HOUSTON BUSINESS REVIEW

TUTORIAL ON SELLING YOUR BUSINESS "Enhancing Value – Financial Perspective Part VII"
By Ralph Fain

Ralph Fain is a principal in the brokerage firm, R/Fain Group. Mr. Fain also has over 20 years of broad business experience with Fortune 500 companies. R/ Fain Group is a professional business brokerage firm which confidentially represents the interests of various sellers and buyers. Each week Mr. Fain will give tips on Business Brokering, and how to sell your business.

Our latest series of articles have dealt with the financial aspects of enhancing the value of a business utilizing different methods –including variance analysis and the “re-casting” of financial statements (summarized again later in this article). Consistent with this theme, today’s article deals with strategies/steps (some long term, some short term) a seller can employ to improve the profit picture of a company.

Please keep in mind that provable earnings/cash flow are the goal and are what a knowledgeable buyer is interested in; provable sales/revenues and provable earnings/cash flow which have been steadily improving and which are sustainable into the future are the attributes which optimize the value (and saleability) of a company.

According to a survey by PricewaterhouseCoopers, some of the most common steps privately held US companies take to improve their saleability from a financial aspect are:

• Improving profitability by containing or cutting costs (relative to cutting costs, it is critical that costs not be slashed beyond what is reasonable just for the sake of improving a short term profit picture – do not cut costs at the expense of future profitability)
• Limiting owner’s compensation
• Restructuring debt - for more favorable terms

Some owners of privately held businesses engage in other strategies to optimize profits leading up to the sale.

These steps may include the following:

• Eliminating private expenditures from the company’s financial records
• Reducing/eliminating family members’ compensation
• Limiting/reducing/eliminating owner’s/family’s prerequisites (“perks”)

Still other methods may include the following:

• Improving methods and exercising budgetary control of costs
• Properly accounting for capital expenditures – properly capitalizing them as asset additions and not expensing them as repair and maintenance expense (in order to minimize taxes)
• Maintaining or improving sales growth and gross profit
• Avoiding very risky projects

Do not however milk the business out of every opportunity. Remember that the best sales prices for businesses are obtained when the business still offers upside potential.

In addition to the above, in order to maximize your company’s sales price, it is incumbent upon you (the business owner) that your company’s financial records are

• Reliable and accurate – the financials reflect the true financial results of the company (e.g., all sales are recorded, all expenses are recorded, etc)
• Comparable – financial statements are prepared in accordance with industry standards and show favorable results upon comparison.

Another way to optimize the saleability of your company is to enhance its financial presentation by “re-casting" the company’s Income Statement. As we have written in previous articles, “re-casting” is a method by which certain items are properly “added back” to the Net Income in order to arrive at Discretionary Cash Flow (basically cash flow to the owner). “Add-backs” can include the following:

• Non-cash expenditures – i.e., depreciation and amortization expenses
• Interest expense – on debt not to be assumed or incurred by the buyer/new owner
• Owner’s salary/taxes/benefits
• Family members salaries/taxes/benefits – add back only if positions filled by family members are not to be continued/replaced or replaced at lower cost
• Non-recurring/one- time expenses – e.g., moving expenses, remodeling expense, etc.
• Rent adjustments – only if rent is to change with the buyer/new owner
• Other owner benefits/add-backs – e.g., owner’s vehicles and insurance, owner’s travel and entertainment, other owner’s perks, etc – portion, if any, not used !00% for business
• Capital expenditures expensed as repair and maintenance or classified as some other expense
• Other - any current expenses which are not to be incurred in the future under new ownership

“Adding back” and “re-casting” can have a major salutary impact on the sales price of a business as it highlights the cash flow of a company and places the company’s financials in a much more favorable light and, consequently, enhances the value of the business to the buyer.

As you can see from the above example, the understanding of certain basic accounting/tax concepts coupled with the requisite adjustments/”add-backs” by the owner/seller can have a major impact on the valuation and, hence, the sales price of a business. Further, by being able to document the revisions, you have increased your credibility and the reliability and accuracy of your company’s financial documentation and, consequently, the buyer’s confidence in you and your company has been enhanced – you have won more than half of the battle!

See you in this same space for the next article which will continue the discussion regarding improving the financial presentation of your company. As always, should you have any questions or require additional information please feel free to contact the R/ Fain Group at 832-646-0832 or via our web site.