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Beyond the balance sheet

12 Top value drivers for when you sell your business

James Tillotson 31/7/2018 11 minute read

James Tillotson FCA of Wellers and David Haimes of Action Coach, explain the key areas of focus to drive up the value of a business in preparation for a sale.

Whilst you're hopefully making money running your own organisation, you'll probably make considerably more at the point that you sell your business. It's why advisors and business coaches implore entrepreneurs to be mindful of their end goal right from the outset of their venture. The sale of your business could come in the form of a trade sale or a management buyout and will often be referred to as an "exit" event.

Many owners build a budding enterprise and then decide they want to move onto something else by realising the value from their business. They will have a number in their head, they then go to the marketplace and sometimes, to their surprise, it simply doesn't happen. What are they doing wrong? Prior to any such process you need to ask yourself 2 vital questions:

  • Is your business sellable?
  • What are buyers looking for when purchasing a business?

The answers to these questions are themselves the drivers of business value which you will need to incorporate into your organisation if you have designs to eventually sell it. In this post we explore these in more detail, along with some tips about the due diligence process.

Improve the value of your business with the right professional help

1. Hub & spoke

Build a business that can work without you being there! This is a key driver to a sale! If you as the owner are integral to the success of the business on a day-to-day operational basis then a potential buyer will see that as too risky to purchase. They won't buy it, so owner-managers need to design themselves out of the business as much as possible early on.

A management team that can run itself without you there is an attractive proposition. That might seem odd, but a great test is to go on holiday for a decent length of time and see how everyone deals with things in your absence. Will your business be as healthy as when you left it?

Don't be the business superhero, it won't sell. Instead your success is a function of how many talented people you can attract and retain.

 

 

2. Business structure

As early on as possible you will need to set up your business with a view to extracting money from a future sale as tax efficiently as possible.

For example, if you, as an individual, sell your shares in the business to someone else, you may be able to apply for something called Entrepreneurs' Relief, which means that the gain you make will be taxed at an effective rate of 10%.

If however, it's the business selling something, then you need to be aware that the sale proceeds are taxed first within the business  via corporation tax rates (currently at 19%). Then, if you then take the money out via dividends, the top rate of dividend tax is likely to apply at 38.1% - the gain made is being taxed twice before it hits your back pocket.

Make sure you identify early on what you're likely to be selling, then organise everything in a manner whereby you'll have the best chance of applying Entrepreneurs' Relief.

3. The business plan

A good business plan should be used as a yardstick to measure the progress of your overall strategy. It ensures you can monitor how well you're doing compared to your initial projections while providing a potential purchaser (or investor) with a clear understanding of the opportunity at hand.

Revisit your business plan regularly. Compare the financial forecasts in your business plan to your actual results on a regular basis (within your management accounts, for example). This will allow you to identify issues quickly and respond to them in a timely manner.

If your aim is to sell the business then you should factor that into your plan so that investment decisions today are conducted with an eye on the future exit goal. The plan can act as a reminder to management so that the decision making process focuses, in part, on matters that will improve the long term appeal of the business to any would-be buyers.

4. Financial systems and performance

High levels of turnover and good profit margins are obvious drivers of value. That said, potential buyers aren't going to simply take your numbers at face value. They will want to satisfy themselves as to the accuracy and robustness of those numbers and gain an understanding of how dependable your numbers are. Think:

  • Reporting
  • Planning
  • Forecasting

If they don't trust the numbers or there are gaps in them then that represents risk, which will reduce the price you may be able to achieve in an exit event. To have dependable numbers means you have to have an effective back office finance function in place. 

5. Intellectual property and innovation

Be sure to protect all intangible assets that are unique to your business. Think brand, trademarks, copyright, patents, website addresses and research and development. Get this looked at from the very beginning by a specialist intellectual property lawyer.

 

 

Protected assets are very important to a purchaser especially if they're intrinsic to the product or customer experience. Avoid the common mistake where a particular intangible asset (say a patent or website) is registered with the owner directly rather than the business. A potential buyer will expect the business to own all assets prior to the purchase.

Furthermore, if you do need to transfer assets from personal ownership to that of the business, don't plan to transfer all of these assets over to the business just before a sale takes place. In the future, at the point of sale, those intangible assets may be worth a lot more than they are now, so you could end up with a significant personal tax liability at the point that you transfer the asset into the business’ name – ensure you get all of this sorted upfront and at the early stages of your business’ life.

Additionally, in respect of innovative businesses, there are generous tax breaks that can be applied for at HMRC - it is therefore worth asking yourself these 12 research and development questions which may lead to a cash refund or a reduction in your corporation tax liability.

6. Growth potential

A purchaser doesn't buy the present or past performance of your business. Rather they would be acquiring it for its future income streams. That means you have to demonstrate that the business remains scalable so they can take it on, grow it to the next level and profit from it.

What are the different channels through which you could grow the business? Could you sell more to existing customers through new products or services? Can the business be expanded into a new location or geography? Can lots more customers come on board with expansion into several territories in a manner known as exponential growth

7. The Switzerland structure

The Swiss are described as very shrewd, they haven't been involved in many wars and as a country they're very wealthy. They've acquired these riches by trying to maintain a neutral stance and limiting their alliances with other countries, organisations or political affiliations. They value their independence. The same applies with a business.

Be sure to not develop your enterprise in a manner whereby it becomes over reliant on one or two customers, suppliers or employees. Lose one of them and a huge chunk of the value of your business is gone. So build systems to run the business and people to operate the systems. Your job as the owner is to then look after the key people.

