EXIT STRATEGY - BUSINESS BUYING GUIDE

1. INTRODUCTION

The decision to exit your successful business will be one of the biggest of your life.

Your business reflects your unique personality. It represents your invested time and energy over many years. When you finally make the definite decision to enter the next chapter of your life, it pays to make sure that you understand the sales process and have a clear vision of the end goal.

This Guide has been prepared to give you, the business owner, in-sight into navigating the minefield of your business sale, and to equip you with essential knowledge so you can move ahead with confidence.

As a business broker, I encounter owners selling for varied reasons; it may be ill health forcing them to sell, a simple need for change or a partnership breakdown. Regardless of the reason, business owners who have a clear understanding of the sale process and how to successfully navigate it, usually maximise their business saleability and capital gain when they eventually do sell their business.

“The business sale prosess is lettered with trap and pitfall for the unwary”

This Guide concentrates on the Business Sales Process. Whilst other professional advisors such as your accountant offer unique and important services, my job is to focus on the practicalities of the sale process and to help you, as a potential business seller, understand this process in greater depth.

My hope is that this guide will clarify the business sales process and will enable you to make informed decisions.

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2. WHAT HAPPENS IF YOU GET “HIT BY A BUS”?

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3. ARE YOU PREPARED FOR AN EMERGENCY?

Having read through the different reasons people sell their business, you may have identified one or two different scenarios which apply to you.

Your reason for selling will often determine
how well the business has been prepared for sale,
and will also affect the sale price of the business.

LETS LOOK AT TWO EXAMPLES:

EXAMPLE 1

Joe has inherited a family business. He has great plans for the expansion of the business and starts to implement changes in the business that will benefit the business in the long term, but which adversely affect the short-term cash flow.

In the midst of these changes Joe suddenly becomes ill and has to sell his business because there is no one else to run it.

Since Joe was not anticipating the sale of his business, as a result of these unforeseen circumstances he will most likely have to accept a lower sale price than what the business may be truly worth since the short term profits have been affected by the changes he was making. Additionally, because of Joe’s illness, a potential buyer may take advantage of the fact that he requires a fast sale, and offer a low price for the business.

EXAMPLE 2

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4. WHO SHOULD I TALK TO?

The decision to sell your business is one of the most important decisions you will make. It is therefore wise to get expert professional advice from those people who know your business, as well as people who are experienced in the sale process.

• BUSINESS ACCOUNTANT: The first person you should speak to should be your Business Accountant. They will have a very good idea about your business finances and the structure of the business. They will be able to advise you of the current profitability of your business, and can help you prepare your finances to give the best presentation to the marketplace. Your accountant can also advise you on the tax implications of selling your business, and can assist you in planning for the investment of the proceeds of sale.

Additionally, I act as a buffer between you and the buyer, allowing you to deflect the pressure and stress of the negotiation process onto me. The costs of my services are more than offset by my ability to pre-qualify the maximum number of prospective buyers, to obtain a higher price due to proper valuation and marketing, and to successfully complete the transaction in a more timely and confidential manner.

• BUSINESS VALUER: If your business is unique or difficult to appraise, employ the services of a business valuer. Note that business valuers are usually experienced business brokers or accountants who are using their market knowledge to provide an additional valuation service.


• CONVEYANCER / SOLICITOR: Find a conveyancer or solicitor who specialises in the transfer of businesses. Settling a business transaction is much more complicated than settling a property, so make sure you are using an experienced business conveyancer.

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5. WHAT’S MY BUSINESS WORTH?

There are a number of valuation methods and ‘rules-of-thumb’ which have developed over time for the valuation of businesses, and particular business industries may even have their own specific methods of valuation. This can be very confusing, particularly if you are comparing businesses from different industries.

Let’s consider an example. Jenny has a successful wholesale/retail business which has an Adjusted Net Profit of $200,000 per annum. An ROI% of 40% is deemed to be appropriate in this instance. With these two pieces of information the potential sale price of the business can be calculated using the formula shown below:

EXAMPLE SALE PRICE = Adjusted Net Profit/ Return on Investment (R.O.I.)%

SALE PRICE = $200,000/ 40%

SALE PRICE = $500,000

Note: a full explanation of “Adjusted Net Profit” and “Return on Investment (R.O.I.)%” appears on the following pages.

