Pitfalls to Avoid When Selling a Business

The sale of a business does not have to be marked with pitfalls. Below are the most common mistakes that seem to be repeated by business owners who do not have the proper guidance.
Pitfalls to avoid when selling a business

  1. Avoided simple “rules of thumb” to value a business.
  2. Listening to other seller sale prices
  3. Overpricing businesses
  4. Bad books and records
  5. Unable to prove owner perks
  6. Year-end adjustments
  7. Inexperienced Business Transfer Attorneys
  8. Inexperienced business transfer CPAs
  9. Bad attitude from seller
  10. Uninformed spouse
  11. Not handling your support team
  12. Messy business
  13. Continuing the course of business
  14. Inadequately plan your exit strategy
  15. Have a thorough knowledge of the tax consequences of selling before you start the process
  16. Not adopting a “dealmakers mentality” in selling
  17. Not keeping an open mind in the length of time required to assist the buyer in transition

1. Avoided simple “rules of thumb” to value a business.

Become familiar with accepted valuation techniques. Most industries seem to have perceived techniques for valuing businesses. Many of these rules of thumb, however, are not accepted by the valuation / lending industry. Owners should avoid listening to uninformed sources for determining value, just because those sources are in the seller’s industry. Owners that have sold a similar business will not be informed sources, in that they tend to not understand all of the intakes that went into making their own sale. Former sellers also usually tend to leave out important aspect of what was included in their sale, such as the inclusion of A/R, real estate, and the handling of debt.

2. Listening to other seller sale prices

In the real estate industry, it is easy to look up comparables on properties. Business sale prices have so many variables that comparables are only one of many components. When a business owner discovers that one of his peers sold a business and also discovers the sale price, the owner immediately equates that price to his business. The big problem with that logic is the sellers always exaggerated the price of their business and no one ever knows exactly what was included in the sale price (inventory, cash, A/R, etc.).

3. Overpricing businesses

The ultimate price for a business is the highest justifiable price a buyer will pay for it. The buyer ultimately determines that price, although you need a amount to start with. Many business brokers will list a business for sale at whatever price the seller asks, event if the Business Intermediary knows the price is too high. The reason for this is that some Business Intermediaries want as many listings as possible. An overpriced business will sit on the market and become tarnished over time due to overpricing. By overpricing a business, a seller could lose a good prospect, because the prospect thinks that there is not enough leeway to come down in price. If you treat the sale of your business like the sale of a used car, you are in for a long and arduous business sale process. If a Business Intermediary is allowed to price a business at the fair market value, the process will be smoother and a seller will ultimately receive the highest justifiable price for his business.

4. Bad books and records

Many times a business owner “lives” out of his business, and his books and records are not kept as well as they should. A solid, well-run business that has incomplete or inaccurate records will negatively affect he sale price and even prevent a sale. If a buyer needs to obtain outside financing for a business and the records are not consistent, this could cause a bank to reject a loan. Even worse a buyer might not feel comfortable enough with the records and never make it to the point of placing an offer.

Having good, clean records is absolutely essential in business transfer. If a proper paper trail for revenue and expenses cannot be documented and supported it is unlikely that the seller will receive his asking price. In fact, one of the biggest reasons deals fail after the contract of sale is signed is due to bad records.

5. Unable to prove owner perks

Key to effective deal making is the ability of an owner to prove cash flow from company financials. Owner perks, for example, can make up a large portion of a firm’s cash flow. If receipts and general ledgers and the connection to the corresponding line item on the P&L statement cannot be traced, the perk should not be included in the cash flow.

Much can be said about the subject of owner perks in analyzing a firm’s cash flow such as the problem of legality. The IRS has specific guidelines in what to legally allow in tax computation. Business owners usually walk a fine line in the area of perks. The problem that arises is that in the process of “hiding” the perks, a paper trail is either lost of impossible to reconstruct. There are many profitable businesses that should have sold at much higher prices, but due to poor records or paper trails, the real cash flow could not be proven. The company’s CPA is often not in a position to assist in the reconstruction of a perk, since most owners do not disclose perks with them.

