Introduction

Most of us have bought or sold a house and understand that many factors determine the price we pay.

We are attracted by the size of the house, the location, and the proximity to schools, restaurants, and work. We have concerns about the purchase price, a higher mortgage, increased utilities and maintenance costs and what a home inspection might reveal.

It should be no surprise that a business purchaser also has to balance the excitement and ambition of expanding the business with the cost of acquiring it, the availability of finance, future profitability, and unexpected liabilities.

The key to maximizing value is to package your business as attractively as possible for potential purchasers. Once a buyer is found, business owners need to ensure there are no surprises or disappointments leading to a change of heart on the purchase price, extra restrictive conditions on the purchase or the sale falling through.

The price paid for a business is often quoted as a multiple of historical earnings. If a purchaser is buying the expectation of future earnings, the multiple tends to be higher in fast-growing industries and fast-growth companies. This is why many businesses move from low value-added buy/sell business models into higher value-added consulting/service models where profitability and opportunities for growth appear better.

There are many advisers around who claim to be able to sell your business for the maximum price.  You need to be able to select an advisor with the credentials and experience in your industry, in your market and in your size of the business, to work with you over a period of months or years to achieve your goals. The right choice should maximize what is important to you: price, post-tax cash, the future of your staff, or the continuation of your culture and the values of the business. The wrong choice could end up losing a sale and wasting a lot of time and emotional energy that might even damage the business for a few years if handled incorrectly. The house sale analogy is relevant here. We can help with the information and introductions to make the correct choice for you.

The key to maximizing value is to package your business as attractively as possible for potential purchasers.

Planning an exit

Much of exit planning is actually implementing good business practices. As a business owner, you will exit at some time, hopefully on your own terms and at a time of your choosing.  To achieve this, it is necessary to plan ahead to ensure the business you are selling or passing on is in good shape to generate future profits for your successor.

It’s equally important that as much cash as possible remains in the business to be distributed to its owners and employees rather than paid in taxes.

It is an often-quoted truism that you sell a business when someone wants to buy, not necessarily when you want to sell. If the dream buyer turns up with an unsolicited offer tomorrow, would you be in a position to maximize that opportunity? Probably not, but forward planning would make life a lot easier should that call come. When a sale takes place it is often the finance team that is placed under the most pressure, due to the need to prepare documents and analyses. It is, therefore, the finance team that is best placed to help you plan in advance.

Ownership, shares, options
Starting with the basics, look at who owns the business. The simplest structure is for all shares to be owned by one person who makes all the decisions and receives all dividends and payments (after tax) for selling the business.

If you have more than one shareholder, do you have a Shareholders’ Agreement? An agreement governs the relationship between shareholders, as well as if an exit opportunity arises, what happens if there is no unanimous agreement on the terms of the exit. It also includes the procedures to be followed, the valuation method and rights of shareholders during an exit, whether by way of a business sale or the death or critical illness of a shareholder.

Are there others who are expecting to become shareholders, perhaps have been promised that they will be? Would it make commercial sense to reward some members of management with shares or options so that they have an incentive to help add value to the business and remain with it? New shares or options may require a valuation of the business if you are going to take advantage of tax-saving opportunities. The basics of option plans have stayed the same for some time but the detailed rules change in most budgets so it is wise to get professional advice before implementing a plan.

Property
Property can be a major sticking point for a purchaser. Assume it will be regarded by purchasers as a large liability which will be a drain on the benefits they are planning on for their business after the acquisition.

If the company owns the property, has it been appraised recently and is the value reflected in the balance sheet? If a buyer is interested in the property, then it is better to have an appraisal available to include in the accounts rather than have uncertainty when sale negotiations have already started. That said, unless the premises are critical to the business and it has to be included in a sale of the business, many buyers do not want to take on a freehold property. You may need to consider how to dispose of property or lease it to another business going forward.

It is worth considering the sale or transfer of property  to a holding company owned by yourself and/or a family member. The property can then be used by the company on a commercial lease and generate ongoing retirement income. As with any property transfer, there are complications: primarily the interaction of a number of provincial and federal taxes that require proper advice sooner rather than later.

A lease may be viewed the same way by a purchaser, regardless of the owner. It is, in their eyes, a long- term commitment that may be restrictive to a growth company or to a buyer who may want to consolidate operations. Clearly, you need to continue running your business and need some security of tenure but is a ten-year lease with upward only rent reviews the right thing to enter into when you might be wanting to sell within three years?

Pensions
When defined benefit pension plans were the norm, employee pension plans were treated with extreme caution by all buyers.

It is unlikely that you have such a plan but if you do, the funding position and the plan valuation will be major considerations. If there is likely to be a problem, it should be addressed sooner rather than later. There have been many instances of pension funding deficits exceeding the business value, which is not a good place to be.

Pension plans are a terrific incentive for employees, but as a business owner, a defined contribution plan eliminates many of the risks.

Intellectual property
Where intellectual property (“IP”) is obvious – physical inventions such as the bigger and better mousetrap – some businesses have registered patents and/or trademarks to protect the unauthorized use of their IP.

Have you considered what you have developed over time in your business? What products, processes or brands do you use that might be capable of being protected and would be worth spending time and money on to protect? Buyers need to know that if your business relies on particular IP to continue to operate, the IP is protected and the business will not be undermined by a competitor who can copy, produce at lower cost and sell in greater volumes.

Have you considered what you have developed over time in your business, be it a product, process or brand, that might be capable of being protected and would be worth spending time and money on?

Contracts
Do you have formal contracts or Terms and Conditions with all your suppliers and customers? If so, have they been reviewed for any legislative changes? Do you know what happens if you sell? Can the contract be replaced by the new owner (or will it remain in place after a change of ownership)?

It is another case of the buyer gaining confidence that the business will continue to enjoy the same or better terms of sale and purchase post-acquisition.

On a similar theme, are there any significant customers or suppliers (over 20% of sales or purchases) and how might they react to a change of ownership? A highly concentrated customer or supplier base can create risk, not only if they fail but also if they might refuse to deal with a potential acquirer for competitive or other more emotional reasons. If it is possible to reduce customer concentration risk by increasing sales, it’s worth doing (and doesn’t require professional advice).

Numbers
Do you budget and forecast the business? If so, how successful have you been at achieving your forecasts? If not, why not? How do you plan for the resources required to achieve your targets? Buyers can be helped to assess your business by reviewing your budgets and forecasts and gain confidence from your ability to achieve expected results.

Also important is to be able to show a rising trend of profits, profitability and cash flow. This should be demonstrated over several years if possible and is not something that can be done overnight. Any “blips” need to be explained honestly and consistently to be credible.

There may be one or two expenses or assets that are likely to be unattractive to a purchaser. Rather than have an embarrassing discussion during sale negotiations, consider removing anything that has dubious business benefit – company housing, overpaid relatives not contributing to the business, the nanny, gardener or handyman who never come to the office but can be found at the business owner’s home, the sponsorship of the local cycling club because it is a personal passion from which the business gets little reward.

Costs such as these indicate that personal and business expenses tend to get mixed together, leading to a suspicion that there could be more and that the taxman might be interested at some future date when it could be the acquirer’s responsibility.

It is also sound financial sense – the business should sell for a multiple of profits, but if those profits are deflated by extraneous costs, the reduction in the sale price will be several times the benefit from a few personal expenses.

Come back for the second part of this article, detailing the due diligence process, available soon!