Commercial Real Estate Finance

This editorial is by Baron Christoper Hanson, principal and lead consultant of RedBaron Consulting LLC, a branding + strategy + turnaround management firm based in Charleston, South Carolina. RedBaron contracts with clients in the $1M to $25M revenue space. Reach baron@redbaronUSA.com, or follow RedBaron Consulting on Twitter at @redbaronUSA.

Even if your small or medium-sized company is NOT for sale, working as if your business is for sale is an über-effective fiscal strategy going forward, especially for family or lifestyle businesses that are not 100% marketplace driven or run by-the-book. Akin to not buying insurance, running a business without potential sale or exit strategy documentation in place is a new form of commercial risk today.

Given the current statuses of corporate downsizing, capital markets and bank lending, and especially the vast re-engineering of business models since the recession, entities nationwide are being bought, sold, and even relocated into greener pastures. Energetic MBAs are exiting Wall Street for the front lines of small business management. Keen entrepreneurs are searching for undisciplined businesses to buy in Anytown, USA.

The challenge is that selling a small business or mid-sized company requires meticulous due diligence and greater analysis time than ever before. Owners must be able to prove 100% of their true financial position to qualified buyers over the last 3-5-7 years. In small and rural towns, bank loans used to be a handshake and one sunrise away. Not anymore, hence the emerging risk of not being prepared to sell or exit in real time.

“Nearly 80% of the owners who sit down with a business broker are unprepared to sell their company at that time,” reports attorney Marc Williams, president of Charleston Business Brokers, in Charleston South Carolina. “Considerable due diligence and vast accounting work are subsequently required because many business owners either have no experience selling a company, or they’ve operated a chaotic or personally-tailored business administration that is not marketable at present.”

Why are so many accountants, lawyers, and consultants perpetually busy inside large corporations? Huge businesses, especially if their stock is publicly traded, must proactively stand ready to entertain a sale, merger, acquisition, or takeover defense at any time. The complexities of large organizations are akin to running a city or even a state. Small, family, and lifestyle businesses are completely different. An owner’s decision to sell, exit, or retire is usually based on a lifestyle change, financial duress, or legitimate burnout.

Small business owners, therefore, face multiple conundrums if they are not prepared to sell. Their companies may be close-knit, loyal, and fun places to work, but they are not always 100% marketplace driven and administratively polished. Some are great businesses to buy, yet many are also a challenge to sell. This is because family and lifestyle businesses are usually owner-preference driven. Many small business owners bend the rules according to their heart’s content. Life and leisure are primary; generally accepted accounting principles (GAAP) and aggressive growth strategies are secondary, or pushed to back burners.

In addition, we often see that when family or lifestyle business owners suffer an extended cash flow setback, norms such as private school tuitions, boats or play toys, vacations and second homes, etc. are fiercely kept. Marketing, human resources, and strategic developments are fiercely cut. Some resort to mildly fraudulent activity to maintain their high-living persona. The business is no longer run like a business, or by the numbers. In fact, some marriages can become awfully strained if a smart-working spouse and a high-living spouse no longer agree financially.

Here’s the thesis: By running a healthy business that is hypothetically (or literally) for sale, sellers proactively place themselves in the discerning shoes, spectacles, and mindset of potential buyers early. Practically overnight, for-sale businesses begin to think and act as if an exit strategy is underway. In a “born-again” fashion, entities steer clear of shenanigans and begin to be led, operated, and managed differently –– more organized, more disciplined, and 100% by-the-book. This is why the culture of start-ups is so exciting, so stressful, so 24/7/365, and so potentially profitable: They are being launched to eventually be sold.

Since potentially lengthier and more sobering cycle times must be endured to sell any business, it makes sense to proactively “right the ship” now. Here are four (4) reasons Why every business should theoretically be for sale today:

1) When a business is for sale, everything gets cleaned up and 100% organized for “now.”

One old cliché suggests “it’s easy to clean your house once you know guests are coming over.” When a business is for sale, the same proactive transformation occurs: everything gets a thorough cleaning, a fresh coat of paint, or a serious tune-up. According to Dan Mahoney, a managing partner at Charleston Business Brokers, “dust, dings, and disarray translate into discounts off the business’s value and sale price.” In my experience, this wake-up call is extremely motivating to business owners and staff relying on hubris or ceremony to sell their company for them.

When a business is for sale, its records and filing systems also become über-organized in preparation for an efficient transaction process. Since meticulous accounting, legal, and human resource documentation must eventually be examined to complete any sale, the message here is to get an early start on this process. For a squeaky-clean and organized business to fetch a great price, three (3) years of intimate payroll, supply chain, expense, and tax patterns must be within reach of any buyer, seller, and mutual council fingertips –– in seconds, not days, weeks, or months. The deal is dead until everything is 100% clean, organized, and readily available for instant inspection now.

2) When a business is for sale, everyone is confronted with 100% fiscal reality and pain.

Owners may be wonderful at the day-to-day selling, staffing, production, and cash collection of their business, yet horrible at the annual accounting, paperwork, and tax planning required. Make no mistake: both day-to-day and annual prowess are mandatory to complete an exhaustive brokerage checklist, a presentable valuation, and a final term sheet. Over time, GAAP neglect leads to unavoidable pains that eventually must be dealt with all at once.

What’s more, articles such as this one are rarely read by the business owners who need intervention most. Righting the ship is sobering, uncomfortable –– yet profitable –– which is why quarterly engagements with tell-it-like-it-is advisors are so highly recommended. Approved accounting, legal, and consulting council are encouraged to forward this article to business owners who need it most.

