Accurate valuation is critical when selling business

Buyers will demand documentation of business assets and financial health

Buyers will also prefer that you have a lot of documentation available for your business. They'll be taking a close look at what the papers actually say during the due diligence process, as negotiations proceed. But the very existence of documentation like sales reports, production reports, employee organization charts, job descriptions, operations manuals — all that paperwork you've tried to minimize or avoid up to now — serves to tell your buyer a lot about your business, and also increases his or her comfort level with the professionalism of your management style.

Add value to boost selling price

Regardless of the state of the economy and of your industry, there are many actions that you can take to improve your business's appeal to buyers before the sale. The main problem is that many of these things take time. If you need to sell right away, you're not going to be able to add much value. Consequently, it's possible that a lot of the potential value of the business will go down the drain.

Improve your income statement

Since cash is king, the most essential step you'll want to take is to clean up your income statement. One way is to have your accountant recast your financials to reflect the way the company should look with new owners. However, some buyers (particularly larger corporations) are turned off by this procedure. They will judge you only by your true, audited financials. If you want to be able to hook these buyers you have to clean up the business itself, not just the statements.

Basically, this means doing whatever it takes to increase your EBIT (earnings before interest and taxes). This may mean something as simple as increasing your advertising expenditures, hiring another salesperson on a commission basis, or keeping your store open an extra 10 hours per week to generate more revenues, and taking a hard look at your expenses to see whether you can reduce them. For example, this may be the time to drop some of the perks the business provides to you or your family members.

Where possible, your accountant might capitalize and deduct over time certain items that might otherwise be expensed and deducted in a single year. Your accountant should also review your depreciation and inventory reporting methods. Ideally, you'd start working on this three years before the sale, since most buyers will want to see three years of financials. (Plus, depreciation and inventory method changes must be approved by the IRS, which can be a lengthy process.)

Improve Your Assets

Take a good look at the assets of the business. Certainly, you'll want to sell off or dispose of any unproductive assets or unsalable inventory. The buyer won't want to pay you for them, and they will only drag you down — better to get what you can from them now, and write off any losses that may result.

Another move you may want to make is to replace any machinery that's nearing the end of its useful life, and do any necessary repairs and upgrades. The average buyer wants to purchase a turn-key operation, so that all they have to do is walk in, turn on the lights, and the business will operate with no immediate need for investment on their part.

You'll also want to metaphorically (or even, literally) put a new coat of paint on the entire place. This is not to say that you should spend a great deal of money on this "curb appeal," but be sure that your location is clean, your landscaping is fresh, any areas open to the public are decorated appropriately, etc.

Disentangle assets that will not be sold with business. The business may own certain assets that are primarily for your personal use (the most common example is a company car) and that you want to retain after the sale. Now is the time for you to buy the asset from the business, perhaps at the current book value.

If the business owns real estate, you might consider removing it from the business and placing it in a limited partnership, so that it will not be transferred in the sale. You can continue to lease it to the new owners, or to someone else, and retain an income stream.

This is a judgment call — for some businesses, the real estate provides the main appeal to buyers and you won't get much for the business without it. Your business broker should be able to tell you whether this is true for you.

Clean up potential liabilities

You should make an effort to clear up any pending or potential legal problems, such as product liability claims, employee lawsuits, IRS audits, insurance disputes, etc. A buyer who purchases only the assets of your business (instead of corporate stock) generally won't get stuck with inherited legal problems; however, the very existence of lawsuits or other problems may raise red flags in potential buyers' minds or even turn them completely off.

Address environmental issues

One concern that buyers increasingly have is whether there might be any lurking environmental problems on your property. Where problems turn up, it's possible that any and all former owners can be held accountable by the government for very expensive cleanup costs.

If real estate will be part of the sale of your business, make every effort to see that there are no leaking underground storage tanks, asbestos, lead paint, hidden hazardous waste, or other nasty surprises around the property. If it's reasonable to conclude that problems are unlikely, an environmental transaction screen conducted at your attorney's direction may be all that's necessary.

Obtain Phase I environmental audit. To be safe from future claims, you'll generally have to obtain a satisfactory Phase I environmental audit by an environmental consultant. The Phase I report will document the clean condition of your property at the time of sale, and provide evidence that any problems must have been caused by subsequent owners. The price of an audit depends primarily on the amount and type of real estate your business owns, but can also vary among environmental professionals. Like any other major expenditure, you should get estimated bids from several licensed consultants before hiring one.

If problems turn up during the Phase I audit, a Phase II environmental audit may be required to investigate the problems and determine how to clean them up. If it turns out that problems are so extensive that you can't realistically fix them before the sale, you'll probably have to reduce your asking price for the business. As an alternative, you may want to consider trying to sell the business without the problematic assets.

Simply not telling the buyer about existing problems is not an option; in fact, many states require you to sign a disclosure form that reveals any and all problems you know about. This is one area where your lawyer's advice will be very important.

Recast financial statements

One way that virtually all small business "dress up" their business before a sale is to recast historical financial statements for the last three to five years, and draw up projected statements that reflect how the business would look with a new owner.

If you're like most small business owners, you've operated your business in a way that's calculated to minimize taxes. You may have given yourself and family members as many perks and benefits as possible, kept your children on the payroll, plowed a lot of profits back into capital improvements, etc. These and other tactics are designed to keep your profits (and your taxes) low, perhaps artificially so.

However, when you put the business on the market, you want to make your company look as profitable as possible. Ideally, you would take steps to improve your actual earnings for several years before putting the company on the block. If time does not permit (or in addition to) this step, you can have your accountant adjust your past income statements to reflect what would have happened if you:

• removed your salary and perks, and those of family members you don't expect to remain with the company
• removed any expenses or income that would not be expected to recur or continue after the sale (for example, income or expenses associated with discontinued products, or gains or losses from the sale of any business assets)
• removed any investment or other nonoperating expenses or income
• removed interest payments on any business loans, since you'll be removing such liabilities from the balance sheet.

Furthermore, your accountant can adjust your past balance sheets to:

• Remove any assets that will not be sold with the company.
• Remove any obsolete or slow-moving inventory. Value the remaining inventory at current replacement cost.
• Value your remaining balance-sheet assets at current fair market value.
• Write off any accounts receivable that are uncollectible.
• Write off any loans the company made to you (bearing in mind this will trigger cancellation of indebtedness income on your personal tax return.
• Remove other debt that will not be assumed by the buyer.

Your accountant may have some other ideas; for example, you may have expensed some costs that could have been capitalized.

Warning

Whatever you do in the way of recasting your financials, make sure that any changes to your historical statements are carefully documented on the face of the statements, so that the buyer knows you aren't trying to cover anything up.

Finally, you should have your accountant take these recast financials and use them to project how your future statements are likely to look for the next five years, making reasonable assumptions about future growth or decline in income, expenses, value of assets etc. In most cases, that means assuming that trends established over the past several years will continue; for example, if revenues have increased by 5 percent a year, it's probably reasonable to assume that growth will continue at that rate.