6. Year-end adjustments

This area of bookkeeping is usually performed at the end of the year when the CPA calls to give the owner the bad news about his income tax exposure. Many owners start playing with costs to reduce their tax liability. Unfortunately, these owners are not concerned about the effect of their adjustments on the company performance related to cash flow, since they are only concerned about the effect of their adjustments on the company performance related to cash flow, since they are only concerned about lowering taxes. One of the main areas owners scrutinize is the ending inventory figure. They know that a lower ending inventory results in a higher cost of goods, therefore a lower net profit resulting in a lower income tax.

Another target area for many owners is the Cost of Goods section of the company’s P&L. We have seen everything including owners compensation end up in the cost of goods sold. The problem is, the resulting picture given to buyers is a very inconsistent gross profit situation when analyzing several years of operation. Many times the owners themselves do not remember what they did and cannot explain it to buyers. This often creates a nightmare for buyers going through due diligence trying to understand the flow of the business. The business may be fine but a year-end adjustment can skew figures such as cost of goods and gross profit, creating a hazy picture to explain.

7. Inexperienced Business Transfer Attorneys

The legal profession is just as specialized in some ways as the medical field. The implications of legal specialization are enormous in the area of business transfer. There are many occasions when a business owner’s personal attorney is not equipped to provide specialized advice concerning a business transfer.

8. Inexperienced business transfer CPAs

As previously mentioned, we find that most business owners get too involved in the sale price and do not pay as much attention to the legal and tax implications of the sale. Similar to the legal field, there are CPA’s that specialize in business transfer. As soon as we list a company for sale, one of the firs things we recommend to an owner is to obtain specialized legal and tax representation. It is interesting that business owners who are normally hard nosed and have to make hiring and firing decisions as a way of survival have a difficult time making the decision to get specialized tax advice. We hear phrases such as “I have the best accountant in the world who has been with me since the beginning and helped me through some tough times.”

The idea here is not to turn your back on trusted representation. We see nothing wrong with getting specialized help and letting your trusted representatives oversee the entire process. Isn’t this what happens in the medical field when you have major surgery? There is the family physician that many times is the referring doctor to a diagnostic family physician that many times is the referring doctor to a diagnostic specialist and then a surgeon (another specialist) performs the actual surgery. Getting specialized help in selling may be the difference between driving a Lincoln instead of a chevy during retirement. We hope you get the idea.

The tax angle has to be handled by a specialized CPA, but some CPA’s also think they are valuation specialists and know more about pricing than a qualified Business Intermediary or valuation company. As far as establishing price, in our opinion, the only people that are really in position to know are either business brokers that are actively involved in day to day aspects of selling businesses or third party valuation firms with good reputations.

9. Bad attitude from seller

Next to bad records is a seller with a bad attitude in terms of hindering a deal. We see very profitable businesses with excellent records, strong cash flow and an excellent history that should have sold, buy did not, due to an owner’s bad attitude. The selling process is arduous for everyone involved especially the seller. The ” I do not have to sell” or “Take it or leave it attitude” does not have a place in business transfer. An owner with an open attitude that treats buyers as guests is more likely to sell. The old saying about catching more flies with honey definitely applies here. An owner with a good attitude who realizes the burden of proof is on him, rather than the other way around, is much more likely to sell his business at a justifiable price.

A good attitude is also important for the support team to portray. If a seller is happy with a proposed deal, then by all means let he CPA, Business Intermediary and attorney know. The support team should be well advised by the seller to stay on their respective sides of the fence in a transaction. They need to portray the same positive attitude the seller has to show a unified front.

