Preparing to Sell Your Business - Minimizing Buyers' Risk
In the last issue (#32), we discussed Preparing to Sell Your Business - Planning Considerations. This issue will discuss Preparing to Sell Your Business - Minimizing Buyers' Risk.
A Favorite Famous Quote
"Before everything else, getting ready is the
secret of success." Henry Ford
Preparing to Sell Your Business - Minimizing Buyers' Risk
Minimizing buyers' risk not only aids the salability of your business, tackling the issues improves the prospects and profitability of your business. Your reward is putting more money in your pocket during your period of ownership. That's why it is never too early to start!
Serious buyers are concerned about risk
As discussed in previous issues of this newsletter series, as buyers zero in on a particular business, risk minimization rises to the top of buyer motivation. They begin to analyze the business by looking at the downsides - the obstacles and pitfalls to their potential success. If the risks discovered in due diligence are too high, even an agreed-to deal can quickly fall apart.
Sellers' discretionary earnings (SDE) below $100,000 is a major obstacle
One of the first risk factors considered by buyers is "Can I rely on this business to continue to support the lifestyle to which I've become accustomed?" With many potential buyers coming from the corporate world, they are concerned with income replacement (and they want to be rewarded for entrepreneurial risk). When buyers inquire about businesses for sale and are questioned by business brokers about their goals, almost all will respond "they want (or need) six-figure income." $100,000 is the lowest number meeting that objective. Coincidentally, that is also about the minimum level of SDE most lenders require to consider SBA financing (because lenders are usually not interested in transactions below $250,000, which requires about $100,000 in SDE).
If a business has less than $100,000 in SDE, the pool of potential buyers shrinks considerably because most cannot afford to live on take-home pay of $50,000 - $75,000 (after debt-service on the acquisition and reinvestment in the business). In addition, below that $100,000 SDE threshold, SBA financing is considerably more difficult to obtain. In this case, the buyer's risk of inadequate income to maintain their lifestyle parallels your risk of not being able to sell the business. To help assure salability, it is extremely important to improve the business to generate a minimum of $100,000 in SDE. Read this article for more information: Issue #57 - Inadequate Seller's Discretionary Earnings (SDE).
Wildly fluctuating SDE is a major risk for buyers
Buyers are also interested in reliable SDE. If the SDE fluctuates wildly from year to year, the buyer's risk is very high if the price is based on the higher earnings level. In reality, when SDE shows considerable fluctuation, buyers' offers will only be based on the lower SDE. Lenders take the same approach. The only way sellers obtain more is through earn-out negotiations which results in future funds being earned by the seller after closing based on the actual results produced by the buyer's operation. To the extent that you can control SDE fluctuations (i.e., avoid accelerating expenses into the current year for tax purposes, etc.), the better off you will be - minimizing not only the buyer's risk, but yours as well.
Lack of second-level management creates risk for buyers
Buyers are always concerned about the transferability of business knowledge and customer/supplier relationships. If all the knowledge about a business resides in the owner's head and has not been adequately transferred to key employees who are capable of running the business in the owner's absence, it's a significant risk that might preclude the possibility of a successful sale. In the long run, the investment in a few key people will pay off. It's not only a good thing to accomplish from the standpoint of selling your business, it is also likely to help the business grow and will provide greater flexibility to you from a personal standpoint. Read this article for more information: Issue #67 - Inadequate Second-Level Management.
Customer concentration issues
Customer concentration is a very significant risk for buyers. If you have a single customer that represents 10% or more of your business, it may be an issue to buyers or lenders. As the percentage of concentration increases, so does the risk for buyers and lenders. Your risk of failing to sell your business also increases. Diversifying your customer base will aid significantly in salability and increase the perception of value. Read this article for more information: Issue #68 - Customer Concentration Issues.
Inadequate financial information
From a buyer standpoint, it's an expensive proposition to fight through financial statements that are incomplete, inconsistent, erroneous or meaningless. Almost all prospective buyers and their advisors will walk away from a business they can't get a handle on because of inadequate financial statements and supporting documents. When you successfully tackle this issue, your financial statements will provide reliable information that can be used as the basis for making decisions affecting the future growth and profitability of your business. Read this article for more information: Issue #66 - Inadequate Recordkeeping / Accounting Systems / Financial Reports.
You can also help minimize buyers' risk by obtaining knowledge of the business sale process. In particular, it's important to identify obstacles to a successful sale and address as many as possible, and disclose any negative issues that you are unable to solve. Process-wise, it is also important to understand the need for confidentiality, the need to sign a non-compete agreement and the need for owners to cooperate in a post-transition (or training) period, all of which help mitigate the buyer's risk assessment. When these types of negatives arise in due diligence, transactions are usually doomed to failure.
And finally, in most instances, sellers must ......