Your Business Through a Buyer’s Eye

You know everything about your business or so every business owner assumes.  Many experience a rude awakening, however, when they attempt to sell or recapitalize their business and the buyer begins the due diligence process.  The bad news is that you can’t avoid the due diligence process if you ever intend to sell or recapitlize your business.  However, you can predict how buyers will generally approach the process of due diligence and prepare for it.  Here are things that are important to all buyers we’ve ever encountered and questions that you will be asked:

  1. How much cash does the company generate?Buyers want to know how much free cash flow your business generates. They’ll want a reasonable salary for the business’s CEO, as well as enough additional free cash flow to pay for the business over five to seven years.
  2. How loyal is your human capital? In many cases, a business’s human capital is more valuable than its’ inventory and equipment. Investors will be interested in how long key customers and employees have been with you; longer tenures increase value. If managers have signed non-compete agreements and customers are bound by long-term contracts, your business is worth even more. Short relationships, on the other hand, mean increased risk and lower purchase prices.
  3. Will any liabilities pop up in the future? Buyers rarely want to assume liabilities that precede their ownership, mostly because they have no way of accurately gauging the amount of risk and exposure involved. Resolve whatever issues you can before you sell, and help buyers understand any remaining liabilities. Buyers may push for an asset purchase to avoid pre-existing liabilities.
  4. What’s your corporate structure?  Whether your firm is an S-Corp., a C-Corp, an LLC, or something else, you have a set of unique tax consequences. Form (or revise) your company’s structure with an eye toward minimizing capital gains taxes and maximizing your net sale proceeds.  Ask the buyer to help you minimize taxes.  They don’t like paying taxes any more than you and will very likely help out if they can.
  5. What is the state of your market? Buyers want to understand your industry, your market, and your company’s position relative to your competitors. Is your market growing? Are you able to increase your gross profit margins? What will your industry look like in five years? Be ready to provide buyers with answers.
  6. Why do you want to sell?  Buyers don’t want to purchase a business in a downturn. Most buyers will readily accept retirement, divorce, or health issues as good reasons to sell, but loss of market share and declining margins will not attract good offers. Think about what is prompting the decision to exit the business now and write it down.  Buyers will appreciate your fore-thought and candor.
  7. Can your business run without you? After the sale it will have to, so create and document systems and procedures that make independent operation possible.  Don’t think you can fake your way through this one.  Buyer’s can smell a business that’s controlled by the owner a mile away. You may need to hire additional managers or begin delegating more responsibility to existing managers, so that you are less critical to your firm’s health.
  8. What drives your valuation above the net book value of your assets?  This question is also known as, “You think your company is worth what?!?!”  Make sure you can quickly and clearly communicate your unique selling proposition and brand identity; your company’s reputation and market strength.  Document the long-term relationships you enjoy with vendors and customers.  Finally, look at your brand and brand awareness: is it a trademark(™) or a registered trademark (®)?
  9. How much do you want? Buyers don’t want to waste your time or theirs.  Don’t use guesswork or anecdotal evidence (a chat with your friend at the club) to determine your company’s market value. Buyers will calculate your free cash flow and generate what they believe a reasonable return on their investment. In general, they expect businesses to generate enough cash to pay the owners a reasonable salary and pay back the purchase price within five to seven years. Your price should support those expectations.
  10. Do you have competent advice?  A seasoned team of advisors like a CPA, attorney, and investment banker will help in a couple of ways.  First, buyers will use this as another indicator that your serious about selling or recapitalizing your business.  Having these professionals on board and up to speed will help streamline the process greatly.

Work on these things now and you’ll not only get more money for your business when you sell it but you’ll also walk away from the transaction feeling much better.