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6. HOW IS THE R.O.I % CALCULATED?

The R.O.I% is derived by dividing the Sale Price of a business by the Adjusted Net Profit of the business (Please see formula below). For example, if Jenny sells her business for $500,000 to Robert, and at the time of sale the business was producing an Adjusted Net Profit of $200,000 per annum, then the R.O.I% for that business will be calculated as:.

EXAMPLE Return on Investment (R.O.I)% = Adjusted Net Profit X 100 /Sale Price

Return on Investment (R.O.I)% = $200,000 X 100/$500,000

Return on Investment (R.O.I)% = 40%

Note that this is a reversal of the formula show on page 5.

An example has been provided below on three different businesses, all with the same Adjusted Net Profit of $100,000. The hypothetical businesses are compared with each other, and note the effect on the overall value that the R.O.I.% has:

As you can see, the lower the R.O.I.%, the higher the value of the business. Remember that the R.O.I.% is derived from the Business Sales Market, to calculate up-to-date R.O.I.%’s on businesses which have recently sold

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7. WHAT IS ADJUSTED NET PROFIT?

The income stream of a business is shown in the Profit and Loss statements prepared by the business accountant. Financial statements of privately held businesses are usually prepared to report income taxes. These financial statements serve the purpose for which they were intended, however they rarely show the economic reality of the business’s earnings or assets.

To determine the appropriate Adjusted Net Profit to value a business, it is usual practice to work on the figures from the current financial year, as this is usually the most up-to-date picture of how the business is performing.

Adjusted Net Profit = Business Operating Profit before Tax, Depreciation, Interest & “Add-Backs”

We discuss “Add-Backs” in greater depth on the next page.

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8. WHAT ARE ADD-BACKS?

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9.HOW IS GOODWILL CALCULATED?

WHAT IS GOODWILL (Intangible Asset)?

Goodwill is the value of a business to a purchaser over and above its net asset value. It reflects the value of intangible assets such as strength of the on-going income stream, reputation, brand name, contracts, good customer relations, high employee morale and other factors that improve the company’s business.

The correct method of deriving Goodwill is very simple and accurate.

Goodwill = Total Business Value less Net Asset Value (See example below)

The first step to calculating Goodwill Value is to determine the Total Business Value, using the R.O.I Method of Valuation outlined in the preceding pages. Once the Total Business Value has been determined it is a simple matter of deducting the Net Asset Value (plant, equipment, stock, vehicles etc.) of the business from the Total Business Value, to arrive at the Goodwill Value, or intangible asset value.

Using our example of a Wholesale / Distribution business from the Page 8 (see below), the Total Business Value is calculated at $370,000, as determined using the R.O.I method of valuation.

The value of the Goodwill is directly determined by the overall value of the business, which in-turn is derived by the R.O.I. Method of valuation as outlined earlier in the report.

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10. BASIC OVERVIEW OF THE SALE PROCESS

Please refer to the “Settlement Process Diagram”

The sale process is initiated by a purchaser formally submitting an Offer in writing for the business. The Offer will usually be drawn up by a business broker like myself, or by the buyers legal representative, and outlines the offer price as well as all the terms and conditions of the offer. The Offer is then presented to you, the business owner, and you can choose to either accept the Offer, or counter-offer back to the purchaser.

Once an Offer has been formally accepted and signed by both the purchaser and the owner, it becomes a Conditional Contract: (also called an Offer and Acceptance) i.e. the contract will stand/be enforceable so long as all of the relevant conditions in the contract are successfully completed or met.

For example, the contract will probably include a Due Diligence condition. Due Diligence is a process whereby the purchasers accountant will “prove up” the income that has been presented during the marketing of the business. The Due Diligence clause in the contract is just one of the clauses that will need to be completed before the contract can become unconditional

Typical conditions on an offer include:

There will be other industry specific special conditions which will apply depending on the type of business being sold. For example, a hotel/pub will require a transfer of the Liquor Licence, a process which is governed by the State Government meaning a contract will include a special condition relating to the successful transfer of the Liquor Licence.

Once the contract has been signed by both the purchaser and the seller, the relevant documentation has to be sent to the acting settlement agents. They will prepare for the settlement of the business, and will also make sure that all the proper documentation has been finalised.

