- How To Choose A Business Broker Intermediary - January 25, 2023
- Buying and Selling a Business in a Changing Market - July 22, 2022
- How to Add Value to Your Business - January 18, 2022
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Business ownership can be a great personal asset not unlike real estate or other financial investments. Not only can a quality business yield cash flow during ownership, its value may appreciate over time until it’s ultimately sold or transferred to others.
Business value can be a complicated topic. By their nature, privately-held businesses are less liquid than publicly-traded stocks. Small businesses typically have more risk but can also have a higher financial return when compared to traditional, liquid investments.
So how can a business owner increase the value of their business, specifically if their goal is ultimately a third-party sale?
If you’d like to understand how to add value to your business, it’s worth considering the three hallmarks of a valuable business:
Improve Financial Clarity
Create Processes & Systems
Build Owner Independence
Business owners who address these important hallmarks of a valuable business are very likely to have more options for exit and attract multiple buyers.
Financial Clarity
Valuable businesses have high earnings as well as high revenue. Put another way, for most small businesses outside of venture capital-backed startups, it’s the bottom line, not the top line on the P&L that matters most to business buyers or investors.
Business buyers seek a consistent, long-term earnings trend that is sustainable and similar to businesses in the same industry. It may sound great that a business keeps half of every dollar that comes through the door. However if the average business in its industry typically keeps only a quarter of its annual revenue, it could be a sign that the owner is overworked instead of properly delegating to a team or skimping on other essential expenses for long-term stability and growth.
When it comes to financial clarity, business owners also need to be able to tell their financial story that is consistent with third-party documentation from the tax returns to the financial statements and all the way back to the business’ bank statements. Being able to do so is the hallmark of solid financial due diligence and will improve the likelihood of a successful sale.
Certain business buyers may appear to be in love with a business concept, brand or industry. However, if the business for sale doesn’t make money, or it doesn’t stand up to the financial due diligence process, the buyer will raise their concerns. Additionally, it’s very likely the business buyer won’t be able to finance the business acquisition through traditional lenders or the Small Business Administration.
Creating financial clarity involves recording income and expenses in a detailed format, appropriately recording expenses and investments appropriately on the P&L and Balance Sheet, respectively, and being able to answer questions about common fees like tax payroll taxes and merchant fees. Recording expenses in modern financial reporting software is a must in today’s sophisticated business acquisition climate. Whether it’s QuickBooks, FreshBooks, Wave Financial or similar, using software is preferred. Handwritten or even Excel-based bookkeeping will likely raise a caution flag by business buyers.
All of this recording and reporting is a great segue to our second hallmark of a valuable business; creating processes and systems for the business operations and administration.
Processes and Systems
Valuable businesses are attractive to business buyers because they have processes and systems for operations and administration. Each process and system ties to all customers, products, vendors, etc. to enable employees, managers, and leaders to report accurately, communicate effectively and ultimately make smart decisions.
For example, when a new customer initiates a purchase, a standard operating procedure should be in place that will allow the order data to flow through the entire business operation and administration. While the purchase order may start in the sales department, it will travel through the warehouse, inventory, shipping, accounts receivable, and ultimately end when the payment of the invoice is received.
Intangible assets such as a good CRM (Customer Relationship Management), an effective lead-generation website, and a great marketing program are very attractive to buyers. Similarly, well-documented HR policies and employee handbooks are vitally important too. Savvy business buyers will recognize a business that is well organized and equipped to serve a growing business.
This type of intangible “goodwill” is what business buyers want to acquire instead of trying to build it themselves. And it’s a value they are willing to pay for!
So let’s bring this all together with our third hallmark of a valuable business, lack of owner dependency.
Owner Independency
If a business has invested in it’s people and processes and systems effectively, there’s a decent chance that the owner is no longer the face of the business. The business owner can probably take a vacation if he or she has a team to manage the business and there’s a plan for how to handle issues that typically arise. If so, this is exactly the type of business that business buyers are most interested in acquiring.
While a small business is inherently owner-dependent in most cases, certain owners are able to succeed in a semi-absentee state for long periods of time. While it’s hard to measure owner dependency, businesses that are effectively structured to earn a profit after supporting all of the systems and people needed to keep owner independence are very attractive to buyers. In fact, if we could all own absentee businesses, there would literally be no limit to how many businesses we could own and how much money we could make.
