Is your business really worth what you think it’s worth? Could you sell your business for what you want to sell it for? Many business owners plan on selling their business to help finance their retirement, or perhaps to harvest a reward for the blood, sweat, and tears they put into building their business. Unfortunately, business owners often make a number of mistakes when it comes to exit planning.
First, the hard truth. According to a 2018 study by the Exit Planning Institute, many business owners won’t be able to sell their business when they want to. There are many reasons for this, but often a business owner is overconfident in terms of the price their business will be able to fetch on the market.
To put it succinctly, as business owners, we tend to believe our business is worth more than it really is worth. Even if we take the owner’s bias out of the equation, many businesses won’t sell for what they could be worth in a perfect world. There’s actually a term for this, it’s called the Value Gap.
What is the value gap? The value gap is the difference between the value of your business according to the market (i.e. a willing buyer) and the value of your business in a perfect state. This gap could cost you a lot of money. Perhaps even keep a deal from coming to fruition if your expectations are significantly out of line with the market.
I reached out to Jason Savedoff, founder of Filament Business Advisors, to learn more about his perspective on increasing the value of a business and how business owners can avoid exit planning mistakes. Here he explains how his firm measures this gap and answers some more of my questions:
Jason: At Filament Business Advisors we measure this value gap through an extensive evaluation focusing on over 100 aspects of a business, which can be grouped roughly into the following categories:
Barriers to entry
Sales and Marketing
The goal is to close the gap between your business and the perfect one as much as possible, to increase the value of your business.”
Lauren: Clearly, that’s a comprehensive list of potential areas to increase the value of your business. A business owner may be wondering what the top priority would be for them to tackle first.
Jason: For most main street businesses, the top priority is cash flow. The process of improving your business’ cash flow should begin about three years prior to sale by increasing revenues and trimming non-capital expenditures.
Lauren: So if a business owner wants to maximize the value of their business and close the value gap, they should start taking action at least three years before they hope to sell?
Jason: At Filament Business Advisors we recommend three years at a minimum, as three years of financials is what most buyers want to see, but most businesses that have positive cash flow can be sold at any time at whatever price the market deems appropriate.
Lauren: We know many business owners view their businesses as their “baby” (guilty as charged) and this can lead to a flawed view of the value of your business. What are some of the biggest mistakes you see business owners making as they head towards an exit?
Jason: Most owners think their businesses are worth more than most buyers are willing to pay. These numbers are not generally based on an appraisal or BOV, but instead incomplete information and often times a lot of emotion.
(Spark note: BOV stands for Broker’s Opinion of Value. It’s an “appraisal lite” that many brokers will offer for free with a listing and sets the basis for the list price.)
Jason: Ultimately, for a main street business, the cash flow will be the primary determinant of what someone is willing to pay, and they will calculate how many years it will take them to pay off the purchase price of that business, given that cash flow. So, the biggest mistake is to let profitability decline while preparing to market a business for sale – this happens frequently as the owner may already feel burnt out by the time she/he decides to sell.
Lauren: Thanks, Jason. That’s great advice for business owners; keep up your profitability and don’t wait until you’re feeling burned out to start planning your exit.
A Recap: 4 Exit Planning Mistakes Business Owners Make When Selling Their Business
Mistake #1 Not closing the value gap by reviewing your business the way a buyer would look at your business.
Example: Perhaps your website is “good enough,” but what would it cost to spruce up your website so that it really stands out?
Think about this the way you would think about selling your home. If your front door was dirty and dated would you leave it as is? Or would you throw a coat of paint on your old door and spruce it up?
Mistake #2 Waiting too long to close the value gap in your business
This one piggy-backs on Mistake #1 but it’s so important it needs its own heading. Plan on it taking 3 years to prep your business to sell for the highest possible price.
From Jason’s suggestions, there are many areas of your business that a savvy prospective buyer will review. Will your management team stay in place? Are there incentives for them to do so? Do you need to set up a profit-sharing and 401(k) plan with a vesting period to encourage key team leaders to stay?
Does your business really run without you? When was the last time you took a true vacation and turned the “keys to the kingdom” over to an employee? Many aspects of closing the value gap will take time to implement. Don’t wait until the last minute.
Mistake #3 Not paying attention to cash flow.
Cash flow is king. A future owner wants to know how much cash flow they are going to be getting out of your business after you’re gone. Make sure you are maintaining your revenue even as you prepare to sell. Also, there is such a thing as being too good at reducing your taxable income in the business. A potential buyer will often want to review three years of financials – make sure yours look good.
Mistake #4 Waiting until you are burned out before you get serious about planning your exit.
Running a business often takes a lot of time and effort. Make sure you maintain your engagement as you prepare to sell. Don’t wait until a health emergency or exhaustion forces your hand. If your profitability dips the value of your business will go down with it.
What are your top concerns about selling your business? Have you found any of these areas particularly difficult (or perhaps easy) to address? Share your thoughts below in the comments section or email us:
Lauren (at) sparkfinancialadvisors dot com
Interested in selling your business? Let’s talk. We can help you with your personal financial planning, exit planning, and incentivizing employees through a well designed 401(k) plan.
Questions for Lauren?
Financial planner and advisor, Lauren Zangardi Haynes, CIMA®, CFP®, works with business owners and leaders in Richmond and Williamsburg, VA. She also works virtually with clients nationwide. As a fiduciary, she offers comprehensive Fee-Only financial planning and investment advisory services so you can live your dreams with confidence.