In my upcoming book, that I will reveal soon, there is a chapter about grooming a business for sale including 5 strategies. The first of these I call: Fixing Your Financials.  Here are the four areas to focus on to cover this strategy.

Provide Three Years of Financials

The financial statements are the first and most important lens buyers use to size up your business. Therefore, it is critical that your numbers are reliable, transparent, and consistent. Reliability means that your income statement, balance sheet, and cash flow statement are accurate and backed up by verifiable data. It is worth investing in an audit with a reputable CPA firm to confirm that your financials are true and fair.

Consistency means that you have prepared multiple years of financials.  be sure to employ the same approach for recognizing revenues and expenses. Companies that reclassify expenses from one year to the next create unnecessary stress for the readers. They erode the confidence of buyers, who will suspect there is something to hide. Especially when you change accounting or enterprise resource planning software, make sure you maintain consistency of records.

From your financials, buyers also draw conclusions about the quality of your management team. Having historically prepared budgets and forecasts with corresponding actual results increases confidence that your team is running the business professionally. This shapes expectations that future projections are likely to be reliable too.  Investors then can take them seriously for valuing the potential of the business.

Recast Your Income Statement

Buyers want to understand the profits your business will make for them into the future. They will study your company’s historical results to verify whether they should trust your projections as a basis for their valuation.

The cleaner your past and the more intentionally you appear to be running the business, the better.  It will increase your investors’ confidence that they need not discount your projections. Typically, you present your company’s EBITDA, EBIT, or net profit, showing the floor level of profitability the business would deliver and how buyers can grow from there.

Make sure you remove any expenses unrelated to the business and expenses. Also remove one-offs and that will probably not reoccur in the normal course of business. These include the following:

  • Expenses incurred for the benefit of the owner that would not be incurred if an independent management team were running the company. These include: personal auto expenses, club memberships, payments made to family members over their contributions to the business.
  • The salary paid to the owner over what a future CEO with the required skills would earn
  • One-time marketing expenses, such as a rebranding campaign or any major nonrecurring marketing initiative
  • The cost of design, development, and investment write-offs
  • Fire and theft losses
  • Lawsuit payments
  • Loss on the sale of assets
  • Charitable contributions
  • Moving expenses

You can usually add back extraordinary expenses as adjustments.  However, quality of earnings matter, and buyers will question your add-backs and unusual accounting practices. You are best positioned to build trust when you present clean financials and a clear, self-explanatory income statement.

Cut Nonessential Expenses

In the last full fiscal year before a transaction and in the year of a transaction, spend only on activities that maintain the business’s growth or that give you a quick payback. The profitability of these years is paramount in the valuation of your company, and you will recoup every penny saved four to six times over in a higher purchase price.

Fixing your financials includes minimizing expenses.

The year before the sale is not a time for a brand-building campaign. Such activities rarely translate to higher earnings immediately, and their cost will depress profitability in the short term. This is also not the time to increase payroll, unless an emergency threatens the loss of key personnel.

Review your R&D expenses. Are they all essential to maintain momentum in the year of the planned sale or the year after that, should the transaction fall through? If not, delay them because they will negatively affect your sale price.

The same goes for major capital investments, such as plants and equipment. GAJ, a tier 1 supplier of fabricated steel components to the heavy equipment industry, made a major investment in new computer numerical control machines before its sale to a Swedish public company. The investments were strategic and would support the long-term growth of the business, but the buyers gave no valuation credit for it. Because the outlay reduced GAJ’s cash reserves and thus its enterprise value, it practically was a gift to the buyer. The sellers could have avoided giving up what amounted to 20 percent of the sale proceeds if they stopped acting like owners and started acting like sellers in the run-up to the transaction.

Shrink Inventories and Receivables

The seller’s sale proceeds are the enterprise value of the business (e.g., five times EBITDA) less the net debt the company owes to third parties.

The more cash you have tied up in assets, the less money your business has in the bank or the more debt it owes. Every dollar of reduction you can achieve in inventories or receivables directly increases the cash proceeds to you upon a sale.

Fixing your financials includes minimizing debt.

In the example in Chapter 3, Seph and Roland’s business Exdom was worth $8 million on the basis of a multiple of EBITDA. However, the business also owed $8 million to the banks that financed its receivables and inventories. The cost of financing the company’s working capital absorbed all its equity value. Had Exdom been able to outsource its fulfillment and sell for cash, the business would have been worth $8 million to its owners.  Not zero.

In the run-up to the sale, consider ways to cut and outsource your inventories if you can do it cost-effectively. Try to negotiate cash or credit card payments with customers, or involve third-party lending. Financing customers is not your core business and doing it yourself likely will subtract from, rather than add value to your company. It also creates a distraction and harms your cash flow. Avoid factoring receivables: It will be expensive and most investors consider it as off-balance-sheet debt anyway.

The less inventory and shorter accounts receivable you carry, the more cash will hit your bank account on closing the sale of your business.

When you have fixed your financials, it is time to make your strategy shine. I’ll cover that in an other blog in the coming days.