I have purchased five companies in my career and most of the sellers didn’t get what they should have for their company because they didn’t run it like they were going to sell it tomorrow. Most small- to medium-sized businesses are run as “lifestyle companies.” And by that, I mean they are run mainly to support the lifestyle of the owner or owners and their families. Most owners have multiple family members on the payroll, even if many of them don’t work in the company. Most family members also have company cars, company credit cards, and expense accounts through which they run almost all of their personal expenses.
As personal expenses rise, sales values fall
Many of the family members are overpaid and some are grossly overpaid. Many family members use the company to pay for personal purchases that have nothing to do with the family business. I knew of one situation where a car dealer and his wife would go to New York City on shopping trips and have clothing billed to their dealership as auto parts. If the IRS ever audited them they would know from the names of the stores that there is no way they sold auto parts.
When I begin examining the books of a company I am interested in buying, many times I am told that the operating expenses of the business were much higher than normal because of family members running personal purchases through the business. The seller always tries to get me to lower the operating expenses by some arbitrary number they pluck out of the air. While I might lower the expenses a little in my pro forma, I never adjust as much as the seller wants me to. You generally purchase a company based upon a multiple of earnings, if the earnings would have been much higher without the added expenses from family members, the sellers end up leaving money on the table. For example, most businesses these days are purchased for six- to eight-times earnings. So if earnings are understated by $200,000 due to excessive family compensation, when you multiply that by six, the sellers leave $1.2M on the table.
What some sellers do is to prepare the company for sale by stopping excessive compensation for up to three years in order to maximize earnings prior to sale. Alternatively, some keep detailed records of excessive compensation so they can show a buyer exactly how much excessive compensation was paid. Just be sure that those records aren’t kept anywhere that the IRS might find them during an audit!
Also, most closely-held businesses don’t have audited financial statements. Generally, the banks I have dealt with, want audited statements so they can be certain that the earnings of the company are real before they will fund the purchase. Most of the acquisitions I have done have had an adjustment to the purchase price for the sellers to pay for a three-year reverse audit. Having auditors do an audit for the three previous years is both time-consuming and expensive. Therefore you will save both time and money selling your company if you get an audit done every year.
The value of happy customers
When I buy a business I also like to see how happy the customers are. I don’t want to buy a business if most of the customers aren’t happy. I have generally gotten the sellers to pay for the cost of a customer satisfaction survey prior to closing. You will benefit from doing this annually anyway, but if you’re going to sell your business, having several years of customer satisfaction surveys available that show your customers are happy will help you get a premium price for your company.
Software licensing and the cost of ‘dead inventory’
You should also check your license agreement with your software vendors. Most software vendors only grant you a license for use of their products for as long as you own your business. Most license agreements aren’t transferable to a purchaser of your business unless a new license fee is paid. I make a purchase price adjustment to cover the cost of relicensing the software to run the business if the license isn’t transferrable for free. The time to negotiate for a no-fee, transferable software license is when you are negotiating to license the software, in the first place. Most software vendors are anxious to get your business and will grant this concession at the time of the initial sale, not afterwards when you have no leverage.
Most savvy buyers also deduct for dead inventory. I generally view inventory to be dead if it hasn’t sold in 12 months or more, but, some buyers consider inventory to be dead if it hasn’t sold in six months. A savvy buyer also deducts the value of dead inventory from the purchase price so make sure that you constantly try to get rid of it via auctions, closeout sales, eBay, etc. Not only is this good business, but it will save you from a large, downward adjustment to the selling price.
Annual Reviews, Noncompetes, Distribution Agreements
I’ve also found that most companies I have acquired had little or no annual reviews of employees in their files. When buying a company, it’s extremely helpful to the buyer if you can look at multiple years of reviews for each employee of the company being acquired. Not having these reviews on file isn’t a deal-killer but if you do have multiple years of annual reviews it helps speed the sale of the company as the seller can see who they want to keep and who they may want to let go.
Another important factor when selling your company is having valid, up-to-date, assignable noncompete agreements with at least your key employees, if not all employees. No one wants to buy a company if they have to worry about key employees leaving and going into competition with them. And, believe me, I have seen it done. A company I knew acquired a competitor and the day after closing, all of the key employees quit and started their own competitive company. The acquiring company lost millions. It was a disaster that could have been avoided if the seller had assignable, noncompete agreements.
If you have distribution agreements for product lines that are critical to the profits of your company, make sure that all of those vendor agreements are readily accessible and see which ones are assignable to a purchaser of your business. If the agreements are not assignable, try to get your suppliers to amend the agreement to make its assignable. No one wants to buy your business if many of your key vendors will not sell to the purchaser of your business.
Jim Sobeck is CEO of New South Construction Supply, a building products distributor based in Greenville with nine locations in the Carolinas and Georgia. He is the author of “The Real Business 101: Lessons From the Trenches.”