Here are three questions to answer to help you objectively assess if your business can attract prospective buyers:
Is your small business profitable?
When the time comes to exit, you will need to have a valuation (an estimate) of the business’s worth. Determining the company valuation will include data from the Seller’s Discretionary Earnings.
When prospective buyers analyze the business, their number one focus is knowing how much cash flow they can generate from the company. Usually, a prospective buyer will expect to see certain expenses paid out of the business that are considered discretionary (optional), such as a car lease, club memberships, and some travel. However, as long as you carefully track these expenses, you can apply those expenses as an Add Back when calculating the value of your business. In other words, since these expenses were at your discretion (optional), you can add the amount back to the value of the company, lowering the operational costs.
In addition to discretionary expenses, there may be other expenses you can reduce. Perhaps cancel optional services you no longer use or negotiate lower prices with suppliers. We all get busy – reviewing expenses is a task that often slips through the cracks. Now that you know this can help increase profitability and the valuation placed on the business, this information may be just the motivation you need.
Does your small business have a track record of annual growth for at least three years?
Next on a prospective buyer’s list is the trendline of the business. Is it growing? Revenue is the most important measurement, and there are other trends to consider. Before we get into those, it is essential to assess the impact of the global pandemic on small businesses. According to the Small Business Administration’s report, the impact of the pandemic has been disproportionate on small businesses. One way to address this during the due diligence process is to provide more than three years of financials. Doing so should show business performance before and after the pandemic. The pandemic hit all aspects of the economy, especially small businesses. So remember, if when you look at your growth, it isn’t what you were hoping, your business is not an isolated case. Growth for all small businesses during 2020-2022 is far from “normal.”
With that said, now, what sort of growth is a buyer seeking? That depends on the type of business (product or service), location (on-site location or remote), and type of industry (healthcare, construction, technology). A traditional business in light manufacturing or a service-based business may show a lower growth rate but may have a predictable revenue stream. Some construction-related companies have seen explosive growth due to housing shortages. However, they face growth constraints due to a tight labor market and pandemic impacted supply chain issues. Knowing what drives growth and what limits growth will be an essential part of the conversation with prospective buyers.
An increase in profitability is appealing to a buyer. Either sales volume or efficient operations can drive profits. Sometimes, with rapid growth, revenue can increase without increasing profit. This happens due to operational efficiency needing to catch up. However, even modest revenue growth coupled with growing profitability will put a smile on prospective buyers’ faces.
Can your business run without you?
Obviously, if you want to sell your business, it will need to continue without you! Before you say “yes, it can,” let’s examine what a prospective buyer will want to know:
- Are vital customers under contract or reliant on the relationship with the owner?
- Are suppliers/vendor agreements in place or reliant on relationships with the owner?
- How will key employees respond to a change in ownership?
- Is the reputation or brand of the business too closely tied to the current owner?
- Will you be able to step away from the business and resist the temptation to meddle?
- Are systems and processes documented for others to take over, or are things “in your head”?
A new owner wants a seamless transition and will invest time upfront in assessing if this is feasible. Frequently a buyer will seek a transition period. They may even require a contractual commitment from you to work alongside the new owner for a while. The purpose of this is a smooth transition so the new owner knows how to run the business.
Can you actually sell your business?
Practically speaking, this will likely take some work as most businesses are sold, not bought. It is wise to put yourself in the mindset of a potential buyer and look at what will appeal to them and what could raise flags. The potential buyer is making a purchase and doesn’t have any emotional attachment to it. Do not overlook any issue that objectively could present a problem for the next owner. Be mindful about using only financial data to determine the value and leave emotion out of the equation. Suppose you cannot find a buyer or do not find a buyer at the price you are seeking. In that case, it may be time to consider other options such as selling to an employee, selling the assets, and dissolving or creating a plan to increase the value of the business making it more appealing to a future potential buyer. You can learn more by reading 5 Things You Can Do When Your Business Value Is Not What You Expected.