10. Uninformed spouse

In certain states, a spouse is required to sign a listing a g reement and closing documents; therefore, needs to be well informed of all aspects of the selling process. Problems with a spouse in a sale usually arise due to poor communication. Your spouse should be present in the first meetings with a Business Intermediary concerning valuation and marketing, since the broker will explain all of the steps of the selling process in the first meetings. The spouse should also be present at buyer meetings, to ensure they are comfortable with the process and the buyer.

11. Not handling your support team

Sellers should be aware that it takes an experienced support team to successfully handle and complete a business transfer. Attorneys, CPAs, Business Intermediaries, lenders and others will need to work together to get a deal done. There is no room for “power plays” or egos in this group. To avoid a major pitfall, a seller should be able to recognize everyone’s area of expertise and make sure he stays within his specialty.

The key term is team. We have seen deals when the Business Intermediary, CPA and/or attorney work in separate vacuums and do not communicate with each other, with each party working in a different direction. If a seller has run a business for a number of years, he knows how difficult it has been to ensure employees work together. Do not assume it could not be the same with your support team. The selling process is the time to use you management skills to ensure a seamless process.

12. Messy business

As discussed in the chapter on “showing a Business”, it is imperative to have an orderly and professional environment to show potential buyers. It is hard to change a buyer’s first impression, so make it a good one.

13. Continuing the course of business

A business is no sold until you are a closing and the final documents are drafted. Many business owners get so wrapped up in the transfer process that they do not pay the attention needed to run their business. The transfer process is long and arduous. Therefore, a deal could be in due diligence for months. If sales slip during that period, a buyer could opt out of his contract. Once business owners know they are getting ready to sell, they focus too much on where they will be spending their vacation or retirement and not enough time maintaining their business. Decreasing sales will negate the efforts of years of business, subsequently reducing the sale price. Sellers who allow their sales trends to drop and profitability to dip, if detected by a lender, are at risk of losing financing.

14. In adequately planning your exit strategy

Choose the right time to sell, have clean records, adequate bookkeeping of owner perks. The old adage “timing is everything” is right on the money in business transfer. The right time for selling might be right for the owner for personal reasons such as retirment, but the wrong time for the business. For example, if sales and profits have been declining, buyers and lenders will perceive that the business is in trouble, and that is the reason the owner wants to sell. If the company has had a bad year in one of the last three calendar years, lenders may back off from buyers attempting to get a loan for the transaction.

In many instances, small privately held companies have adequate records for the IRS, but not enough detail or paper trail for adequately documenting owner perks. The owner should have adequate paper trail and explinatgion of all areas of owner compensation from the general ledger, to financials to the firm’s tax returns. This accountability should be prepared for the past three corporate years before a sale. Click here to find out more about Exit Planning.

15. Have a thorough knowledge of the tax consequences of selling before you start the process

Owners should seek council with their CPA before they start the selling process, to get an understanding on the potential tax implications of a sale. In many instances, the company’s CPA should also be consulted after the broker has been selected, and the type of sale has been recommended. Having a basic understanding of their tax ramifications before the process starts, can keep a sale from bogging down later in the deal.

16. Not adopting a “dealmakers mentality” in selling

Avoid drawing lines in the sand early in the sale. Many business owners have a predetermined idea of the value of their business before they ever consult a broker, and have already determined that they will not sell at below that figure. As in any form of selling, selling a business is a process of give and take, and drawing a line in the sand, will usually set a barrier to going forward. Business owners considering selling should therefore try to keep an open mind in all aspects of the sale.

17. Not keeping an open mind in the length of time required to assist the buyer in transition

Plan on the possibility of signing a consulting agreement that will be fair to and will assist the new owner. In most companies, the owner has acquired specific skills that cannot be passed on to a buyer in one or two months. It is a standard in the brokerage industry, that sellers stay on after the sale for one month at no charge. This is not always adequate, but the seller wants to move on with his life. A consulting agreement, with adequate compensation allows the new owner to consult with the seller when a specific need arises, and still allows the seller to have control over their schedules. Having an open mind to this possibility can go a long way to reducing buyers concerns over learning the business.