Business owners tend to be optimistic. Why else would someone risk money, time and other opportunities to fulfill a vision or be their own boss? They have no doubt that their business will succeed.
However, many businesses fail. Bloomberg, Forbes and Inc. Magazine have all published dire statistics. One estimate has only 4% of businesses passing the 10-year-old mark. One has 50% of businesses failing in five years. So you survived this, that’s great! How can you go wrong?
When the time comes to sell your business, your thoughts likely shift to visions of you floating in a pile of cash with a palm tree in the background. Business owners tend to overestimate how much they will get from selling their business – by a lot. This is where the optimism works against you.
Shocked? I’m sorry about that. But there are things you can do:
- Understand deeply how you make money. Which products and services make the most margin? Are you including all your costs, such as the extra time it takes an employee to prepare for the sale? Without understanding which products or services drive up your profit, how will you increase your profits and the selling price? A good cost accounting system is critical for this analysis.
- How much cash does your company generate? While your business may be a labor of love for you (or maybe not), for a buyer, it’s an investment. They will want to know how much more cash it will generate than, say, investing in a dividend-paying stock. Small businesses are huge risks (see the statistics in paragraph 2). They will want to be compensated more for this risk. Get a true cash flow statement prepared by a CPA. You can then calculate “free cash flow” which is generally cash from operating activity (meaning not receiving funds from banks, investors or your own bank account) minus the cash in or out from selling or buying equipment you use to run your business. This is the cash available to spend outside of the business – the true “paycheck” of the business owner.
- Get your books on US GAAP basis. This will show that you are serious about measuring your profit and being transparent to potential sellers. US GAAP is based on decades of established rules and managed by a board of experts. It is the gold standard. Because investors understand GAAP, they will have more clarity into the performance of your business than one that does not use GAAP. This will increase the price they will pay because your results are more credible.
You need to start this journey three to five years before you want to exit. Investors will want to see a history of your profit based on these useful measures.
I have a client who did not pay attention to his books. His business boomed. When he wanted to expand, he did not have the information to obtain financing. He had to hire me and other consultants to restate his books. This was very expensive. In many ways, getting your books in shape is a “pay now or pay later” approach. If you were buying a business would you rather buy from a company whose books were not transparent, one who scrambled to get it done or one who had the foresight to invest in measuring business results? I am guessing the last one.
Investments are vital to business success. This one is no different.