Build for the Buyer: What Does Your Business Look Like to An Outsider?

Architect woman with a plan.Business buyers look at several elements in determining whether a business is attractive to acquire.  Competitive advantage, a large and loyal customer base, growth opportunity, along with stability and skill of employees are among the considerations.   Before these factors are evaluated, however, the business buyer is going to scrutinize the company’s financial track record and its ability to increase profits.  First and foremost, buyers acquire businesses for the income and cash flow they generate.  Two metrics are used to measure cash flow and profitability, and are also the basis for determining the sales price of a business.  Seller’s Discretionary Earnings (SDE) measures cash flow.  It is comprised of pre-tax earnings, depreciation, amortization, and interest; plus owner’s salary, owner’s perks, and non-recurring expenses.

Earnings Before Interest, Taxes and Amortization (EBITDA) measures profitability.  EBITDA is net income with interest, taxes and amortization added back.  The asking price for a business is calculated on multiples of SDE or EBITDA.  SDE is typically the method used for small to medium businesses valuations and ranges from 1 to 7 times SDE.  Market data for similar industries, intangible assets and risk influence the multiple for any given business.  So, what can a business owner do to increase the multiple?

Start Now.  Every business owner will eventually want to exit, and very often that is accomplished by selling the company.  The selling process takes anywhere from six to twelve months, but preparing a business for sale should begin well in advance of the decision to sell.  Business owners who plan to sell in the near term have less time to implement improvements but can still take steps to increase SDE.   The building blocks that create solid SDE and deliver increased profits and cash flow also influence business risk.   And the advantage to planning ahead when selling is not a short term goal, is improved earnings for the owners.  It’s never too early to build for the buyer.

Build Infrastructure.  A solid framework to support business operations is crucial to optimal productivity and profitability.  Three key areas are:

  •  Finance/Accounting—The first and most critical test in a business sale transaction is passing the financial review.  Accounting processes and policies must be in place to ensure invoicing and collections are timely and consistent; accounts payable and debt payments are on schedule; tax payments are current; inventory is managed for obsolescence; and depreciation and amortization schedules are proper.   Internal controls are necessary to ensure the accuracy of the transactions and safeguard the company’s assets.  Financial reporting integrity is the cornerstone of a business sale.  Adequate documentation of all transactions must exist as demonstrated by timely preparation of financial statements.  A prospective buyer cannot verify cash flow or earnings if financial records are poor, and as such, have no basis for determining SDE.
  • Operations—Business processes that are efficient and lean will yield the highest results.  Creating systems that eliminate duplication of effort and reduce risk by closing process gaps are the key to operational efficiency.  Implementing and optimizing appropriate business software improves internal communication, provides information for well thought out management decisions, and supports a good customer service program.  A tight, well run operation with low risk not only enhances SDE but also shows that a company is disciplined and sophisticated with readily available information for analysis and planning purposes.
  • Human Resources—Human capital management and risk reduction are achieved through a comprehensive HR program.  Attracting and retaining the best possible employees who are appropriately matched with job responsibilities are critical to the delivery of any company’s product or service.  Organizational development is optimized by compensation analysis, wage rate determination and process implementation.  Programs to ensure regulatory compliance reduce the risk of adverse actions for incorrect employee status determinations, contractor issues, immigration law infractions, and diversity issues.

Selling a business is not easy.  The process of determining the value, finding a buyer and negotiating the transaction is complex and time consuming.  Optimizing sales price is much less a function of the sales process than value that has been built up over the long term.  So, look at your business from the outside and build for the buyer.

This is Part I of a four part series on selling a business.  Read C3 Advisors’ blog for future articles on Process Pays, Combining Cultures, and Tax Tactics.

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One Response to “Build for the Buyer: What Does Your Business Look Like to An Outsider?”

  1. tanya griffin Says:

    Well put! I like this one.

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