Personal Finance
Business

January 07, 2019

Selling a Business: 6 Things to Do to Plan Properly

For many successful business owners, the sale of their company represents a significant portion of their retirement plans. The City National Small Business Report revealed that 40 percent of business owners are counting on the sale of their business to make up more than half of their retirement portfolio.

Yet, the survey also found that half of business owners don't have an exit strategy from their business. And of those that did state they have a plan, less than half were developed with the guidance of a third-party expert.

Having an exit strategy is vital both in terms of continuity of the business and in terms of your personal financial and retirement planning.

“A big part of helping business owners prepare for a sale or a transfer of ownership of the business to their children is helping the owner assess where they are relative to their personal financial goals," says Natasha Davis, a wealth planner at City National Bank.

Your financial goals and expectations will largely shape the decisions you make when selling your business.

What to Consider If You Plan to Sell Your Business

Be sure that your company is prepared for a sale well before the transaction occurs.

“Owners need to plan for a sale in advance," said Jody Padar, a CPA and owner of New Vision CPA Group in Mt. Prospect, Ill. "This means getting the business in the best possible shape in terms of the financials as well as business processes and management."

Davis recommends business owners start planning for their exit 10 to 15 years in advance to be best prepared. This often requires stepping back and looking at the company the way an outsider would.

Business owners should consider the following when planning their exit from their company and discuss these strategies with outside experts.

Assemble a Team of Experts

The City National Small Business Report revealed that a majority of business owners who do have an exit strategy from their business didn't consult with an outside expert to help create or evaluate the plan.

Davis suggests that business owners build their team of experts, including a financial advisor, tax attorney, estate planning attorney, business attorney, certified public accountant and any other professionals needed so they can begin working collaboratively to prepare your business for sale.

Decide Who Will Purchase Your Business

It's important to make some decisions as to who will buy your business and how the sale will work. Again, earlier is better here, as your decision will have many implications on how you run your business and how you prepare for your exit.

The most common type of sale among business owners is selling to a known buyer, such as a current company manager, a grown child or another family member.

Roughly 56 percent of business owners surveyed in City National's report who said they had an exit strategy said they planned to sell it to family or a known buyer.

If your plan is to pass the business on to the next generation in the family, there are many things to consider. Davis, Padar and Chicago-based small business consultant Barry Moltz all cited potential family dynamics as an issue not to be ignored.

How will the owners derive value from the transfer? Will the children buy them out in some fashion? Are the owners' other assets sufficient to support their retirement?

They also noted that it is important that children “earn" the right to run the company rather than just swooping in and taking the reins. They need to be involved in the business in order to gain familiarity with operations and credibility with employees and managers, perhaps by starting near the bottom and working their way up.

If there are no family members who are interested in the business or qualified to run it, then the business owner would be wise to think about alternatives such as selling to internal managers, if applicable, or to an outside party. In this case again, it is optimal if the owner can make this decision as early as possible as it will be a key part of their exit and retirement strategy.

Figuring this out early on will also help ensure that the owner prepares the business so it fetches the fullest value possible in a sale. While family members who are already involved in the company may be more forgiving of unorganized processes, outdated technology and systems, or challenges in hiring and retaining skilled labor, external buyers are more likely to be skeptical of these types of scenarios.

Moltz also put it well in terms of the need for defined business process, “Every day at the company shouldn't be an improvisation."

Having five to 10 years to work through some of these obstacles will help prepare the business for external review.

Ensure Your Financials are Organized and Transparent

Moltz urges his small business clients to clean up their financial statements prior to even considering selling the company. “Clean up any skeletons in the accounts or other sloppy accounting practices," he advised.

Padar added, “Good record-keeping and a good internal accounting system are important. Prospective buyers will dig into the financial records to ensure that there are no serious financial issues." At a minimum, they will review your company's profit and loss statement, balance sheet and cash flow statement. A more thorough review would encompass your detailed general ledger accounts, including all transactions for a period of time. Potential buyers will want to see that you have a process for collecting accounts receivable in a timely manner and also that you're paying your accounts payable on time and are in good standing with vendors.

A prospective buyer wants to be sure the financials you present are truly representative of the financial state of the business and that you're using the best accounting practices. Along these lines, having a modern, up-to-date internal accounting system is a must.

