by Matthew Sampson, CFP®
Vice President, Wealth Planning
As a business owner, you’ve likely spent decades of your life building a company that has provided well for your family, community and various stakeholders. For many owners, selling or transitioning their business often ranks as the most important financial decision of their lives. Not only is this decision often highly emotional, but many additional factors exist that require careful attention and evaluation.
In 2018, our wealth management chair, Mary Lago, CFP®, CTFA, co-authored and delivered a presentation on business succession planning strategies around the state. This article summarizes many of the key insights shared in the presentation and serves as a guide to help you focus your time and resources on the most critical items to address as you prepare to sell your business.
Before going to market, it is beneficial to have already decided on your direction, whether that be a sale to a third party, family business transition or employee stock ownership plan (ESOP), to name a few. Being uncertain of your desired path will add complexity and fatigue to the sales process. Time kills all deals, and lacking direction in your game plan is sure to add time. The foundation of your tax and estate planning should already be in place prior to selling your business. Partnering with your professional team to review your entity structure, wealth transfer strategies, asset allocation and charitable intent all require a significant investment of time and are best completed prior to selling your business. Having your personal financial planning objectives in order first will allow for a smoother, more efficient and effective sales process.
As the saying goes, timing is everything, and selling your business fits this adage perfectly. Business owners often want to sell when their company is at peak performance, while buyers will invariably demand future upside. Buyers are purchasing a vision of the future, and most require credible growth prospects. It is important to recognize that market conditions can change quickly, potentially causing exit windows to close. Having a keen understanding of the current M&A cycle is critical to maximizing your exit. The economic outlook, availability of credit and current interest rates will all have a direct impact on the number and aggressiveness of potential buyers. Furthermore, valuations are generally based on a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA). The EBITDA multiple you command will be much higher in excellent markets than it is in average and poor markets. If you recognize your company is on the downside of a cycle, your potential buyers likely will too. Keep in mind your needs do not dictate the sales price. Market conditions, M&A activity, future growth prospects and strategic synergies do.
Often the question is posed, why sell when my business is thriving and firing on all cylinders? While this question certainly has merit and should be weighed against your age and remaining working years, we are reminded of the dark side to the “golden goose.” Many owners tend to reinvest the lion's share of free cash flow back into their business, resulting in a large concentration of wealth. While it is true wealth is often built through concentration, it is equally true that wealth is preserved through diversification. If you are approaching age 60, nearing retirement, and are reliant on the value of your business to fund your retirement and future lifestyle needs, it is likely advisable to sell while clear and identifiable upside within the business is available. History is littered with examples of owners that waited too long to exit or transition and were forced to make a dramatic downward shift in lifestyle during their golden years.
Another critical area to address early in the sale planning process is to standardize your accounting. Oftentimes owners manage the books on their own without any formal training in the discipline. For businesses that grew rapidly, it is not uncommon to find that their accounting systems have not kept pace. Regardless of the specifics, if your accounting isn’t standardized, it is advisable to hire a CPA firm to normalize your accounting standards, accounting records and procedures prior to beginning the sales process. While this may seem like a daunting and expensive undertaking, putting in the work will provide more transparency in the financials and lead to a smoother due diligence process.
Additionally, cleaning up your balance sheet and managing for profitability in advance of the sale will also help maximize your exit. In an ideal world, it is advisable to pull back or eliminate personal expenses running through the business several years before beginning the sales process. Otherwise, when reviewing your marketing package, buyers will see the normalization of cash flow and personal expense add backs. While on the surface this isn’t a deal killer, chaotic add backs tend to leave a negative first impression. Personal expenses to consider eliminating can include a variety of non-business expenses such as: travel, meals, entertainment, country club dues, membership dues, season tickets, vehicles for you and your family, etc. You may be able to convince a buyer that personal expense add backs were justified, but if the purchase is being financed, lenders may not be as lenient and likely will not include those expense add backs as part of the seller’s discretionary earnings (SDE) calculation, resulting in a lower sales price. Making these changes in advance of the sale will help you showcase a well-managed and profitable enterprise.
Assembling your team of professionals is another critical step in the process. This includes your transaction attorney, estate planning attorney, CPA, investment banker/business broker and wealth management professional. Ensuring all your professional partners have open and clear communication channels will help alleviate the complexities that are bound to present themselves. Each of these professional partners has a key role to play in helping you evaluate your options and maximize your exit.
In closing, we hope this article has sparked some ideas or considerations that may not have been on your radar. Separating yourself from your life's work is never easy. As you prepare to enter this next phase of your life, do so with confidence that you have prepared for this moment. As President Dwight D. Eisenhower famously said, “plans are worthless, but planning is everything.” For additional resources on transitioning to retirement and valuing the resources of time and money, please see our first quarter 2022 Wealth Management Insights Publication.
Ferguson Wellman, Octavia Group and West Bearing do not provide tax, legal, insurance or medical advice. This material has been prepared for general educational and informational purposes only and not as a substitute for qualified counsel. You should consult qualified professionals to understand how this information may, or may not, apply specifically to you.