What Happens If?
You may not have any intention of selling your business today. But, what happens to your business if you get hit by a truck, fall ill or are injured in some other way making you unable to operate your business for a fairly long period of time? Will your spouse step in? Do you have a trusted employee that can run things? Now might be a good time to give this some thought and discuss it with family and advisors.
You have spent time, effort and money building your business. Your business is probably your and your family’s biggest asset. So, what happens to this asset if one of the unfortunate events mentioned above actually occurs? Without some strategies to deal with the unexpected, your business could be in serious trouble by the time you recover and return to work. Or worse, if you fail to survive an illness or injury, your family/heirs will be forced to create a plan of action to run the business or, at least, operate it until it can be sold. The obvious time to come up with a plan for the unexpected is before it happens.
This type of plan is different than an exit strategy. An exit strategy provides a plan that can be followed for a planned retirement or cut-back. Illness, accidents and death are seldom planned events. They are sudden events where the owner and operator of a business becomes incapacitated and, if there is not a written plan of action the business could find itself in jeopardy.
This written plan of action should outline your wishes in the event of illness, injury or death. Is there someone who can run things until your business is sold? If you are the main cog in the company’s success and you are not able to be there, how will your customers and suppliers feel about doing business with your company? Maybe now would be a good time to get key person insurance, increasing your own life insurance to cover taxes in case of death. It may also be a good time to pick a successor – just in case. If there isn’t someone who could take over, is there someone who could at least keep things operative until the business is sold? Maybe it’s time to have your spouse or one of your children learn something about the business – again, just in case. Maybe you have an employee who could keep things running until the business is sold or until you are able to return to work.
In addition to your family and advisors, it might also pay to talk to a professional business intermediary. You may not be ready to sell, but if selling becomes a necessity in the future, a consultation with a business intermediary can provide you with a lot of valuable information about the sales process to help you plan now.
Increasing the Value of Your Business
Considering selling your business? Just want to increase the value of your business? Here are some areas to look at that can fairly quickly increase profits, which are, after all, a main building block in creating value.
• PRICING: Are the prices of the products or services set too low? Owners too often continue with the same prices year after year without revisiting their pricing structure.
• CUSTOMER SERVICE: Despite all of the above Elevating the quality or amount of customer service may not only increase business and support the higher prices suggested above, but also encourage customers to pay more promptly, increasing cash flow.
• EXPENSES: Owners should review what they pay for inventory, supplies, utilities, insurance, technology and any other expenses. Are you getting the lowest price possible? Are you taking advantage of all available discounts, etc.? It may pay to check pricing from other suppliers and vendors. Every saving increase profits and subsequently profits.
• INVENTORY: In some cases inventory levels may be higher than necessary. Retail operations want their stores to look “busy,” but they don’t need a basement or warehouse full of inventory. In today’s fast-moving economy, inventory can be supplied almost on demand – in most cases. This should be balanced by still taking advantage of special pricing on certain items or stockpiling hard-to-get inventory.
• OUTSOURCING: Some services, especially in today’s environment of the self-employed, can be outsourced. While replacing workers is not pleasant, and should only be done if substantial savings can be realized, outsourcing is often worth investigating.
• EMPLOYEES: Now may be the time to get rid of any disgruntled employees. Happy and contented employees make for a profitable business.
These are just a few areas to consider to help increase profits and, subsequently, increase value.
Unreported Income: “Show Me the Money!”
Prospective buyers don’t want to hear about “what the business really makes” – they want to see the books and records that show what is down in black and white. Here is the old story about proper accounting procedures, or lack of:
A Greek restaurant owner had his own bookkeeping system. He kept his accounts payable in a cigar box on the left-hand side of his cash register, his daily cash returns in the cash drawer of the register, and his receipts for paid bills in a shoe box on the right side of the cash register. When his youngest son graduated as a CPA, he was appalled by his father’s primitive bookkeeping methods. “I don’t know how you can run a business that way,” he said. “How do you know what your profit is?”