Prepare Your Business to Run Without You There

Many small business owners are involved in all aspects of the business, both internal operations as well as external sales and marketing efforts. Whether you're courting a third-party purchaser or grooming your next-generation owner, ensuring the business can run without you is imperative.

One of Padar's clients decided to bring in an outside CEO to run his company while he was exiting and preparing for a sale. This plan ensured that professional management would be positioned to carry on within the organization. This same client is also going through a digital transformation to cloud accounting and the use of a state-of-the-art sales management system to prepare for the transition.

In addition to preparing your company internally, it's also smart to take steps to ensure that customer relationships can be managed without your assistance. This means that senior managers in all areas must be prepared to take over.

Start that process by giving these managers increasing responsibility over time. Doing so will both build their confidence as managers and reassure you that these are the right managers to move your company forward after you exit. A business that can operate smoothly and successfully without you is much more valuable to a buyer, since that person is buying a business, not a business owner, Davis noted.

Obtain a Business Valuation

It's important to obtain a professional, outside valuation of your company before looking to sell it.

"A valuation is really the glue that holds the whole strategy together," said Davis.

Your valuation can be utilized in a number of different ways, including setting a benchmark for a selling price, tracking the effectiveness of strategic decision-making to increase value and for evaluating tax strategies.

Many business owners may think a higher valuation is better, but that's not always the case. Depending on how you plan to sell the business, there are situations when a higher valuation is better and when a lower valuation is desired.

For example, if you plan to sell to a third-party, a higher valuation is more desirable, since that will set the benchmark for what an outside buyer should pay. The final sale price may be below the valuation, but it establishes an unbiased benchmark.

On the other hand, if you're obtaining a valuation to start gifting company stock to your children, a lower value is favorable. You may gift up to $15,000 or $30,000 from a married couple to anyone tax free. A lower value will allow you to transfer more assets while taking advantage of the gift-tax exclusion.

Plan Ahead for Retirement

For many business owners, the value of their business represents a very significant portion of the assets that they plan to use to fund their retirement.

Davis stressed the need for business owners to set as much as possible aside in a retirement plan, such as a 401(k), to protect your retirement goals from unanticipated events that may prevent a sale of a company or make the sale price lower than anticipated. Events like a data breach, damage to your company's reputation or even a rapid change in technology that you didn't anticipate can impact your business sale - and also your retirement nest egg if you're solely relying on the profits from the sale.

Davis noted that the structure of the sale will also have a major impact on retirement funds. Whether an owner is selling to retire or just moving on to another venture, it is important that they plan for their cash flow needs after leaving the business. \

Business owners can easily end up asset rich but cash poor, which can make transactions like buying a dream home difficult since obtaining a mortgage could be tough. This might occur if some of the sale proceeds are deferred, or if the owner invests the proceeds on a long-term basis but neglects to set up regular, short-term cash flow to fund their lifestyle.

“When the business is being sold, the transaction might include both a lump-sum payment and some sort of residual income for the owner for several years," Davis said. "In some cases, they might retain ownership of the business's facilities and receive rent from those facilities. Each transaction is different, however."

Beyond the financial aspects, Moltz said, he always asks clients, “What will you do on the first day after the sale closes?" Retirement must include keeping busy and having a reason to get up in the morning.

If, like many entrepreneurs, your business was that reason for many years, what will that reason be going forward?

Small business owners need to think about their exit strategy from their company. Issues like business continuity, management succession and their own retirement plans are key factors.

This is an area where all business owners should seek professional guidance to ensure they have a workable exit strategy in place.

Given the complexity and the number of options available, it's important to consult with professionals to evaluate your situation before a sale. City National Bank's wealth planners can help you weigh your options. To learn more, contact us.

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This article is for general information and education only. It is provided as a courtesy to the clients and friends of City National Bank (City National). City National does not warrant that it is accurate or complete. Opinions expressed and estimates or projections given are those of the authors or persons quoted as of the date of the article with no obligation to update or notify of inaccuracy or change. This article may not be reproduced, distributed or further published by any person without the written consent of City National. Please cite source when quoting.

City National, as a matter of policy, does not give tax, accounting, regulatory or legal advice. Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations and readers should seek professional advice.