By William Bruce, President, American Business Brokers Association.
This series of articles covers the issues involved in selling your business. In our last article, we discussed possible reasons for selling your business and the importance of being able to give a legitimate reason for the sale.
This time we’ll talk about getting your business ready to sell. The time, effort and expense that you expend in getting your business ready to take to market will pay handsome dividends. Don’t underestimate the crucial importance of preparation.
In short, spiff up the place! Start first with curb appeal. Stand back and take an objective look at your business location as you approach from the street. Look critically and make a list of the things that need attention. Prune the overgrown shrubs, haul off the trash, clear the sidewalks, paint the building. Do whatever you need to in order to give a good first impression.
Even in the sale of a business, first impressions really do count. You might think that business buyers would normally concentrate on the profit and loss statement to the exclusion of appearance, but some prospective buyers that I’ve worked with were just never able to get over a shoddy look when they turned into the parking lot.
On the other hand, I’ve had some buyers tell me they knew from the moment they saw the business that it was the one they wanted. And this was before they saw any of the financials! The first impression was just that good.
Next, go inside your business with the same critical eye and clean it up. Get all those files off the floor and back into the cabinets. Steam clean the carpets and wax the floors. Paint the dirty walls. Replace the light bulbs. Put inventory on the shelves. In summary, make the place look neat and inviting. After all, the prospective buyer is trying to convince himself that your business is where he ought to spend the next ten to twenty years. Make it easy for him to picture himself enjoying the nice, neat, bright environment of your business.
In summary, there is just no sense in taking the chance of getting off on the wrong foot with an otherwise good prospect because of a poor appearance. This is one phase of the selling process that you can control one hundred percent. Take control, and turn it to your advantage.
Business buyers – and their lenders – will expect, at some point in the process, to see at least three years of your financial statements and tax returns. As we’ll discuss later, you should not give these records to every Tom, Dick and Harry; however, qualified prospects who have signed a confidentiality agreement will expect to be able to review the financial performance of the business. Accordingly, you should make sure that all of your financial statements and tax returns are up to date.
Which brings us to a real problem. Your profit and loss statements and tax returns, if they are like the books of most privately held businesses, don’t show much profit. They may even show a loss. It’s because – let’s see, how shall I delicately say this – most business owners do not keep books to pay income taxes. In fact, most business owners make strenuous efforts to write down any profits. You may be making an excellent living out of your business, but you’re taking advantage of all available possibilities to reduce the profit that you show Uncle Sam.
As an example, take the sale of a large restaurant that I recently handled. The profit and loss statement from the business was actually showing a small loss. However, the owner’s wife drove a Lincoln Navigator which was listed on the books of the business as a company vehicle. The company also paid for all her gas and maintenance on the Navigator although she has no role in the operation of the restaurant. Same for the daughter’s Honda which she drove back and forth to college. The daughter was also on the payroll as an employee of the restaurant which furnished her with spending money at college, although she never actually worked at the restaurant. The family ski vacation to Colorado was charged to the business because the owner attended a business meeting for a couple of hours while in Aspen.
You see where I’m heading here, don’t you? By the time all these items plus any non-cash expenses were accounted for, the restaurant was actually producing a nice yearly cash flow for the family. (Hey, I’m not with the IRS and don’t express an opinion here!)
But the situation presents a problem for a potential buyer of the business. The owner’s bookkeeping practices camouflage the actual cash producing ability of the business. The solution for someone selling his or her business is the cash flow worksheet.
Computing Cash Flow
So first let’s define cash flow. Some business brokers refer to it as owner’s discretionary cash flow or ODCF. Owner’s discretionary cash flow is defined as that amount of cash that the business produces in a year’s time that is available (1) to pay back any debt that the owner of the business incurred to buy the business, and (2) for the owner’s compensation.
Another way to express it is that ODCF is the amount of cash the business produces after all necessary operating expenses – and only the absolutely necessary operating expenses –have been deducted.
This process of computing cash flow is referred as the recasting or normalizing of income. In recasting a profit and loss statement, this is the procedure that is used to compute ODCF:
- Start with the company net profit (or loss) as shown on the profit and loss statement or tax return.
- Add any non-cash deductions that have been taken such as depreciation and amortization. (These are “paper deductions” allowed by the IRS for which no check is written.)
- Add any interest expense (because you will be selling the assets free and clear so the buyer will not incur this expense. It will be available for his debt service, if any.)
- Add the owner’s salary and perks (because this amount will be available to the new owner for his own compensation.
- Add any family perks (cars, vacations, non-working employees, etc) that have been run through the business as a business expense.
- Add any one-time, extraordinary expense items that will not be routinely incurred again (such as a major repair bill).
The total of these items will give prospective buyers a more accurate assessment of the cash producing ability of your business and is referred to as owner’s discretionary cash flow (ODCF).
You should have a cash flow worksheet prepared for each of the last three years, plus an interim worksheet for the current year. If you’re using a business broker, he has a form and software for quickly producing this report. But he’ll need your help in identifying the items on your P&L that are not necessary business operating expenses, so plan on sitting down with him and assisting in this project.
There is one more point I need to make here before we leave the subject of cash flow. If you have had cash income that you cannot prove, just remember that this is part of the owner’s income that you have already benefited from and, if you can’t prove it, then it cannot be reflected in your selling price.
Now that you’ve spiffed up the place and cash flow has been computed, we’re ready to talk about how to value your business, which will be covered in the next article.
(Readers of this blog can order the entire series of articles by requesting the 26-page booklet, “How to Sell Your Business While Avoiding Costly Mistakes.” To request your copy, please email William Bruce at WilliamBruceOnline@gmail.com.)