Originally published on Maine Business Brokers, 9/10/2015

Exiting your business requires pre-planning to maximize the value of the sale, ensure an orderly closing and avoid any complications during the sales process.  The following simplified analysis requires business owners to look at three categories to determine which factors might impact business value and salability. These three categories are: Income Statement Items, Balance Sheet Items, and Capitalization Items.

Income Statement Items:

1. Cash Element. Some businesses may have cash revenues that are not reflected accurately in the financial statements. While this may have immediate tax benefits you can’t “double dip”: buyers won’t pay for profits that can’t be proven. If the cash element is significant it may have a material impact on the salability of the business, especially if the cash component is the difference between business profitability and break-even. Keep in mind that buyers will be wary of any business with a large undeclared cash element; as it could be indicative of other parts of the business that are also not fully documented.
2. Rent. Many business owners also own the real estate occupied by their business. Generally they are kept as two separate entities with the business paying the real estate entity lease or rent payments. There are advantages to this arrangement but often the rent payment does not reflect “fair market value” of the space; the owner either overpaying or underpaying for a variety of reasons. You’ll want to normalize the rent to both accurately reflect business cash flow and real estate “Net Operating Income”. Each are primary drivers for business value and property value.
3. “Related Employees” Cost. If you have family members working in the business, taking a paycheck or providing services make sure that the service or cost is normalized. A spouse filling a key sales role without a paycheck or a brother in-law plowing your parking lot for free distorts your actual business expenses. Conversely, if you are overpaying relatives or family members you should normalize that to improve business cash-flow.
4. Barter. Do you trade for services? While that may be beneficial to you as the owner you can’t expect a buyer to want or need those exchanged products or services. If the services or products received are essential to your business operations, consider moving the relationship to a traditional payment arrangement prior to selling.

Balance Sheet Items:

1. Inventory. Overstating cost of goods can reduce your taxable income but it will also create understated inventory value on the balance sheet. Misstated inventory could impact working capital estimates and may require an amendment to a past tax filing or a large one-time adjustment at closing. This could have considerable tax consequences and should be discussed with your accountant. Additionally you’ll want to accurately represent the true inventory value of “clean and salable” inventory to a prospective buyer.
2. Depreciation Re-capture. Recent IRS allowances have allowed businesses to aggressively write off depreciable assets far faster than their useable life. Buyers may want an adjustment to asset values in the allocation negotiation to create their own “depreciation tax shield”. Like an inventory adjustment, a depreciation adjustment could create a significant taxable event for the seller.
3. Non-performing loans. It’s not uncommon to have loans between the business and the owner(s). Often those loans will remain on the balance sheet without any paydown of principal or even interest payments. Those loans will need to be addressed at closing–“defaults” will be recognized as income to the loan recipient and can create a taxable event.

Capitalization Items:

1. Deferred maintenance. It’s difficult to move ahead with needed capital investments when you are thinking of selling your business. To a seller it may seem like spending money they’ll never see returned in the sale proceeds. But keep in mind that aging systems, unsightly exteriors or broken equipment will hurt the salability of the business and require additional capital from the buyer. Buyers could be dissuaded from the acquisition if they feel that the seller has neglected the business and at the least, they can use the deferred maintenance to negotiate a lower price of the business
2. IT/Software. Are your IT systems and website up-to-date? Are you using desk bound software systems that require costly support and upgrade expenses? If there are better IT solutions for your business you should at least identify them for interested buyers.
3. Curb Appeal. Last but not least, don’t ignore the obvious. A well maintained and clean property, groomed landscape, ordered production and operations floor and presentable employees do add to the appeal of your operation. Buyers will recognize a seller that takes pride in their operation and will help assure them during the acquisition process.

We highly recommend you consult with your “professional team” when thinking of an exit strategy. Your lawyer, accountant and intermediary should work cooperatively amongst themselves and with you, to create an exit strategy. Understanding how to prepare your business, the tax implications of the sale and the process of selling is critical in this planning process. A quick analysis of these elements can help you prepare your operation for the transition and could make a significant different in the realized value of your business.

Copyright © 2014 by Brian D. Hanson, President, Maine Business Brokers – all rights reserved. Mr. Hanson is the author of “A Basic Guide to Buying a Business” and holds quarterly workshops for both business buyers and sellers.  He is a SCORE Certified Mentor in Portland, Maine