“Well, son,” the father replied, “when I got off the boat from the old country, I had nothing but the clothes on my back. Today, your brother is a doctor. Your sister is a speech therapist, and you’re a CPA. Your mother and I have a nice car, a city house, a country house, and plenty of money for retirement. We have a good business and everything is paid for. Add all that together, subtract the ‘clothes on my back,’ and there is your profit.”
Great story and it is probably an accurate depiction of many small businesses, even in today’s world. Unfortunately, today’s buyers are not going to buy a business—not for anywhere near what the business may actually be worth in the marketplace—without checking the books and records. Buyers will not pay for what they can’t see. Some sellers want it both ways. Since they haven’t reported this income to anyone, they haven’t paid taxes on it; and now they want to sell it as a real number. They also seem to forget the most important part – “skimming” is against the law.
Joseph Bankman, a professor of tax law at Stanford University Law School said, “Nothing is as good as taking half your income off the books to start with; that’s better than any phony deduction. That’s the biggest single source of revenue loss in the tax system.” What these sellers may fail to realize is that the Internal Revenue Service (IRS) has audit guides for many different businesses. It tells them, for example, how to roughly calculate annual sales and expenses of a pizza place by tracking its purchase of cheese. Any seller who doesn’t think that the IRS can’t figure out income and expenses of most businesses is kidding herself. Too many small business owners think that they are getting away with it – but they just haven’t been caught yet. If they kept accurate financial records they probably would get a much higher price for their business, most likely making up for more than what they would have skimmed.
What happens is this: a business owner gets ready to sell, realizes that due to his or her unreported financial dealings, the business won’t sell for anywhere what he had hoped for. Now he is in the position of having to reveal to a prospective buyer how he is skimming from the sales, paying help under the table to avoid the usual employee costs, or padding expenses. Buyers do not look favorably on sellers who attempt to justify their price by revealing how they are cheating the government(s).
Here are some tips for business owners who are considering selling:
• Plan now to maintain accurate financial records. When it comes time to sell, you will be able to show a prospective buyer where the money is and what it was used for.
• Keep in mind that a selling price is usually based on the cash flow of the business. The dollar you hide today will most likely be worth two or three times that when it comes to selling price. Think long-term, not short-term.
• Talk to a business broker professional. He or she can provide some education about how businesses are priced. They can also offer suggestions on how to gather the necessary information for a prospective buyer.
By following the suggestions above and reporting all income, by taking only legal deductions and maintaining accurate financial records, when it comes time to sell and the buyer says “Show me the money” – you can!
The Highest Price Vs. The Best Deal
Naturally, sellers want the highest price they can get for their business. In come cases, however, it might not be the best deal. For this reason, every offer should be scrutinized carefully. When an offer is presented, the first thing a seller looks for is the price. If it is lower than anticipated, the seller’s first reaction is to give it back, initiating the case for its being much too low. A seller should consider an offer carefully and avoid a hasty reaction.
Here are a few alternatives that might offset a lower price:
• an offer with no or very few, and easily satisfied contingencies
• a consulting agreement or other deferred compensation
• a quick closing
• all cash, if that’s important
• employment contracts with relatives or long-time employee(s)
• business vehicle to remain with the seller
• buyer has a long success record indicating long-term survival
• short-term payment period if seller financed
When a professional business broker is involved, he or she can point out those areas that may offset the price, down payment or the structure of the deal. After all, the important thing is not what a seller gets, but what he or she gets to keep!
What’s Selling Now?
A recent survey revealed the following percentage breakdown of last year’s business sales by business types. The information was furnished by business brokerage firms nationally and compiled by Business Brokerage Press.
Retail businesses | 17% |
Food & Drink related business | 14% |
Auto related businesses | 9% |
Distribution type businesses | 11% |
Manufacturing businesses | 16% |
Service type businesses | 25% |
Other | 5% |
Professional Practices | 4% |
Figures rounded
Service type businesses include dry cleaners, quick print, video stores, etc. Other businesses include coin laundries, delivery, product, and vending routes, and any that don’t fit into the other categories listed.
