Getting the Maximum Price When Selling a Business
Every business owner wants to get the maximum price when selling a business. Additionally, the steps to sell a business are many and complicated but when a business owner decides they want to sell, the starting point is a business valuation.
Part of the purpose of the valuation is to normalize the performance of the business over the last three or four years so potential buyers can see trends and decide this is a business of interest to them. My personal process is also to approach third party lenders who typically approve SBA loans to get their take that this is a business they would have an interest in approving an SBA loan.
To put the valuation together the necessary documents are the tax returns for the last 3 or 4 years, a current profit and loss statement and current Balance Sheet.
I recently asked a CPA and a Certified Appraiser why tax returns were the main documents used to determine the value of a business. The two reasons I was given are that tax returns are documents the business owner submits to the IRS; which is a Federal government agency. As a result, by law a third party lender can request a copy of the document from the IRS as long as they have the permission of the business owner. This therefore provides the lender with some protection that the document they are using to assess the performance of the business is true and correct. The second reason for using the tax returns is that the business owner signs it. Right above where it is signed, there is a clause that comes with an acknowledgment that starts with “Under penalties of perjury…” It is therefore expected the signor or business owner is aware of the accuracy of the tax return as they have no legal defense that they didn’t realize the tax return was not accurate.
The fact that tax returns are the basis of a business valuation is real important to the seller. At the end of the day, the purpose of the tax return is to report the annual sales and expenses to the IRS and obviously pay as little tax as possible. When a business owner wants to sell their business, their goal is the exact opposite, that is, get the highest valuation possible and therefore the highest price from selling their business.
With this in mind, a qualified business appraiser as part of their valuation process will normalize the performance of the business by recasting the financial statements.
Recasting simply means obtaining the SDE or Sellers Discretionary Earnings of the business by adjusting certain items to reflect reality. These items include:
- Owner salaries including payments to family members.
- Any nonrecurring expenses.
- Interest payments.
- Depreciation expenses.
- Rent expense.
- Owner discretionary expenses including owner bonuses and pensions.
- Any known increases in fixed expenses.
The recasting process arrives at a much better representation of the business and actually helps the buyer if they choose to get third party finance.
It is also proper to recast the balance sheet. The balance sheet shown on a tax return is generally not even close to accurate. For example, a balance sheet on a tax return shows the depreciation value of fixtures, furniture and equipment as well as buildings if the seller owns the building. Another figure that is generally way wrong is inventory as few owners have the time or inclination to get it accurate.
If you are thinking of selling your business and it’s in the next few years, start making an Excel file spreadsheet with any one off expenses you may incur as these are legitimate add backs that need to be taken into account when valuing or selling your business.
Privately held businesses have a unique position in the business world. The only time a business owner really has any interest to know the true value of their business is when they plan to sell. Otherwise, nobody needs to know and there are too many other things to do with your time when you own a business.
Are you thinking about selling your business? Would you like to know the value of your business? If you would like more information please visit my website Business valuation.
For more immediate help you are welcome to send an email to Andrew Rogerson or give me a call on 916 570-2674.