Most business owners begin preparing for a sale when they decide they are ready to go to market. Many of the issues a buyer will eventually examine, however, are much easier to address two or three years earlier.
Advisory List recently asked three M&A professionals, each working from a different seat in the transaction, what owners should be doing well before a sale. Fahaad Potrik, CPA, Co-Founder and Head of Financial Diligence at Rapid Diligence, contributed the financial diligence perspective.
This adapted version highlights Potrik’s guidance while also covering several of the broader preparation themes raised in the original three-advisor discussion.
Build the financial history before you need it
Potrik’s team works on the diligence side of transactions, where buyers hire professionals to stress-test a seller’s numbers.
One issue he sees is personal and discretionary spending running through the business without being clearly documented along the way. A buyer’s quality of earnings team may ultimately normalize those expenses when calculating EBITDA, but the seller is in a much stronger position when adjustments are supported by contemporaneous records rather than reconstructed months later.
For an owner who may sell several years from now, Potrik recommends maintaining a monthly, accrual-adjusted profit and loss statement along with a separate, consistently tagged schedule of addbacks and one-time expenses.
Doing this every month gives the seller a multiyear financial history and creates a paper trail supporting legitimate adjustments.
It also forces the company to identify working capital and revenue recognition issues before a buyer’s quality of earnings team finds them during diligence.
Pay attention to revenue quality while there is time to change it
Potrik also identifies customer concentration as a problem that cannot simply be fixed immediately before a sale.
A concentration analysis will quickly show when a company depends heavily on a narrow group of customers. Likewise, a business built primarily on transactional revenue cannot suddenly create years of recurring or contracted revenue shortly before going to market.
Revenue trends matter as well. Multiple years of declining revenue can make financing more difficult, and the historical trend cannot be rewritten once a sale process begins.
These are precisely the kinds of issues that make early preparation valuable. An owner several years from a possible exit still has time to diversify the customer base, improve revenue quality, and establish a stronger operating history.
Build a company that can transfer to another owner
The broader Advisory List discussion also emphasized that financial performance is only one part of sale readiness.
Buyers need confidence that the company can continue operating after the current owner leaves. A business in which the owner controls the major customer relationships, makes nearly every important decision, or holds most of the institutional knowledge presents a different transition risk than one supported by a capable management team and documented systems.
Owners preparing several years in advance have time to delegate responsibilities, develop managers, document processes, and make key customer relationships less dependent on one individual.
The objective is a company whose performance can continue through a change in ownership.
Make sure the important assets are ready to transfer
Another theme in the original three-advisor discussion was the importance of making sure the assets associated with the business are properly controlled and documented.
That can include trademarks, patents, websites, domain names, social media accounts, and other intellectual property tied to the company’s goodwill.
Lease arrangements can matter as well. If continued operation depends on a particular property, the seller should understand the lease term, landlord considerations, and any issues that could complicate the transition to a buyer.
These issues may receive relatively little attention during ordinary operations but become much more important once a buyer and its advisors begin diligence.
Preparation creates options
The common thread is that the most important preparation cannot be manufactured during the final months before a sale.
Potrik’s financial guidance provides a practical place to begin: create clean, consistent financial records now and maintain them over time.
At the same time, owners can use the years before an exit to improve customer diversification, reduce owner dependence, document the company’s systems, and make sure the assets a buyer expects to acquire are ready to transfer.
The earlier that work begins, the more opportunity an owner has to address problems before they become transaction problems.
Source
Originally published by Advisory List and adapted from the three-advisor feature How to Prepare a Business to Sell: What Three M&A Professionals Want Owners to Know, Years Before They List.
