Selling a business presents valuable lessons.
Having participated in hundreds of business sale and purchase transactions, I’ve had the unique opportunity to learn what dealers think as they reflect on the sale of their businesses. Human nature often compels people to doubt themselves and look back at the things that could or should have been done differently.
I’m going to outline 10 things dealers told me they would go back and change if they could do their transactions over again. Hopefully, those of you who are considering a future sale of your business will be able to avoid these missteps, whether your sale is today or more than 10 years from now.
1. I Wish I Had…Made the Difficult Employee Decisions
One of the hardest things a business owner can face is an employee (or more than one) who isn’t cutting it. I’ve seen too many situations in which a long-term, key employee is retained longer than he or she should be, whether because they’re no longer a good fit or they aren’t producing at the level they should be. Often this is done out of loyalty or sympathy.
But these issues come to light in the discovery process. Buyers figure it out quickly, leaving the dealership owner to tap dance around why they have this less-than-ideal employee. Most dealers who have faced this say they wish they had done something about it earlier; either by holding the employee accountable and repairing the situation or letting the employee go. They often realize that it would have been best for all concerned—employee included—to simply part ways.
2. I Wish I Had…Paid Down the Debt
No one incurs debt with the idea of damaging their company. It’s always a means for capitalizing on an opportunity or solving a problem. At face value, debt isn’t always a bad thing. However, when it comes time to sell the business, many owners are not prepared for the effect it will have on the final value received.
Business sales are almost always done on a cash-free, debt-free basis. This means the seller retains whatever cash they have on hand at closing and pays the liabilities that exist at closing, including accounts payable, lines of credit, business loans, vehicle loans, floor planning loans, etc. As such, every dollar of debt acts to reduce the net value received by the seller. In addition, any debt that is secured by a lien and a UCC filing would need to be paid off at the closing, if not before. So the effects are felt immediately. Owners we’ve worked with who had a bunch of debt have, one for one, wished it had been paid off earlier.
Regarding liabilities, there is a subsection to consider. By definition, deferred service revenue is a liability to the business for service contracts longer than one month that you have billed and/or been paid for already. Because you have the money (or the A/R if it’s been invoiced) there is an obligation to service that account for the prepaid period. When most of your contracts are monthly contracts collected by the leasing company and remitted to you, the liability is minimal.
However, some dealerships have chosen to bill the service contract for the full term of the lease up front. In this case, the dealership gets paid by the leasing company in advance. Unfortunately in most cases, the money is then spent, leaving the liability to deliver service, parts and supplies for the next 36 to 60 months with no money on hand to cover the costs.
It is important to understand that buyers will look to deduct the liability for prepaid/deferred service from the purchase price. I’ve seen cases in which this equates to hundreds of thousands of dollars. In extreme cases, it can even lead to a business with a negative value. Though it seems like a great cash-flow move, taking multiple years of service payments up front is a slippery slope that can—and most likely will—come back to hurt you later.
3. I Wish I Had…Built a Strong Sales Team
This seems like an obvious one, but is often overlooked. When exploring a business, acquirers regularly consider how they will be able to maintain or grow it going forward. The easiest way is to take over a well-producing sales team. As such, the lack of a strong sales team can hurt a potential sale. This is especially true when most of the sales are being done by one or more of the business owners. In this case, the buyer usually requires the owner to stay on for a longer time period than he or she might want to in order to transition the customer base.
4. I Wish I Had…Trained My Replacement
Many of the business owners we work with aim to sell their businesses and hand over the keys at closing. In reality, this is a rare situation. The buyer will most likely want the owner(s) to stay on for a transition period. However, this period can vary greatly depending on the circumstances. The best way to ensure that the time is minimized is to have someone in the business already who can take over your role. When your contribution to the business is in the form of high-level vision and leadership, with little to no day-to-day transactional responsibilities, you are easier to replace. At the other end of the spectrum, if everything in the business runs through you, it is almost impossible to replace you quickly. In these cases, buyers will often require that the owner stay on for a few years. This may not be good news if you’re looking for a quick exit.
5. I Wish I Had…Paid Myself More
As the owner of a business, it can seem that everyone else is in line to be paid before you; employees, manufacturers, vendors, the government, etc. In the day-to-day cash flow struggles, many an owner has cut or forgone their own pay to make ends meet. This often becomes very real when negotiating with a buyer. If you have underpaid yourself, the buyer points out that they will need to pay someone more to do the job. In modeling this out, the buyer reduces the profit you’ve been showing, thereby reducing the purchase price. The general rule is that in order to secure your own financial future (as well as your present), you need to pay yourself at least a fair market wage for your role. This forces the business to create the money needed. If you put yourself at the end of the line, the money will often run out before you get paid. If you own the building you’re operating from, this would also include rent. I’ve seen too many businesses that pay themselves below-market rent. This creates the same effect as paying yourself below-market compensation. Not only will you make less money as you go along, you’ll end up with a business that’s worth less than you thought it was.