 

 

8. The valuation see-saw

Typically, a purchaser may consider paying in two separate amounts of money when they buy a business:

  • What they pay you in respect of the business itself
  • What they need to put into the business to ensure there is sufficient working capital to allow for it to continue to trade

If the business needs a lot of working capital to be put in at the point of sale in order for it to function properly then that means the buyer will have to write a cheque for a lot of money on the second point. That negatively impacts on the first cheque they write. Thus a business that is sold with sufficient working capital prior to sale is more preferable when thinking about the eventual sale value.

Also, make sure your systems operate in a manner whereby you get paid for your products/services before you have to pay your suppliers. Known as positive cashflow, this is a vital sign of a healthy business.

 

 

9. Quality of revenue

Different types of sales are worth different amounts of value when it comes to your business. A lot of one-off sales, such as projects, or products that you only sell to a customer once aren't regarded as the highest quality revenue.

Buyers prefer recurring revenue because it's less likely to be dependent on you and your people. Build a business around recurring revenue models with the aim of achieving a higher valuation. Consider the following different types of recurring revenue as you build your business:

  • Long term contracts - think commercial property contracts
  • Auto-renewal - examples include mobile phone, gym and insurance contracts
  • Sunk money subscriptions - buying equipment and hardware which means you can only use that suppliers services, purchasing an Apple laptop which only operates on iOS and iTunes
  • Subscriptions - magazines, wine clubs, software
  • Sunk money consumables - consider Nespresso coffee machines where you then have to buy the Nespresso coffee capsules
  • Consumables - toothpaste, cereals basically things that can be sold over and over again

10. Achieving monopoly control

The ideal situation is where your business can control the price. To achieve this requires customers to love your products or services so much that they're not going to buy from any competitors. You have to build a brand with a significant connection to your customers, so much so that price almost becomes an irrelevance.

Take Harley Davidson, they've built a whole environment around their brand. You purchase one of their motorcycles and you become part of a club. You wear the brand apparel, go to their events and end up doing the marketing for them. You're emotionally attached to their brand, it ends up not being about the product but instead the lifestyle, also known as critical non-essentials.    

11. Choose who you do business with and customer satisfaction

Identify who your top 10 customers are. Understand the traits that make you want to do business with them. Then stick to doing business with those that are a close fit to this ideal customer persona. This will help build your brand and to develop a more profitable business with customers who are happy to sign up to your payment terms. 

Buyers want to know how content your customers are, so choose them carefully. A buyer is purchasing your customer base. If they're really satisfied then the likelihood of revenue continuing will be very high. Unhappy customers mean it will be an expensive business to maintain requiring a lot of investment in marketing and customer care to prevent them from leaving.

 

 

How satisfied are your customers? Do you know? If not consider conducting surveys to gauge things like your net promoter score and demonstrate this to a potential buyer.

12. Advisors

We would, of course, say this, but make sure you work with good advisors all along the way. The right guidance from a combination of business coaches, accountants, lawyers and other professionals working as a team can add value, right from the initial business plan and modelling, to designing and setting up systems, raising finance, getting the paperwork in order, financial reporting and corporate finance activities at the point of exit (as well as corporate and personal tax planning throughout).

They ensure good housekeeping along the way which makes the business more attractive to third parties. They'll counsel you so that you don't make decisions such as engaging in spurious tax avoidance schemes to save money which can jeopardise attracting a buyer. Your advisors should also have extensive networks so that they can recommend other specialists as and when you need them.

A bonus tip on the due diligence process

Once you achieve a certain level of performance and your financial position is strong, your business will either generate interest or you'll seek out a buyer yourself. The business will be ready to go to market and there are brokers who can help you find purchasers. That said, you'll have a great network and you'll know the key players in your industry, meaning you're as well positioned as any to do this.

 

 

A some point with a buyer you will enter into a discussion about how to take things forward. At this initial stage you will create a headline document called ”Heads of Terms” or a Term Sheet”. This states things like:

  • What the sale price is
  • What exactly is being bought
  • The expectations of the due diligence process
  • Timings
  • The exclusivity period
  • Confidentiality

Keep the terms as simple as possible, 2-3 pages at most to save time and make the process efficient.

You will then move onto the more formal due diligence process - this is a critical appraisal of the wellbeing of your business, specifically:

  • Assets
  • Liabilities
  • Commercial potential

It's split into:

  • Financial due diligence - understanding your books, data and tax position (accountants)
  • Legal due diligence - employment contracts, lease agreements (lawyers)
  • Commercial due diligence - the value of your customer base and customer perceptions (all advisors)

Entering into heads of terms doesn't necessarily result in a sale. Have everything organised and in the right place so that all the necessary and relevant information is to hand and easily accessible by the purchaser and their advisors - think about your systems, shareholders agreement, articles of association, statutory books, contracts, business plan, forecasts and staff. It's essential to this process. Make sure all accounts, employment contracts, leases etc. are well documented and filed clearly.

Making everything clear and easily accessible to the buyer will add value to the process as it will reflect a robust business underneath it all. Finally, don't change advisors at the last minute as they won't be able to answer any of the important questions. Be sure to have a settled team well in advance of any sale.

Maximise your return when your sell your business

The content of this post is up to date and relevant as at 31/07/2018.

Please be aware that information provided by this blog is subject to regular legal and regulatory change. We recommend that you do not take any information held within our website or guides (eBooks) as a definitive guide to the law on the relevant matter being discussed. We suggest your course of action should be to seek legal or professional advice where necessary rather than relying on the content supplied by the author(s) of this blog.

 

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