What does this mean to you as a business owner? It indicates that service type businesses seem to be creating the most activity from business buyers, followed by retail and the food and drink sector. The service sector has also been the leader in businesses sold by business brokers for the previous two years. This coincides with the growth nationally in the service sector coupled with the broad range of businesses included in it.
The food and drink sector, which includes restaurants, fast-food, taverns and the like, has always been a popular one for buyers. One reason is that most people frequent these types of businesses on a regular basis and therefore are familiar with them. Plus, there has always been a certain “celebrity” status connected with this sector.
However, statistics aside, today’s buyer has more knowledge, experience and education than ever before and is willing to consider almost any type of profitable business.
Where Your Business Is Located Can Affect Its Price
The most recent editions of BizComps, the leading resource for comparable sales data (www.bizcomps.com ) has some interesting information on small business pricing based on the three major regions of the country – Eastern states, the Central states and the Western states. They cover thousands of actual business sales over a ten year period. Here is the breakdown:
Location Average Sale Price
Western states $299,500
Central states $221,951
Eastern states $285,941
Using the Western states as the base, since that region of the country has the highest average price business, businesses in the Central states sell for 74 percent of the average price in the Western states; and the average price in the Eastern states is 78 percent of the Western states average.
What Will Your Buyer Be Looking For?
The buyer loves your business; it’s just what he or she has been looking for. He has reviewed your financial statements and has made an offer contingent on several items. You’ve reviewed the offer and it looks fine, so what’s next? The contingencies in the deal mean that the buyer or his or her advisors have some concerns. In larger deals, this process might be called due diligence. However, in the smaller business sale, the items of concern are usually spelled out as opposed to a general review of everything. The reason for this is that larger businesses or companies have a lot more areas of concern than the typical smaller business.
Most contingencies concern the review of financial statements and/or business tax returns. Others may involve lease issues, the seller staying on for a set period of time, or some very specific issue such as repaving the parking lot, if the landlord won’t or isn’t required to.
Unfortunately, some contingencies may be hiding other ones such as a list of fixtures and equipment included in the sale. Sounds easy on the surface, but the seller forgot that two pieces of equipment currently not in use need repair or the walnut desk in the office belongs to Grandfather Smith and is not included. Or, while reviewing the lease, the buyer discovers that the landlord requires that the business must close by 9:00 PM or some other restriction applies and was not disclosed. Deals have fallen apart over similar issues.
Most contingency problems can be resolved prior to the business being placed on the market. The seller should do all of the following:
• Check the status of all furniture, fixtures and equipment (FF&E). Remove any that are not included in the sale or are inoperable if not in use – or make repairs.
• Review any contract such as the lease, any equipment leases, and contracts that will be assumed by the buyer. Make sure there aren’t “clinkers” in them. If there are, disclose them to a potential buyer out front – and be sure your business intermediary is also aware of them.
• Be prepared to answer questions such as:
– Are there any environmental, governmental or legal issues?
– How long will you be willing to stay and work with a new buyer – at no cost?
– Will the employees stay?
– Why was last year the worst one in years?
– Why was last year the best one in years?
The list could go on and on, but sellers need to be ready. Buyers don’t like surprises. A business broker professional knows the process like a book and can be invaluable in preparing the business for the marketplace.
A Seller’s Major Concerns
For many owners, selling their business is a new experience, and there is always the fear of the unknown. Selling a business is a not only a major economic decision, but it can also be an emotional one. After all, many business owners have spent many years, and a lot of hard work building the business. When the decision to sell is made, there will inevitably be accompanying concerns. However, when faced head-on, these concerns can usually be addressed and resolved. Here are some of the major concerns and ideas on how to deal with them.
Getting the Highest Possible Price
Every seller wants to get the highest possible price for their business – that’s a given. Here is an old, but very accurate definition:
- The Asking Price is what the seller wants.
- The Selling Price is what the seller gets.
- The Fair Market Value is the highest price the buyer is willing to pay and the lowest price the seller is willing to accept.
