In last month’s article, we looked at mistakes four to six of the “10 Biggest Mistakes Business Sellers Make” when selling their businesses. This month, we finish the series by considering the final four mistakes sellers make when selling their businesses.
Mistake #7: Hiding Profits
It is understood no business owner enjoys paying taxes. Furthermore, tax avoidance (and/or deferment) is on the mind of most every business owner. As you can imagine, we have seen just about every trick in the book (legal or otherwise) used by owners to reduce the taxable income of their businesses.
Because corporate tax rates in the USA are among the highest in the world, it is only natural for business owners to seek ways in which to reduce their tax bill. However, as you consider your options to lower your taxes, be aware: if a buyer cannot readily and easily “find” your profit, while you may lower your current costs (your taxes), you are also significantly impacting the future value of your business in the eyes of buyers.
Consider the following scenario involving two of our former clients in the imaging supplies industry. One client, Company A, was very profitable and played no “games” with its financial statements. The Company wrote down/off slow-moving/obsolete inventory on an annual basis, the two owners paid themselves reasonable salaries and generous bonuses, and the owners did not run any personal expenses through the business. Buyers could easily see the profits of the business, trusted the value of the inventory and ultimately, the winning bidder for the business paid an above market price for the company.
Company B was a similar sized business and a competitor to Company A (actually, Company B was a little bigger than Company A and had a more diversified product line and customer base). The three owners of Company B told us “we hate to pay taxes.” They ran sizeable amounts of personal expenses through the business, employed numerous family members who did not really “work” at the company, paid themselves below-market salaries, played games with their inventory and A/R, and routinely deferred revenue and increased expenses at the end of the year in order to defer/avoid taxes. We were able to ultimately sell Company B, but for significantly less than Company A…and at a price we believed was much lower than market. The bidders for Company B said they struggled to get a clear picture of the true earnings of the business, which ultimately lowered their valuations.
I recently published an article entitled “Investing in Taxes.” The gist of the story is if you are considering a sale of the business, you are better suited to pay more in taxes while showing the true profits or earning potential of your business.
When considering hiding/deferring profits in your business, remember this: buyers have zero imagination and will only pay for the profits they can see.
Mistake #8: Managing to Sell
This mistake is the converse to Mistake #7. Buyers are not dumb (or if they are, they have already been fleeced by someone else). Buyers can tell when a business owner has been managing the business, and its financial performance, to pump up earnings immediately preceding a sale.
For example, we were consulting with a company whose owners told us they had been considering a sale for several years. We asked them about their capital expenditures/investments over the past five to seven years. What we learned showed us the owners were managing their financial statement in anticipation of a sale. The company routinely invested $200,000 to $300,000 annually in new equipment for their warehouse and assembly areas as well as for systems upgrades; this was a practice they had employed for many, many years. However, in the two years before we met with the owners, their capital expenditures dropped to less than $15,000 annually.
Furthermore, in the past, they had expensed as many capital expenditures as possible but in the past two years, what limited expenditures they had were capitalized, not expensed.
We also learned in the last two years, they had slashed travel reimbursements for their sizeable salesforce. The owners forced the sales staff to stay in lower priced hotels and cut daily meal allowances by 50%. The owners also discouraged their sales team from treating customers to meals. While all of this may make good business sense, the company went from zero turnover in its sales staff to high turnover.
These tactics, and more, had the desired effect the owners sought: the company improved its operating profits by more than 15% over the 2-year period while sales only increased 5%.
We let the owners know if we could see through their “smoke screen” with just a few questions, buyers would be able to as well. We suggested they would not be able to achieve the sale price they sought because their expectations were built upon unstable, inflated earnings. We chose not to accept the assignment of selling the business.
The owners marketed the business on their own. After many buyer visits and many offers significantly lower than what the owners desired for the business, the owners took the business off the market and reverted to their original travel expense and CapEx spending policies. We expect to be in the market with the business sometime next year.
Buyers today are very sophisticated and data driven. They can spot trends very easily and are not often fooled. See Mistake #9 for our best advice as to how to avoid this issue.
Mistake #9: Letting Off the Gas
My father, who founded our company 35 years ago, always told clients, “Run your business as if it will never be sold…sprint to the finish line.” Never have words so profound been spoken to help business owners operate during the difficult process of selling a business.
Too often, owners who are selling their businesses state: “I won’t make that decision now, I’ll let the buyer figure it out.” We also often hear comments to the effect of: “We need new computers, but we’ll make do and let the buyer spend the money to upgrade the system.”
What happens if you don’t sell the business? Just because the business is for sale is no guarantee it will be sold. If you defer business decisions today…even seemingly small ones…you could hinder the company in the future.
There is a natural tendency for business owners to get complacent (dare we say “lazy”) when they are involved in the sale of the business. It is only human to let your foot off the gas a little and take it easy knowing soon you will have sold your business.
However, it is critical for business owners to resist this temptation. One of the most difficult conversations between buyers and sellers is when the seller has to explain why the company’s revenues or earnings have declined during the time the buyer is looking at the business. These conversations are never pleasant and often painful.
The business owner who manages as if the company will not be sold, who literally “sprints to the finish line,” will be rewarded with a better sale price as well as an easier sale process.
Mistake #10: Selling It Yourself
At the risk of sounding self-serving, selling your business yourself is like the surgeon who operates on him/herself: it might be successful but it will be extremely painful. Selling a business is a full-time job and not one for beginners.
Recently, we successfully sold a top company in the imaging supplies distribution business. This was the third company we sold for this client. The owner told us even though he knew most of the likely acquirers for his business, after selling one business on his own, he would never repeat that mistake. He said having an intermediary representing him and his company was invaluable.
Consider this: in a typical business sale process, an intermediary and his/her team will spend approximately 500 to 1,000 hours working on the deal. As a business owner, you already have a full-time job. Do you really want to work a 2nd, full-time job managing the process of selling your business?
Whether you employ the services of an investment banker, a business broker, an intermediary, your accountant or an attorney, make sure the person/group you engage to represent you has extensive deal experience and a fundamental understanding of your industry. Your advisor will more than earn their fees for helping you not only to avoid the top 10 biggest mistakes sellers make, but he or she will also make the process easier and better for you.
Those are the last of our Top 10 Mistakes for Sellers. Next up is a look at the Biggest Mistakes Buyers Make. If you have any questions about the Top 10 Mistakes Sellers Make, please feel free to contact me to discuss them with you.