A brief note on settlement agents: a good one is worth their weight in gold!! They are a massive help when selling a business, and are an excellent source of information about procedures and the legal aspects of selling a business. It is important when you are selecting a settlement agent to work for you that they have sufficient experience in business transactions.

Part of my role as a business broker is to ensure that the settlement process goes smoothly. The settlement process is one of the busiest times for a business broker, and I stay involved in the process right through until after the monies have changed hands.

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11. THE SETTLEMENT PROCESS

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12. SPECIAL CONDITIONS OF SALE

DUE DILIGENCE – WHAT IS IT?

Due diligence means the process by which the purchaser and their accountant prove that the Net Profit of the business is true and correct. Due diligence will involve a more detailed investigation of every area of business starting from the financials down to production and even such things as ‘by who’ and ‘what time’ the business is opened and closed.

As a business owner it is important to be aware of the purchaser’s requirements when it is time for Due Diligence. Everything should be available and in-order as this will generate confidence in your business and hopefully speed up the sale.

WHAT IS A “RESTRAINT OF TRADE”?

A Restraint of Trade protects the purchaser from competition by the outgoing owner, once they have bought the business. A Restraint of Trade restricts the previous owner of the business from setting up a similar business for a defined period of time, or within a defined geographic region.

The reason behind a Restraint of Trade is that in most instances the outgoing owner has a strong network of clients and a loyal staff following, and it would be very easy for them to open up the same business “down the road” and destroy the goodwill that they have just sold to the purchaser.

TERMS OF PAYMENTS / VENDOR FINANCE

In most instances in Western Australia, the entire purchase price is paid at settlement. However in some instances there are staggered payment terms, or amounts are kept aside (say 20% of the purchase price) to ensure that the business continues to perform under the purchaser in the same manner as it did for the previous owner.

In some instances a purchaser will require the vendor to provide some ‘vendor financing’ as a way of reducing their risk, or as a means of funding the acquisition of the business. These terms and conditions must be clearly laid out within the Offer to Purchase document, and must be agreed to by the owner, prior to the offer being accepted.

TRAINING/HANDOVER PERIOD

The purchaser will usually ask to have the seller assist for a short period after the sale so that they can be introduced to important customers and be shown the procedures of how to operate the business in the most profitable manner. This period of time is usually between two weeks up to four weeks.

If the purchaser requires the previous owner to work longer than two to four weeks, it is usual practice for a suitable wage to be negotiated for the previous owner to ensure they are remunerated for this time.

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13. Practical Selling Tips

PART 1 - Before you sell

1: “WHY ARE YOU SELLING?”

This is the #1 questions buyers ask. You need to have a good reason for wanting to sell (that is logical to the buyer). If your reason for selling seems weak, the buyer will be suspicious and may conclude you are selling because there is something wrong with the business that they have not yet spotted. If they are suspicious about the business they will walk away, or, will not pay you as much for it.

Selling your business is all about Buyer Confidence;
No Buyer Confidence = No Sale

2: BE THE ONE IN CONTROL OF THE DECISION TO SELL. Be proactive about deciding when you want to sell your business, rather than having circumstances dictate terms. Never allow yourself to become a forced seller of your business as a result of economic or other reasons as you will achieve a lower price because first, you will not be selling at the most opportune moment to maximise value, and second, anxiety will force you to accept lower offers than you would otherwise consider.

3: START TO ORGANISE WELL IN ADVANCE. You are only going to sell your business once, so it does pay to do it right first time. Now is the time to tidy up all the loose ends and finish the things you have been putting off. Get all of your finances, supply agreements, contracts etc. in place prior to putting your business on the market. Talk to your accountant or to your business broker to help you with this.

There is nothing that causes more problems in the sales process than an unexpected surprise discovered late in the day. Thorough prior preparation of your business, its leases, contracts, documents, title deeds and so on, helps prevent unnecessary surprises.

4: TIDY UP YOUR BUSINESS (AND KEEP IT THAT WAY) First impressions count! If you put yourself in the buyer’s shoes and were to visit your premises today for the first time with the thought “Should I buy this business?” how impressed would you be? Does your business look tidy, with everything in its place, or is it chaotic? Remember that a good impression will make the buyer confident about you and your business.

