There are many hurdles directors must clear when positioning a business for a profitable sale, writes Domini Stuart.
Many of today’s business owners have worked hard to build an asset that would eventually fund their retirement. They may even have ploughed their profits back into the business rather than a superannuation fund.
But business intermediary and corporate adviser Paul Nielsen estimates that, when the time comes to sell, only 50 per cent of small or medium-sized enterprises (SMEs) will get as far as the contract stage and that just 40 per cent of these will actually settle at a fair market price.
“There’s no guarantee you will be able to find someone who wants what you have to offer,” he says. “I spoke to someone the other day who wants to sell the medical centre in rural Queensland he’s been running for over 20 years, but finding someone who is prepared to relocate to a small country town is like looking for a needle in a haystack. You have a much higher chance of success if your business doesn’t require special knowledge and can run in one of the capital cities.”
There is also the matter of disruption.
“Entire retail concepts are disappearing, while others are under serious threat,” says Tony Arena, who owns the business broking and business valuation business BCI Business Brokers. “Wholesalers, manufacturers, service providers and professionals are all vulnerable to new technology, automation and artificial intelligence. No-one wants to buy a business with no future.”
He suggests that all buyers are looking for profitability with maintainability and transferability of income.
“Maintainability is having a viable future,” says Arena. “Transferability ensures a seamless transition from one owner to the next, so a business with efficient systems, effective operations manuals, sound management and a strong brand will be more valuable. It’s also important that the business can run smoothly with little or no input from the current owner.”
Identifying potential buyers
It will be easier to set your business up for the most profitable sale if you know your target market.
“If you think an investor will be interested, having a general manager who can continue to run the business will be a big plus,” says Arena. “If you are more likely to sell to a private individual, you will need to focus on an easy transition.”
Nielsen has found that businesses turning over less than about $5 million a year are most likely to attract private buyers.
“In this case, business brokers will start by assessing fair market value – what they think business will sell for,” says Nielsen. “This includes an evaluation of the risks associated with the business, such as the length of time left on the lease and whether key employees are likely to remain after the sale. This year I have included cybersecurity in my risk assessment because a successful cyber attack can cripple a business financially. Buyers want to know that there is adequate protection in place for their investment along with well-tested disaster recovery procedures.”
The owner must then decide whether to go ahead with a sale at that asking price.
“Sometimes sellers want to ask for significantly more but that’s a waste of everyone’s time,” says Nielsen. “A bank’s valuation for loan purposes will come up with a similar figure to ours so, even if you could find someone willing to pay an inflated price, they wouldn’t be able to borrow anything like the full amount.”
Businesses turning over more than $5 million are more likely to attract strategic buyers.
“Here it’s more a question of how much the business would be worth to a particular buyer,” says Nielsen. “For example, you might be manufacturing and selling a product in Australia that has a potential market overseas. This would be worth more to someone with existing international distribution channels than someone who would have to start exporting from scratch.”
Experienced intermediaries keep track of companies that are not actively looking to buy but might be tempted by the prospect of a sound strategic purchase.
“We approach them with a business profile and, if it’s of interest, we arrange for them to meet the owners and negotiate a possible sale,” says Nielsen. “First we ask them to sign a confidentiality agreement. This is very important as knowing the business is for sale can create an atmosphere of anxiety and uncertainty among the employees.”
Business owners can help themselves by staying in touch with the market and being on the lookout for emerging opportunities.
“If your business is land-rich it could become more attractive if the land is rezoned for development,” says Ursula Hogben, practice leader and general counsel at LegalVision. “Or an overseas company planning to enter the Australian market might prefer to buy your business rather than start from scratch. A good business adviser can help you to stay informed.”
Where a family member or current employee is planning to take over the business the succession process should be agreed well in advance.
“If the business is owned by a company, you need to know whether the new owner will purchase the business assets or the whole company – the shares – upfront or over a period of time.” says James Douglas, a Business Sales Practice Leader at LegalVision. “If various family members are intending to take over from a sole trader, you should consider setting up a company structure with a shareholders’ agreement that sets out the rights and obligations of the family members who will be directors and shareholders. This can help to prevent future disputes.”
In some cases a staged exit works well.
“The benefits could include retaining customer goodwill and providing the new owners with an opportunity to learn from existing directors or owners,” says Charlotte Sandell, corporate advisory manager at HLB Mann Judd Sydney. “It might also be tax effective.”
It is important to seek professional help well in advance of a planned retirement or exit from the business.
“An accountant can advise you on the best structure for the business from an asset protection and tax perspective while it is operating and leading up to a sale,” says Douglas.