Add Value to Business for Your Best Outcome
In conclusion, it’s not easy to build a business that has maximized it’s value, but those business
owners who have enjoyed the opportunity to sell their businesses to multiple buyers often enjoy more profit and more time and freedom from their businesses.
Even if a business owner does not plan to sell, paying attention to these three hallmarks of a valuable business will improve the owner’s income as well as quality of life.
Hi,
My client expense all capital purchases on the P&L. Some of those capital purchases could have been capitalized instead. Now that he wants to sell the business, ebitda is not as attractives as it could have been had he capitalize.
Certain investments that could be capitalized – for simplicity, many private business owners record the investment in certain capital items as expenses on their income statement. Office equipment, software, and many repairs that could qualify for capitalization treatment are often expensed by sellers. This treatment has the effect of reducing reported income, which results in lower EBITDA and taxes. It is common to recast these expenditures as fixed assets, which increases EBITDA.
Would a Buyer accept the reacting/adjustment to account for depreciation?
Thanks
Hi Jacques,
It isn’t unusual in a small business to find all (or nearly all) capital expenditures for things like office equipment, software and major repairs to be expensed on the P&L instead of recorded as a capital asset on the Balance Sheet and subsequently depreciated. The Code Section 179 deduction is permitted by the IRS and is mirrored by many states so doing this on the company’s accounting records essentially means the accounting records will match the company’s tax returns in terms of net income.
As for the computation of EBITDA in such a situation, yes it is possible to recast these ‘capital expenditures’. Doing so will create an Asset on the Balance Sheet and a corresponding Depreciation or Amortization Expense on the company’s P&L. Then EBITDA could be accurately calculated for each year in question by adding back depreciation and amortization expenses year-by-year.
Whether a buyer accepts the re-casted P&L and it’s EBITDA calculation really depends on the buyer. Generally speaking, the fewer the recast/adjustments when computing EBITDA, the better.
One other matter worth considering is the fact that a sophisticated buyer will look at any capital expenditure carefully because if the business is asset heavy — needing assets to be increased/replaced on an ongoing basis — the value of the business will be adjusted. CAPEX — is the Capital Expenditures required to operate at a given level of operations/profitability and it’s an important consideration when buying a business. It takes cash to maintain CAPEX and for certain asset-heavy businesses and in such a case, it’s a big consideration/cost of doing business!
Hope this helps a bit…
Hi! Thank you very much for this forum. My question has to deal with registered address vs. principal place of business. I have a registered agent, but my question mainly pertains to the principal place of business. My business is primarily run from home. I rented a PO BOX from the USPS for the mailing/billing aspect of the business. Privacy is IMPORTANT to me, so I do not want to use my home address for anything outside the bank. The bank knows I work from home, and I mentioned the need for privacy to them. I know a business address is required in all crucial aspects of business operations. Considering the list of where a business address is important below:
.
Opening business bank accounts (CHECKS) or merchant accounts
Opening accounts with your suppliers and vendors
Receiving statements, invoices, payments, and bills
Filing for legal contracts, licenses, and permits
Communicating with your customers.
.
What address should I use? I have street addressing with the PO BOX, but should I purchase a virtual mailbox for the professional image?? I am confused about what to do. I know there are beneficial tax deductions for using a home as a business. My concern here is simply privacy.
What address should I display as my business address without jeopardizing my need for privacy? Please let me know. Thank you!
Hi Ashley,
I understand your dilemma.
The official physical address is an important one for many reasons. And you will need to identify the proper address to third parties for as long as you own and operate your business. It’s wise for you to give this matter careful consideration!
If you desire personal privacy regarding your home address as it’s related to your business, then you really have no choice but to rent a physical workspace. This may not cost as much as you think as there are many co-working or shared workspaces available for businesses (startups and even mature businesses!)…
If you do choose to rent a small workspace and also use your home office space for your business, you may be able to deduct some of your home office expenses on your tax returns. You should consult with your tax preparer / CPA regarding what you need to do to take advantage of eligible home office expense deductions.
Hope this helps a bit.
All the best Ashley…