At the heart of 100% fiscal reality is deciphering the “creative ways” in which business owners have spent company money over time. This is especially sticky when owners or spouses have purchased assets for themselves, their family, or their lifestyles on company books. “Depending on whether an income-approach or an asset-value valuation is used, purchased assets either go to new owners, or their collective expense tally can be added back to bottom line EBITDA calculations –– which can potentially increase a business’s sale price,” states Daniel Messervy, managing director of Charleston Business Brokers.

Getting a head-start, to differentiate between actual and discretionary business expenses is a core recommendation and process for every business. Once a GAAP valuation and brokerage checklist are complete, the most painful fiscal reality for owners/sellers is stomaching the actual, salable price of their business. Sellers often wildly hallucinate that founder hubris, family lineage, years of internal blood and sweat –– and a stockpile of lifestyle debts –– are somehow worth silos of cash from an external buyer. Some sellers even dream up the notion they’ve earned multiple “get-out-of-jail-free cards” for their heroic entrepreneurship, in hopes of canceling out the blemishes, bad decisions, and potential skeletons discovered during due diligence. When a business is properly positioned for sale, this Tom Foolery vanishes quickly.

As a rule of thumb, only the seller’s discretionary earning patterns –– the free and clear profits that owners earned and actually reported each year from operating their business –– determine the sale price. Obviously confirmed inventories, intellectual property, and other asset valuations are additionally negotiable. Strangely enough, family or lifestyle businesses that sent three children to private school, secretly afforded a yacht, or sustained a voracious wardrobe habit can be especially attractive to buyers without such dependents or lifestyle expenses.

In RedBaron’s experience and observation, serial entrepreneurs make great business buyers and sellers because 100% fiscal reality is their first, second, and third language. On average, only 20% of business sellers understand this reality and are prepared to fully move forward with a transaction in 30-60 days. Do you know what your actual business valuation number is right now? If your business was up for sale, this 100% fiscal reality would be endured, and become your new daily dashboard almost overnight.

3) When a business is for sale, all transactions, payments, and accounting practices improve.

Ad-hoc payments in cash, rampant bartering, under-the-table labor, and local “family discounts” destroy valuations, especially in rural and small town business regions where family and lifestyle businesses have operated the same way over generations. Not only are some of these “gray area” practices illegal, they also require more accounting time and fees to prove accurate P&L, inventory, and tax records. When a business is for sale, owners have no choice but to say “NO!” to valuation-harming, future sale price-reducing, debt-increasing decisions, transactions, and relationships.

What’s more, all transactions on either side of the balance sheet must be freshly policed.Akin to clean books and paperwork, only profitable transactions and 100% owner transparency can support a healthy business valuation and sale price going forward. In fact, during this critical phase of “righting the ship” before the sale, new processes, new policies, and new marketplace presentations may begin earning the business new profits (more sales + lower costs + clean books). New customers, not new debt, are where retained earnings reside. The owner’s goal becomes a more profitable sale later, not a lifestyle cash-cow today, a mindset Dave Ramsey would indeed endorse.

New policies and the word “NO!” can be especially challenging to that pool of constituents on the fringe of owner-present businesses –– insiders and regulars that seem to get special off-the-books hook-ups and discounts. Almost immediately, owners realize that unprofitable “friends and family relationships” are not transferable to new owners if a business is sold. This shock and awe period can be uncomfortable. Foul language and flying objects are not uncommon. One recommendation, applicable to many issues discussed herein, is to form an advisory group that meets once per month to discuss critical points of pain, new decisions, and required changes that must be implemented. This flushing-out process is essential to aligning varying opinions and emotions on board the ship, to shape a more realistic, mutually acceptable term sheet in a nearer future.

4) When a business is for sale, due diligence reveals all potential deal-killers upfront.

The words “no sale” are extremely unhelpful to any seller in any industry. Killed deals waste vast amounts of time, money, and effort. In many ways, selling a business is akin to preparing to run for political office. Every small business, be it owner-operated or owner-absent, has a roster of blemishes and embarrassing decisions from the past to reveal or fix –– especially if the entity has been run by the seat of its pants. Reputable business advisors use mutually exclusive and collectively exhaustive checklists to remove potential deal-killers early.

Before a business goes on the market for sale, its blemishes, bad decisions, and scary skeletons must each be faced, and hopefully fixed, well in advance. Blemishes are small and easily fixable: lost receipts, failure to file critical paper work, unpaid parking tickets, etc. Embarrassing decisions are cause for further exploration: a bad hire or theft, funding a nanny or sports car via the business, undocumented bartering, unpaid taxes, sketchy transaction discounts, etc. Serious skeletons in a business’s closet, however, can be deal-breakers. Messy litigation, blatant environmental violations, serious labor law infractions, tax liens, and conscious acts of fiscal fraud are just a few extreme examples.

Even if your business is not for sale, investing in a few hours with a qualified business broker, accountant, or experienced consultant each month or quarter ($75 to $200+ per hour) can begin paving the most proactive, direct pathways toward a 100% clean, fiscally accurate business valuation.

Since 100% fiscal reality takes more accounting and admin time prior to a successful close, beginning the process now is a prudent risk reducer and opportunity clarifier for all parties related to the transaction. Because due diligence finds, uncovers, and exposes everything a business (owner) has ever done –– AND discounts off the sale price are the penalty –– putting your business up for sale will define the actual value of your entity in today’s market, in real time.

Contact:

RedBaron [branding + strategy + turnaround management]

www.redbaronUSA.com

Majestic Square
211 King Street, Suite 104
Charleston, South Carolina 29401 USA
Office : 843.641.0331  Mobile : 843.628.9388

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