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Pre-Sale: Cleaning Up Your Balance Sheet

Before you sell your business, make sure to minimize your expenses and maximize your presented earnings.

You’re a business owner who is contemplating a sale. Intuitively, you understand that it’s important to make your business look as attractive as possible to potential buyers. If you haven’t sold a business before, you probably don’t know the best way to accomplish this.

Generally speaking, you want to look profitable, efficient and upward trending. You want your employees to look productive and your customers to appear loyal. You want the potential buyer to see valuable assets and minimal liabilities.

What really makes a company look attractive? A strong balance sheet? Sure, a strong balance sheet is important but what smart buyers want to see most is that your company’s cash flow is strong; your company is most attractive when it’s making money.

Buyers Care About the Balance Sheet

Imagine you are on a date, and you need a topic of conversation. Naturally, you would avoid saying something along the lines of “sometimes I forget to clean my bathroom” or “statistically, this relationship probably won’t work out” (even if both things are completely true). It’s a much better idea to present yourself — and the potential partnership — in a positive light.

Follow the same principle with your balance sheet. You need a strategic plan to make it as appealing as possible so you can find the right buyer. I’m not recommending doing anything underhanded; rather, I’m talking about taking some extra care and putting your best foot forward. (To make another analogy, you would certainly clean your home and take good marketing photos before listing it for sale, right?)

This process is most effective when started at least one or two years in advance. You may want to sell your business much more quickly, but you still want to start this process as early as possible. (For more legal and practical advice about selling your business, check out this Financial Poise Webinar.)

Cleaning Up Your Expenses

When I was a financial adviser, I’d ask to see an itemized list of all of my client’s monthly expenses. The point was to find potential places to save money, which I called “trimming fat.” No matter how frugal or disciplined the client was, we always identified unnecessary expenses: magazines they did not read, grocery stores that were too expensive, mutual funds with unnecessarily high expense ratios, etc.

Business owners experience similar expenses. There may be unused fraternal memberships, outdated advertising expenses, unread periodicals, or company vehicles that end up being used for personal functions. In fact, there may be a few months’ worth of lunches and a few vacations thrown on the company credit card. You may have a relative or friend on payroll whose performance doesn’t really justify his or her salary.

All that said, you do not have to do this. One reason is that many buyers (or their advisers) are sophisticated enough to see such expenses themselves and account for them when evaluating the business.  When this happens, transaction advisers often refer to such expenses as “add backs.”  This is because the money spent on expenses that a buyer thinks are unnecessary will be “added back” to EBITDA.  When a buyer does this, it is sometime referred to as “normalizing” earnings.

Other Possible Expense Items

  • Check with your accountant to see if there is any excess depreciation above what is necessary to cover replacement costs for capital equipment. In a similar vein, see if there is any excess amortization over the value of business assets.
  • Dig through and find non-recurring expenses. If they are unrelated to business operations, they should not detract from the company’s discounted future cash flow.
  • Identify insurance expenses on assets or key personnel (including yourself) that will not be transferred to the buyer.

Cleaning Up Your Earnings

When you decide to sell your company, the incentives for reporting earnings tend to reverse. Think about it this way: if you’re going to own the business next year or three years from now, you want to under report your current earnings and reduce current tax liabilities. When you think you might sell the business next year or three years from now, you want to report as much income as possible to increase your valuation.

Consider an aggressive sales campaign in the 12-24 months before putting your business on the market. (For more on the buying and marketing stage, check out this Financial Poise Webinar.) The key is to do this without incurring a lot of new costs. On the other hand, however, a buyer who conducts due diligence may notice such sales and interpret them as tactics designed for the purpose of making the business look better.

Maybe you have an old client or customer list you can dust off. Maybe your accounts receivable are a little older and, with a little focus, can be brought current.

Another good rule of thumb: Not all kinds of earnings are created equal. Earnings that come from high-margin products or services are more desirable than earnings from low-margin products or services. Repeatable and dependable earnings are much stronger than inconsistent ones. You might consider shifting your operational focus to emphasize healthier revenue streams.

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