Don’t Make These 3 Critical Mistakes When Selling Your Business
In 2014, I helped one client successfully acquire two small businesses. But in three other cases, the sellers declined the offers I proposed on behalf of my clients.
For those that declined, there were some common problems hindering the successful sale of their businesses.
The expectations for the selling price were way too high. I quickly learned they were not coached going into the selling process of their business. The same holds true for one of the sellers that agreed to our purchase price.
Poor financial reporting was indicative in all the businesses I evaluated during due diligence. In two cases, I personally had to reconstruct the numbers. One of those business owners was even working with a franchise business brokerage firm. But the numbers were horrendous. The poor financials meant I was skeptical of anything they said or explained with respect to numbers of any kind.
Finally, two of the three owners that declined were winging it during the entire exit process. I could tell they had not put much time into planning the sale of their businesses.
I’m not picking on the three that refused our offers. In working on scores of business acquisitions and divestitures over the years, these three vital mistakes are regrettably the norm.
Let’s unpack these mistakes and take a deeper look.
Mistake 1 – Lack of Planning
The best time to start the planning process for selling a business is the day it’s started. Sound extreme? Not at all. The activities for prepping a company for sale are essentially the same for running a thriving and growing company.
Administratively, I start building a digital data room for all of my clients the first day I start working with them. The digital data room includes legal documents about the corporation/LLC, contracts, financial statements, tax returns, documentation of key workflows, and much more.
Below is a screenshot of what my digital data rooms look like (most categories have 10 to 15 rows of supporting detail):
There are several strategic by-products that are derived from this work. We’re able to use this digital data room for loan renewals (which go extremely fast for my clients), year-end reviews and audits, and succession planning.
Planning for the sale of your business is more than completing an administrative checklist. It’s about making sure we have great relationships with our customers, great processes for delivering goods and services, great employee retention practices, solid relationships with all of our partners and vendors, and a sound strategic foundation for growth and operational excellence.
Should you fail to plan your exit, then you probably plan on closing your business instead. At best, poor planning will yield a very small dollar for your business.
Mistake 2 – Poor Financial Reporting
This one’s a killer in my book. This is where I sometimes want to chuck my finance career and mow lawns for a living (I’m too old to be the bat boy for the St. Louis Cardinals).
Here’s a truism we can hang our hats on in the world of small business–financial statements from these business owners are generally abysmal. The reasons include the following:
1. Questionable revenue recognition practices.
2. Inconsistent COGs and SG&A expense reporting over any trailing 12, 24, 36, or even 60-month time period.
3. Poor balance sheet reporting (missing accruals and contingencies).
4. Overall, poor general ledger design leads to financials that are not meaningful.
5. Mis-reporting of owner/personal expenses.
There are more, but you get the overall idea.
Every business owner starting on day one, needs to commit to receiving timely, accurate, and meaningful financial reporting. I’ve learned from experience that owners with this type of reporting are generally weak CEOs from a performance standpoint.
A big takeaway? Get your reporting cleaned up now, which will help you in selling your business. You may not get top dollar for your business, but the due diligence process from beginning to end will go much faster compared to having poor reporting.
More importantly, better financial reporting means you will become a better CEO.
Mistake 3 – Unrealistic Expectations
Probably the biggest mistake any business owner can make before selling a business is expecting the impossible–the really big check that’s based on a dream or a wish. Yet, the business owner sees no reason why he/she cannot obtain this dream number from any buyer.
One of the first discussions I have about the exit process with the seller is how the math works when it comes to business valuation. It’s not perfect, but it’s a starting point. At this juncture, I’m aiming to set realistic expectations.
So let’s look at the following example. The basic assumptions include the following (and I’m going to keep it super simple):
• Projected earnings in year 1: $100,000
• Expected earnings growth: 8% (in reality, this number will never be constant)
• Required Return from Seller: 15% (this is just a guess)
In the snapshot below, these assumptions yield a net present value (the value of those earnings streams in today’s dollars) of nearly $700,000. The seller is deflated because he/she is wanting $1,000,000.
Okay, so if the seller wants $1,000,000, let’s revisit the assumptions.
Assuming our earnings starting point can change from $100,000 to $150,000, our net present value grows to almost $1,000,000.
Or assume we change the growth factor from 8% to 18.6%, and our net present value exceeds $1,000,000.
Finally, if the buyer’s required return is dropped to 6.5%, my client will get a big check for $1,000,000.
As you can see, there’s work to do in order to meet the expectation levels of $1,000,000. By reverse engineering the results, we can focus our efforts on one of several objectives. We can work on growing the bottom line now. Or, we can work on developing strategies that will lead to higher, predictable, and sustainable earnings growth rates. These initiatives are in our control. Lowering the buyer’s required return is not within our control (and this topic is well beyond the scope of this discussion).
To recap the mistake of having unrealistic expectations, you need to understand the math fundamentals of business valuation through the eyes of a buyer (or hope the buyer is incompetent and will pay you a high, unreasonable price for the business).
The best advice I can give you is to seek out someone that has been through this process more than once. Do so several years before it’s time to sell your business. Learn from their success. Learn from their missteps.
Improve your odds of earning top dollar on the sale of your business by avoiding the costly mistakes many of your peer CEOs commit when they sell their businesses.
I also encourage you to watch the interview between Dr. Jeffry Cornwall and Paula Lovell below, where she discusses the exit plans of her PR firm. The interview is less than 10 minutes, with some great takeaways.