When it comes time for a business to sell, having good financial records is one of the most important aspects that will not only bring a higher purchase price, but it will make the business more attractive to prospective buyers, and it will eventually aid in getting it sold. If you are preparing to sell your business, or even thinking about selling it in the next few years, there is one big thing you can do immediately, which could help you increase your selling price and the ability to sell your business: clean up your books.
Clean Financials=Higher Valuation
A tax return doesn’t always tell the whole financial story of a business, because in order to find a business’s value, we perform a financial recast from the tax return. The owner’s salary, depreciation, amortization, interest, and any non-essential business expenses are added back to the bottom line to show the true owner benefit or discretionary earnings. These “add-backs”, as we call them, will also need to be provable. If a seller pays for all of his family members’ cell phone bills through the business, then of course, the new owner won’t have that as an expense, so it gets added back in. However, a buyer will want to see proof that the phone bill is paying for those personal family lines and isn’t actually an expense of the business. The rule with add-backs is if you can’t prove it, we can’t add it back. So, our best piece of advice for sellers who are listing their business for sale is to limit those personal expenses coming out as business expenses. Clean up your books and run the true numbers so it is very easy for a buyer to see the real bottom line of income and expenses.
If there are extensive add-backs to a recast, it makes the numbers less believable to a buyer, and in turn lowers the perceived value of the business right from the start. In fact, with businesses who have a large number of add-backs, we will use a lower industry multiple to arrive at our opinion of market value when we are valuing the business for sale. So, the clearer and more transparent the books are from the start, the higher the asking price will be.
Clean Books=Easier Due Diligence
As with most small businesses, there are many personal expenses accounted for in the financials. Because this is so common, your business broker will perform a financial recast to add back in those provable personal expenses. Some of those add-backs are automatic, but a buyer will question excessive add-backs of personal expenses, so the least amount as possible in a business’s tax returns the better. Also, unreported cash income can scare buyers, since it’s often not provable, so you might want to start accounting for all of your income, including cash, leading up to the sale of your business, because no buyer is going “take your word for it.” For any questions regarding your financials or Tax Returns, always consult with your CPA for professional advice.
Numerous add-backs will definitely make the Due Diligence process more complicated. The cleaner and more solid your financials are, the easier the Due Diligence process will be for both buyer and seller, because everything will be transparent and easily provable. A buyer is purchasing a business based on its owner benefit or discretionary earnings. The way that a seller proves their owner benefit will be critical in standing up to the test during the buyer’s Due Diligence. If you were a buyer, would you just take the seller’s word for it that they made $300,000 last year? No, you wouldn’t…you would want to see proof of that. Having clean books makes the process of Due Diligence much more straightforward and transparent.
Getting the Business SBA Lender Approved
It’s no secret that small business owners aim to maximize expenses on their tax returns, in order to show the least amount of profit possible. While that is a common practice to minimize tax liability, it can also negatively affect your business’s chances of qualifying for an SBA loan, and ultimately could hinder your chances of selling your business. At least 50% of buyers utilize SBA financing to purchase a business, and if the books aren’t clean, then the business might not qualify for a loan.
Most non-standard add-backs will not be acceptable to a lender, and they won’t consider them when looking at the valuation of the business. Lenders need to perform their own appraisal, to make sure that the business is cash flowing enough to make the loan possible. Any add backs that a lender does allow will absolutely need to be proven by the seller. Having clean books will bring a higher appraised value from the bank and more confidence from a lender when evaluating whether or not they will lend on it. Getting your business pre-qualified for an SBA loan before it even hits the market allows us to give potential buyers confidence that it’s a quality business, with good financials, because a lender has already said that the business qualifies. That is a great selling point that we want to be able to advertise, in order to get the business sold.
How Long Do the Books Need to be Clean?
Ideally, you want to want to minimize your non-business expenses or personal expenses on your tax return for the 3 years prior to listing it for sale, but 1-2 years of cleaner books is better than nothing. Even showing one year of clean books can make a huge difference to potential buyers and lenders. We can actually show them the financials side-by-side, and they will hopefully be able to see exactly where you have made changes. For example, if the business was paying your personal car payment, and the car is not conveying with the business, and it is not an essential business expense, then taking it out of your business expenses entirely will show a much clearer picture of the expenses to the buyer. You should be able to prove to the buyer that you were taking it out of the business in previous years, and now in the most recent financials, it is not there.