On the rare occasions all the stars align it is possible to sell a business in a matter of weeks. In most cases it will take significantly longer.
“I would expect six to nine months for a small business, one to three years for a larger business looking for a strategic sale,” says Nielsen.
vMeanwhile, any fall-off in sales, revenue or profits could have a negative effect on the sale price.
“A business sale can be very disruptive,” says Sandell. “Engaging experienced advisers to help manage the transaction can reduce the distraction for business owners and allow them to maintain their focus on running their business.”
The wait can be particularly stressful if there is a business threat on the horizon.
“If a major competitor is looming, regulations are changing or the market for your goods or services is shrinking, you might have already missed your opportunity to attract maximum price,” says Hogben.
Adequate preparation is vital.
“Two to three years of financial statements and tax returns will help show that the directors have been keeping good records and fulfilling their duty of care,” says Hogben.
“You must be able to demonstrate that the business has been well-run and that you have a strong history of corporate governance, including directors’ meetings, sound policies and procedures, and correct company and Australian Securities and Investments Commission (ASIC) records. You must be paying your employees correctly at or above an Award rate and your tax and superannuation payments must be up to date. A business at risk from law suits will be undervalued.”
Buyers will be looking for a forecast as well as a history of profitability.
“It is important to remember that buyers are investing in the future revenue of the business, but your predictions must be realistic as well as positive,” says Sandell.
Medium- to long-term contracts with a range of suppliers and customers provide a degree of certainty – as does evidence that you own, lease or licence all relevant intellectual property (IP).
“Strong, fully-protected IP will increase the value of your business,” says Hogben. “This includes up-to-date, active social media sites for your brand. IP created for the business must be assigned to the business – you should check that all of your contractors and employees have signed employment agreements that include this stipulation. The agreements should also include non-compete clauses so that a buyer can feel confident no-one is going to leave and set up in competition.”
The correct information
Where negotiations get as far as due diligence, the seller will be required to provide considerable amounts of detailed information.
“Many business owners are not adequately prepared for the quantity of documentation and inquiry required by prospective purchasers,” says Sandell.
Problems unearthed by due diligence stop many potential sales in their tracks.
“Sometimes the numbers just don’t stack up, either because the owner has fraudulently misrepresented the business or as a result of a poor long-term financial strategy,” says Nielsen. “Some owners deliberately undervalue their stock to save on tax but, as this accumulates year on year, you can end up with a lot of value tied up in stock that can’t be included in the sale. Others take cash out of the business without reporting it. Again, you pay for that when you want to sell the business because it’s not reported as income in your financials. Apart from being illegal, it’s a false economy.”
A buyer’s inability to raise finance can also blight a sale.
“It’s increasingly difficult because banks have become more risk averse – they’re usually looking for bricks and mortar security,” says Nielsen. “Potential buyers might have gained management experience in a large company and feel ready to start their own business but don’t have enough equity in their home to make the purchase.”
This is creating something of a crisis.
“It’s true that the generations that entered the property market at inflated prices are usually still carrying large mortgages so they have limited capacity to gear up in order to purchase a business,” says Peter Langham, CEO of Scottish Pacific Business Finance. “Their capacity to run a business is also severely limited as they will not have ready access to a source of working capital. Where the business is being passed on to a family member or key employee, people are increasingly using debtor finance as a smart solution. In the right circumstances this can allow successors to raise the purchase price or pay out siblings as they remove personal risk from the business.”
Increasing the odds
There is no guarantee that any business will sell – but many do, and for a good price. The right preparation is essential.
“Ideally, you should have an eye on retirement and the sale of the business right from the outset,” says Arena. “We are living longer, we are healthier and most of us are working towards optimising mental and physical health so that we can have a happy time in retirement. It’s too late to start thinking about these things when you’re about to sell your business.”
Ten tips for boosting your sale price
Tony Arena shares his suggestions:
- Keep stock down to reasonable levels. Buyers won’t pay for unsaleable stock.
- Keep upgrading your equipment. If it is sub-standard, the buyer will discount the price.
- Keep your shop/office/warehouse clean to create a good impression when potential buyers visit.
- Aim for a wide spread of clients and negotiate contracts with them if at all possible.
- Automate your business as much as possible to reduce the uncertainties associated with employees.
- Build a strong online presence.
- Protect all of your IP.
- Ensure your employees are well-paid and well-trained
- Keep and update a business plan. This could form part of the sale
- Get the timing right. There is a right time in the economic cycle, industry cycle, calendar cycle and the personal lifetime cycle of you as the owner. Getting all of these right is something close to a miracle but being aware of them can help you to plan.
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