but that they will also have to deal with the hassle of facility repairs. This can often add a new round of negotiations prior to the closing which often result in purchase price adjustments. As you plan your exit, engage a building inspector and fix the issues long before transaction process starts.
9. Sharing the News Prematurely
This is an exciting and transformative event for all involved. Sharing the news before it becomes real though, can create many issues for your team, your clients, and your community and for the buyer and the transition.
A pending business sale can cause a lot of unrest and speculation among your team which sometimes translates into employee turnover. If clients find out, some may start looking for alternative employment rather than wait and give a new buyer a chance. The business needs to remain stable and financially healthy while the right buyer is found. Once a buyer is located, there will be plenty of time to answer questions and provide assurances before the transition actually happens. Have a plan for the announcement. This is particularly important for key team members.
10. Waiting too Long to Plan
This is a very common mistake. Don’t wake up one day and decide “now is the time to sell!” There are many details to prepare including appraisals (business and real estate), building inspections, tax implications, and the retirement plans such as cash flow, health insurances, and what you are going to do with you time. Additionally, if you do not have a buyer already, you may need to find one on the market – it may take some time to find the one!
Exit Planning Mistake Avoidance
A successful sale and transition is a life-changing event for all involved. It is worth making the time to plan your ideal exit and then a back-up plan or two. Make your decisions with full knowledge of the relevant facts and you will have a plan that once put into place, will get you where you want to be, when you want to be there. In fact, renowned business author, Michael Gerber, author of best seller “E Myth” states that your purpose in starting a business should be to sell it. All actions in starting and building your business should have this aim.
If you are looking to buy or sell a business, the team at GTP are more than qualified to guide you through this process.
Acknowledgement: Much of the information provided in this article has been drawn from an article by David McCormick and Sherry Everhart of Simmons Mid Atlantic, Veterinary Practice Sales & Appraisals.