Business Valuations

Preparing your business for sale means much more than sprucing up its curb appeal and improving the organization and cleanliness of the plant. Clearly, these are important factors to create a positive first impression. However, there is a substantial amount of planning that should take place well in advance of exposing the business for sale. While the preparation process can be time consuming, the 5 steps reviewed in this article can significantly increase the value of your business.

Preparing your business for sale means much more than sprucing up its curb appeal and improving the organization and cleanliness of the plant. Clearly, these are important factors to create a positive first impression. However, there is a substantial amount of planning that should take place well in advance of exposing the business for sale. While the preparation process can be time consuming, the 5 steps reviewed in this article can significantly increase the value of your business.

Step # 1: Update and Normalize Financial Statements
One of the most important information items that potential buyers will be relying on is your company’s financial statements. If they are unaudited, you may want to consider upgrading the quality of the financial statements to an audit. The key advantage of audited financial statements is that financial information will have more credibility in the eyes of the buyer and may enhance the value of your business.

The business owner and advisors must have a good understanding of the reasons for fluctuations in revenue, gross profit percentages and expenses from year to year. Furthermore, it is a good idea to normalize the historical financial statements to show the true profitability, by adjusting for items including:

• Uneconomic management remuneration and bonuses;
• Salaries paid to non-working family members;
• Benefits paid on the owner’s behalf that would likely not be incurred by a buyer; and
• Non-recurring expenses.

Step # 2: Prepare Projections
A well-reasoned and realistic business plan incorporating a projection of future profit for the next one to three years can result in a significant increase in the value of a business. Therefore, such projections are an excellent vehicle to paint a picture of the future plan for the business, specifically identifying growth opportunities and untapped expansion potential.

The preparations of projections may allow you to demand better terms, as it may convince buyers of the growth potential of the business. A properly prepared business plan and projection may also enhance the buyer’s ability to secure financing for the purchase.

The projections are developed using a “bottom-up” approach. This means that the projection is built upon the underlying assumptions (e.g., number of units that can be sold each month; selling price per unit; actual and potential customers, market penetration, etc.).

Step # 3: Gain an Understanding of the Value of Your Business

Obtaining an outside valuation of your business has the following advantages:

• Prevents leaving money on the table by undervaluing the business;
• Provides a benchmark for evaluating bids for the business;
• Provides an understanding of the value drivers of your business — which can enthuse prospective buyers about your business and indicate those drivers which are currently “weaknesses” that need to be addressed prior to sale; and
• If the lowest price that an owner will accept greatly exceeds the business valuation, it may not be the appropriate time to sell the business.

One of the best ways to enhance the value of your business is to take the current weaknesses in the business and change them into positive factors. For example, changing a business with a high percentage of sales derived from a few large customers, to one with a broader customer base can result in a significant enhancement to the value of the business.

There are many excellent resources dealing with this stage in the sale planning process. We recommend “Good to Great,” by Jim Collins and “100 Ways to Win the Profit Game,” by Barry R, Schimel, CPA and Gary R. Kravitz. Also, an independent business valuation can be conducted or an operational review of your business can be performed to recommend strategies to enhance the value of your business.

Step # 4: Plan for Tax Consequences of Sale
It is imperative that you consider the tax implications of a sale well in advance. For example, if the business satisfies the criteria for a Qualified Small Business Corporation (“QSBC”), a sale of shares could qualify for a $500,000 capital gains exemption. If the business does not satisfy the criteria because some of the assets may not be used in an active business carried on in Canada (e.g., marketable securities, real estate, excess cash, etc.), it may be possible to “purify” the company by transferring these passive assets to another corporation on a tax deferred basis utilizing the provisions in the Income Tax Act.

You should also consider whether it is more advantageous to sell shares or assets. Vendors usually desire to sell shares, primarily to obtain the capital gains exemption. On the other hand, purchasers usually want to buy the assets of the corporation for two primary reasons:

A. The purchaser (unless specifically assuming certain liabilities) will not be responsible for liabilities that are not known at the date of closing; and

B. On an assets purchase, the buyer has the ability to step up the cost base of depreciable property to fair market value, thereby increasing the capital cost allowance available to be deducted against future taxable income.

It should be noted that in most circumstances it is necessary to have held the shares in 3 the QSBC for a period of 24 months to take advantage of the capital gains exemption.

Step # 5: Diversify Management Talent
If you ask a private equity firm what is the most important factor in assessing whether or not to invest in a business and what price to pay, the first response is usually the quality of management.

It may be difficult to sell a business that depends solely on the owner, and the price of the business will be negatively impacted because of the increased risk from the buyer’s perspective.

When a business is too dependent on the owner, there is risk of loss of:

• Customers that only have a relationship with the owner;
• Key employees that have remained with the company because of the owner; and
• Suppliers who may have had a long-term relationship with the owner.

Therefore, it is critical to broaden the strength of the middle management team to reduce and hopefully eliminate the risks in these areas.

Summary
While other steps are required in the pre-sale planning process, the above five steps can significantly increase the likelihood of a successful sale and positively impact the selling price.

When you are ready to sell your business, it is important to assemble an appropriate team of advisors including a qualified M8cA advisor and a lawyer experienced in such transactions. The right team will identify and contact potential prospective buyers and maximize the overall deal value.

Five Steps to Maximize the Value of Your Business was authored by Bruce Roher. Bruce is a Partner in Fuller Landau’s Valuation and Litigation Support Services Group. To contact Bruce directly, please call (416) 645-6526 or email broher@fullerlandau.com