Today’s buyers are more educated, more sophisticated, and more demanding than ever before. They seem to be searching for a “sure thing” – yet, many are afraid to make the leap-of-faith necessary to make the final plunge. Buyers are also more numbers conscious than in prior years. Somehow they think they can buy a business and continue with business as usual.
Sellers, on the other hand, must understand that the buyer may buy with an eye to the future, but is only willing to pay for the past performance of the business. The buyers believe that the future of a business is up to them and they should reap the benefits of their efforts. The value or price, however, in their minds, is based on what the seller has done with it.
In order to obtain the highest possible price, the seller should make sure that the financial records are crystal clear. Any issues, whether, financial, operational, legal, or environmental, should be addressed and resolved prior to putting the business on the market. Hidden issues have sabotaged more sales than anything else.
This may seem a contradiction, but the seller must go to market initially with a fair price. Too many times, a seller’s first inclination is to start with a very high, and very unreasonable, price. They may feel that the business is really worth what they are asking and may be unwilling to accept the fact that the price is unreasonable. The thinking is that an interested buyer can always make an offer. Interested buyers will feel that the price is so high that a fair offer would not even be considered. A professional business broker can advise buyers on what is reasonable and what is not.
What is a Contingency?
A contingency in the sale of a business is a condition in the contract of sale or offer that must be resolved, satisfied or rectified by either a buyer or seller. If they are not satisfied then the sale will generally not go forward. Most offers on a business contain one or more contingencies. The sale may be subject to the buyer obtaining financing, or the seller repaving the parking lot. Experienced business brokers have seen just about every contingency there is. Most of these are placed in the offer by a buyer who has concerns about one or more issue and needs it or them to be satisfied before proceeding with or closing the sale.
It may be as simple as the sale is contingent upon the buyer receiving a five-year extension of the lease by [a certain date]. Or, the offer to purchase may state that the sale is conditional upon the buyer’s approval of the seller’s books and records.
The difference between the two examples is that in the first one, it is a specific event that must be satisfied, and a time limit is specified. The second example is open-ended, meaning that a buyer could opt out of the deal by disapproving the books and records essentially for any reason.
Here are some tips on contingencies:
- There should be a time period in which the contingency must be satisfied. Without it the deal could go on almost forever.
- It, or they, as the case may be, should be reasonable. There is no point in making the sale contingent on moving the building to the next state. As they say – “it ain’t going to happen.”
- Contingencies should be limited to very important or critical issues – those that impact whether a buyer will actually purchase the business or not. Minor items should be resolved prior to an offer being written.
- Confidentiality or proprietary issues may influence whether a buyer will buy the business, but the seller is not willing to proceed until an offer containing price and terms is agreed upon.
- Contingencies come in all sizes and shapes. Very few offers don’t contain at least one, and usually more than one. They are an inevitable part of selling – and buying a business. A business broker knows what is reasonable and what is not.
A Lease Primer
The following is provided as a simple explanation of common leasing arrangements within a small business transaction. It is not intended to provide legal advice.
The New Lease
A new lease is created generally when the prior lease has expired or is about to and when there are going to be substantial changes to the existing lease. A new lease would be executed between the purchaser of the business and the landlord. It is a new document either drafted by an attorney or used in a standard form that is available at stationery stores and in many books. A new lease involves negotiations between the owner or purchaser of the business and the landlord.
The Sub-Lease
A sub-lease is nothing but a lease within a lease. For example, if the seller of a business is permitted to sub-lease the premises, he or she, as far as a new owner is concerned, is the landlord. In this case, the actual landlord is still dealing with the seller and has no relationship with the buyer. Obviously, the seller needs the permission of the landlord or lessor to assign or sub-lease.
The Assignment of the Existing Lease
This is the most common form of allowing a buyer the use of the premises in which the business is located. In an assignment, the seller is “assigning” all rights to the existing lease to the new buyer. Once the assignment is executed, the seller usually has no more rights in that lease. However, in most assignments, the landlord reserves “all rights” in the lease. In other words, the seller, who may be a tenant or an assignee, is still responsible to the landlord if the buyer does not perform.