5: ITS NOT SOLD UNTIL ITS SOLD! Don’t let either your operations or the way you are presenting your business slip as you go through the sales process. Keep the business looking attractive, keep the hours being worked normal, keep the stock at the appropriate levels, right up until the time when you have signed on the dotted line and collected the cash .

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part 2 - The Sale Process

1: SET A REASONABLE TARGET PRICE

Whatever valuation method you use, you should set a reasonable target price for your business. As a business broker, my aim is to sell your business for as much as possible, without pricing it out of the market. Setting a ridiculously high price can be a major mistake as:

• it may well scare away many potential buyers;
• it tells people you are not very serious about selling your business;
• it means your business may remain for sale for quite some time, which may lead potential buyers to think there is something wrong with your business which is preventing it from being sold.

2: GET THE BEST HELP AVAILABLE

Good professional advisors, like your accountant and a business broker, cost money. But good professional advice makes you more money than it costs. Selling your business is probably the most important single transaction you will ever undertake, do you really want to do it on the cheap?

3: BUYERS NEED TO FEEL CONFIDENT ABOUT YOU AND YOUR BUSINESS

Much like buying a second-hand car, the thing that your buyer fears the most is that they are buying a lemon that you are getting rid of to avoid some inevitable collapse or crisis. Your job is to be sympathetic to these concerns and do everything in your power to make them confident about the long-term prospects and risks of your business, so they feel comfortable to be able to invest in it.

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part 3 - The Negotiations

1: BUSINESS SALES ARE A 'PROCESS', NOT AN 'EVENT'

Putting together the perfect deal is difficult and achieving a successful sale will require both parties to be flexible and creative in negotiation. The goal is to create a win-win situation for both sides and to keep the ball rolling. It’s my role as your business broker to best protect your interests as the business owner, and to negotiate the best price possible for you, while still ensuring the interests of both parties are protected.

2: TERMS ARE AS IMPORTANT AS PRICE

Since the business sale negotiations are not simply about price but also about broad terms of the deal, in addition to your target and drop-dead price, discuss with your business broker the objectives you are trying to achieve and your views as to your preferred deal terms including the warranties you are prepared to give before getting into these negotiations.

3: TAKE TAX ADVICE

There is not much point in negotiating 5% up or down on the price you are selling for if you have not planned the sale so as to pay 20% tax rather than 40%. Your accountant is the best person to speak to help you legitimately minimise the amount of tax you pay on the transaction. Talk to them upfront before beginning negotiations so that the right structures can be put in place.

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14. Summary

The services of a good business broker and business accountant will ease a lot of pressure that you may feel during this time, but the fact remains that you will be in a time of transition, and with transition it is not uncommon to experience some anxiety.

Some businesses sell quickly; some take longer to sell. The entire sales process should take between one month and five months, from listing the business for sale up until successful handover. In some instances however, the process can take longer than this.

Your business is your key strategic asset;
give your business sale the same thought,
care and attention you give to its everyday running.

My advice is begin to plan your exit strategy today! You have probably heard it said that “those who fail to plan are planning to fail”. Begin planning the successful exit from your business today, so as to fully enjoy the rewards of your labour when you do eventually move on. Even if your intention is not to sell for many years in the future, begin identifying and implementing now the systems and strategies that will maximise your business’s value when you sell in the future.

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15. ABOUT THE AUTHOR

How Can You Benefit From My Services?

I aim to add value for my clients through the following services:

• Business Broking - I enjoy helping people successfully transition into, and out of, quality businesses. I am dedicated to providing the highest quality service, documentation, and marketing for all my clients in regards to business transactions.
• 
  
• Business Valuation / Business Health Checks - As a licensed valuer I am well-qualified to undertake business valuations, and have a solid history in providing business valuations for a range of circumstances.
• 
  
• Buyers Representative & Negotiator - I successfully approach companies, not currently for sale, on behalf of buyers who are keen to acquire that particular business. Alternatively we can canvass specific industry sectors on behalf of buyers who are looking to acquire a business within a certain industry.
• 
  
• Sales Transaction Documents - I prepare legally binding and enforceable sales transaction documents for buyers and sellers who may have already agreed on a sale price.

Blair Macdonald

WE RECOGNISE VALUE

TEL: 0433 149 144

E: blair@perthbusinessvaluations.com.au
W: www.perthbusinessvaluations.com.au

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