6. I Wish I Had…Better Managed My Inventory
The effects of poorly managed inventory are far reaching. One impact that many owners don’t consider is carrying too much inventory, especially equipment. Acquirers don’t like to get a lot of equipment in an acquisition. First, it adds to the money needed to buy the company. Second, there will be quotas to attain post-closing, and starting with a lot of equipment (usually purchased by you to make quota or earn a rebate in an earlier period) puts the new owner behind the eight ball.
Of course, no dealer wants to lose what they paid for the inventory on hand at closing. The best solution is to keep inventory levels moderate in the months leading up to closing a sale.
Another inventory issue that’s tough for owners to swallow is the handling of obsolete product. No one wants to pay for something and then throw it into a dumpster. Buyers will look closely at inventory and only accept what is truly sellable or useable in the immediate future. If you have obsolete inventory, it’s best to handle it prior to taking your company to market. More importantly, I’ve had quite a few clients tell me they wish they had managed it better all along so that they could have sold off as much as possible before it became obsolete.
7. I Wish I Had…Known My People Were Backlogged
Business valuations are largely based on historical financial performance. As such, the accuracy of your financials is critical. I’ve seen too many situations in which the financial reports are not accurate due to backlogged entry. For example, when payroll is done by an outside payroll company, the basic requirement is that you have money in the account to cover the paychecks and various payroll tax payments. When dealer personnel are busy, it’s easy to put payroll entry aside as a way to cope with other tasks. However, if it isn’t done on a timely basis, you’ll have an income statement that shows more profit than what was really created.
I’ve seen the same situation with credit card expenses, cash application, closing service calls, customer billing and more. During due diligence the buyer will be digging into the details of the business’ financials. When you have issues with backlogged work, they almost jump off the screen. Not only does this lead to embarrassment for you, but it creates doubt and uncertainty in buyers. They start to wonder what else they can’t trust in your data. I’ve seen problems like this lead to a deal falling apart.
8. I Wish I Had…Tracked the Add Backs Better
Every deal we’ve participated in had some level of profit add backs. These range from the personal expenses of the owners (entertainment, personal travel, country club memberships, boats, cars, etc.) to business expenses or one-time expenses that won’t be incurred by the new owners going forward (accounting fees, legal fees, certain donations and sponsorships, extraordinary training, leasehold improvements, etc.).
Of course, the nature of these add backs can sometimes lead one to intentionally not leave a paper trail. While that makes sense for obvious reasons, it can create a situation in which you don’t get proper credit for add backs because they cannot be proven. In addition, it leaves you not knowing how much profit you are actually making. I have found that when asking owners to ballpark what their add backs will be, most underestimate it considerably.
9. I Wish I Had…Handled the Tax Process Better
Paying taxes is something no one enjoys—most would rather get a root canal. Because of this, the process doesn’t get the attention it should. The first regret I’ve heard on many occasions is that owners wish they hadn’t always filed for an extension. Reviewing tax returns is an important piece of the due diligence process. When the most-recent year isn’t available for nine months after the close, it creates problems. Along with this, most owners have their accountant prepare their tax returns using documents provided from the business’ internal accounting system. Yet many do not go back and make the accountant’s tax adjustments in the system. This leads to internal financial reports that may be dramatically different from the tax returns. When buyers see this, it raises questions.
The final tax issue relates to regular audits. This is particularly important for larger companies with more than $10 million in annual revenue. Having your books formally audited annually will not only provide tremendous insight into what’s happening in your company and how well you comply with generally accepted accounting principles (GAAP), but it will make the due diligence process much easier. In larger transactions buyers will often bring in an outside accounting firm to complete what is referred to as a quality of earnings assessment. This is an audit of the books to prove out the net income. When the books have been regularly audited by an accounting firm, things go very well and the final numbers usually end up where we thought they would be. When the books haven’t been audited, we’ve seen some big swings in the final numbers.
10. I Wish I Had…Looked at My Business Through the Eyes of an Acquirer
We all get caught up in day-to-day issues, and sometimes find it difficult to step back from the business and view it from the outside. I’ve had many clients tell me they learned a lot through the sale process and wish they had known much of it earlier. When you look at your business through the eyes of an acquirer, you often see things you never saw before. You just need the willingness to look at the business differently and accept some guidance. One of the reasons we offer a dealership valuation program is to provide the road map for this type of business review. Those who have completed the process come away with a list of items to address and a roadmap that leads them in a better direction.
Looking back at a significant business or life event always gives one pause to consider what could have been done better. The beauty of being part of a tight-knit industry is the ability to learn from those who have already been where you’re heading. My hope is that you’ve found a few nuggets of useful information in the items above and can use this data to improve your company and set yourself up for a successful future.
Jim Kahrs is the President and Founder of Prosperity Plus. He may be reached at jkahrs@prosperityplus.com
Comments