Preparing for a future sale

By Malcolm Ross | June 1, 2010 | Last updated on June 1, 2010
6 min read

As a financial advisor who works primarily with business owners and their families, I’ve observed that very few owners start out with a clear objective of building a business in order to sell it down the road.

Instead, they struggle to develop the business as a cash flow engine and then, due to fatigue or a health event, realize their wealth is concentrated in this company and start to consider how they can use some or all of the business’s value to fund retirement. When this turning point is reached, there are four groups of people who generally need to be considered: family, employees, strategic partners and finally competitors or consolidators.

Occasionally, I have seen a complete outsider come in and buy a business, but most frequently this leads to poor outcomes for the clients and employees, and even at times the seller.

So how would it look if we start with the end in mind? I asked Pino Bacci-nelli, president of Pacific Business Brokers, what top contributing factors a business owner needs to address in order to sell his or her company at a premium. He says advisors need to tell clients to:

Invest in taxes – In other words, maximize the bottom line and pay the taxes due. It will pay off big-time as a large component of the business value is earnings, or bottom line, driven. “Purchasers pay for earnings and buy the assets,” he says. Clean up your books – Most deals fall apart when poor bookkeeping records and financials are discovered in due diligence. Maximize your bottom line by becoming more efficient in everything you do, and maximize efficiency in all the assets you own. Develop procedure manuals so that personal goodwill is minimized and commercial goodwill is maximized.

Divest yourself – Get key people in place and empower them. Give up control of the present in order to gain control of your future; and make people accountable. Strong management depth is critical to a business value and a major driver. Don’t try to do it all yourself!

Remember that to the purchaser, a little growth is likely not going to make a huge impact other than provide comfort and confidence. But a little drop can become a deal-breaker because it can cause the purchaser to lose trust. So keep your eye on the ball and grow the business while you are thinking about the exit.

When valuing a business, much weight is given to the financial efficiency as reflected by the bottom line return on capital employed. Many small and even mid-sized businesses keep good accounting records but, as John Nagy, FCGA, Past President of CGA Canada and shareholder of Reid Hurst Nagy suggests, in certain organizations, although the bookkeeper is doing a great job of keeping the accounts, there isn’t enough timely financial information that is meaningful for management and decision-making. Recently we’ve seen a number of progressive accounting firms offering their clients online comptrollership services and creating a dashboard of information the owner/manager can see at a glance to identify the key performance indicators. This level of financial management creates a proactive response to productivity issues which is lost in the generality of traditional financial statements.

Ric Payne, founder of the international Principa Alliance and the Accountants’ Boot Camp suggests accountants can add much more value to their clients by working as business guides and mentors, and should look beyond the traditional role as historians of the firm’s financial information. The key for a business owner who wishes to sell his or her company for a premium is to have all five fingers on the key performance indicators. Smart business owners know it’s the people in their organizations who have the relationships with clients, manage the business processes and create the climate for success. Therefore, a key to optimizing business value is to create the team and environment in which they can grow effectively.

Constant staff turnover is a significant limiting factor in business growth, but choosing the right people involves more than gut feel.

Michael Povey, Principal of Vancouver-based HR consultants 5th Option, put it this way, “Business owners of small growing businesses gather around themselves people they want to work with. As the corporation grows and some of those people seek new horizons or new staff are hired, the decision of who to hire becomes more difficult and often compromises are made.

“Do you bring in senior-level resources above your existing staff or do you look to bring in bright stars with potential for growth? These decisions can impact relations with union employees, and it can threaten established staff. Understanding your organization, the leadership roles and job descriptions and formalizing these are essential to not only avoid potential problems but to ensure that management succession is a continuous process in your organization.”

Building policies and procedures and recruiting and developing suitable staff not only build value but by bringing in the right entrepreneurial management skills the business owner creates succession alternatives, adds Povey.

Tax lawyer Paul Lailey, talking about the most common issues in his experience for business owners going through the sales process, commented that frequently business owners will use their corporations to buy cash-value life insurance and portfolio investments or rental properties.

These activities tend to clutter the transaction, generally resulting in a sale of the business assets and goodwill, but losing out on the small business capital gains exemption.

“By properly structuring the ownership of the corporation and creating a holding company to hold assets not required for the business operations, the business owner can ensure he or she has the flexibility to secure both the capital gains exemption while retaining the separate control of the non-business assets without triggering unnecessary taxes.”

Rob Radloff, CA, head of technical planning at Investaflex Financial Group also comments that business owners often will not consider the long-term problem that exists with insurances being held in an operating company, because when the business is sold, the owners usually like to take the insurance out of the company. But, because the insurance isn’t “real property” under the Income Tax Act, any transfer of the policy will trigger a taxable disposition.

If the business is being sold because the insured owner has health problems, the fair market value of the policy may be greater than the cash surrender value, and result in a significant and surprising tax consequence. Radloff recommends business owners always consider creating a holding company to optimize ownership flexibility.

Perhaps most important, Baccinelli recommends business owners use mentors, advisors and professionals – including outside advisory boards – and be open to constructive criticism. This will help grow the company, and that in turn will add to the value.

As a family business advisor, I have witnessed first-hand the value of advisory boards in helping business owners transition both from one level of business to the next, and also from one generation to the next. They provide the sounding board for new business ideas and a perspective that often can’t be gained from within an organization where authority structures may inhibit the staff from freely challenging a position held by the owner. It can also provide the mentorship role for emerging managers.

But the biggest single barrier to succession is often the lack of real readiness of the founders to retire and hand over control.

Beginning with the end in mind requires the business owner to define life after business. This involves nurturing family relationships, developing hobbies, participating in community and service organizations and defining purpose.

The role of the trusted advisor is to help the owners define their purpose today and in the future; and then to help them identify their priorities and the services and tools to ensure that these are met. Teamwork is key, and is perhaps the biggest challenge for those trying to implement a multidisciplinary approach. However, in our experience, if the advisors are all client-centric in their outcomes focus, this collaborative process is particularly rewarding.

Always remember the business you’re dealing with is a constantly evolving organism that responds to the impact of change. Since change is certain, we must put in place processes that enable effective response to change. Business owners need guidance when they do not know which questions to ask, and trusted advisors need to align their services to help optimize the value of the business.

So start early and follow through in ensuring stable growth.

  • Malcolm Ross, Comm, CFP, CLU, TEP, is President of Investaflex Financial Group, a boutique advisory firm that works with businesses, owners and their families to develop integrated wealth management, succession and estate plans.

Malcolm Ross