I'm regularly surprised by the number of business owners who have grown a profitable and successful company yet don't know the basic issues they'll face in valuing and selling their firm. This could prove costly when these owners do sell if they haven't taken the proper steps to prepare the company for sale.
As I've seen over more than 20 years advising owners selling their businesses, this is not a process for the thin-skinned or impatient. Selling a company is complicated, detailed and very time-consuming. That's why it's prudent to hire an advisor to package your business, find potential buyers whom you wouldn't have thought to contact and negotiate a transaction with the best price and terms.
Even if selling your business is a distant dream, it pays to educate yourself now. If you apply the following five basics to start preparing your company for an eventual sale, you're far more likely to be happy with the deal you'll eventually reach:
1. It could take you more than two years to prepare for a sale: Probably the most consistent benefit for any Canadian resident who plans to sell a company is the federal small business capital gains tax exemption for the first $750,000 of proceeds from the sale of shares in a privately owned business. This tax-free exemption can be attributed to any number of shareholders provided they have been shareholders for at least two years and the company meets certain other tests that your accountant can explain.
My firm recently represented a company with six siblings and a mother as equal shareholders, who therefore qualified for a total of $5.25 million in tax-free proceeds from the sale of the business. The fact that it takes two years of ownership of the shares to qualify for this exemption (in addition to the normalizations noted in the next point) shows how long it can take to prepare a firm for sale so shareholders maximize their after-tax proceeds.
2. EBITDA, EBITDA, EBITDA: If the real estate world is all about location, location, location, the M&A world is all about EBITDA, EBITDA, EBITDA—which stands for earnings before interest, taxes, depreciation and amortization. You can easily calculate this number from your income statement: go to the pre-tax earnings line, then add back interest, depreciation and amortization. It's this number that will be multiplied anywhere from two to 10 times (most often three to five times) to determine the purchase price. This is a gross simplification of the valuation process, but it's a good rough estimate.
To maximize your EBITDA, you should minimize your "normalizations." This is a nice word that means personal expenses run through the business to minimize the taxes payable. The most common examples are spouses on the payroll who have no role in the company, vacations and personal purchases paid for by the company. One fellow I encountered raced powerboats and put tens of thousands of dollars of fuel through the business as travel expenses. The problem with normalizations is that they decrease your firm's earnings and therefore EBITDA, which in turn reduces the company's sale price.
Say you were running $100,000 worth of personal expenses per year through your business. This would reduce your selling price by $500,000 if the buyer were paying a five-times multiple. Your tax savings on the personal expenses, which would vary widely depending on your firm's situation, would be dwarfed by the half-million-dollar reduction in the purchase price.