January is customarily the month noted for people making resolutions. If you are a business owner and contemplating the sale of your business within the next three years, let me suggest a few resolutions that might assist you with making your business more valuable and attractive to the marketplace.
1. Start running your business like a business; not your personal checkbook. No one likes to pay taxes, but profits are important to buyers and lenders to prove that the business will be able to pay back debt and generate an appropriate income to sustain the buyer. The more income that you can show, the more your business is usually worth. When you consider that most businesses have a value that is approximately 3 to 5 times earnings. (Please note that there are other important factors, such as balance sheet items, earnings’ trends, and industry attractiveness that also impact value, but bear with me on this.)
For our example, let’s also assume a multiple of 4 times earnings. Let’s also assume a combined Federal and State tax rate of 40%. In this example, by not accounting for $10,000 of income, you save $4,000 in income taxes. However, you lose $40,000 in the value of your business. Acknowledging that you would also pay taxes on that $40,000 increased amount, let’s assume a tax rate of 30%, which results in $28,000 of after tax gain. (Note: The lower tax rate of 30% assumes that the increased $40,000 at the time of sale will involve long-term capital gain rates, which are lower than the ordinary income rates applied to operating profits.) Therefore, the result of “investing” the $4,000 in taxes is $28,000 in value as a result of the sale. Most of us would be happy with a 700% return on an investment. Although the actual results may vary, I believe that the concept is apparent.
2. Let your advisors, particularly your accountant, intermediary, and attorney, know that you are planning to sell your business and ask for suggestions for improving your business to achieve a better outcome. For example, we have a document, Positioning Your Business for Sale, that might be of assistance to you.
3. Look at your business through the eyes of a buyer. Do you have appropriate staffing? Is your equipment and software up to date? Is your documentation in order? What type of first impression is conveyed when parties call on the phone, walk in the door, or access your website?
As it usually takes some time to “turn a battleship around” and most buyers, lenders, and advisors will generally go back at least three years in the due diligence process, it is better to implement your resolutions sooner, rather than later.
We wish all of you a healthy and prosperous 2016.
(originally published in January 2016 eNewsletter)