Avoid These Funding Mistakes That Kill Business Valuations
Eliminating bad debt will make your business much more attractive for sale.
June 29, 2017
5 min read
Opinions expressed by Contractor the contributors are theirs.
Having a well-funded business that doesn’t rely on bad sources of debt goes a long way in making a business attractive to buyers and ensuring it gets an attractive valuation. But the choices that produce a good track record don’t happen overnight; it takes years of preparation to ensure the best possible sale years later.
Now is the right time to sell a small business: In the first quarter of 2017, 2,368 deals were closed, up 29% from the previous year, according to BizBuySell Analysis Report. However, only one in five listings in the online marketplace for the sale of small businesses closed a deal in 2016. funding is one of the most important factors that lead to to success Sales. In their simplest form, attractive businesses are funded by good debt while unattractive businesses are built on bad debt. Often times, financial decisions made early in the life of a business determine whether a business can be successfully sold years later.
Good debt falls into three categories:
- Funding to acquire capital assets that improve workflow and efficiency or facilitate more efficient use of labor or assets
- Debt to acquire real estate that can be sold with the business or held after the sale as an additional source of income
- Loans and working capital lines that help the business grow.
Start with a review of the funding and use of capital assets.
Businesses need to have good permanent funding for at least three years to create the most efficient and profitable organization. This planning begins with a review of capital funding. For example, printing and construction companies are notorious for buying high-end equipment that is often underused. If this equipment is only used 20% of the time, it creates a fixed cost of debt coupled with variable income that does the business a disservice by creating a balance sheet where cash flow does not justify debt. Since buyers only care about repeatable cash flow, the end result will be a lower purchase price.
Entrepreneurs who wish to sell should examine all of these assets on the balance sheet to make sure the business is in good financial health. A business using debt to finance underutilized assets, including machinery and real estate, should remedy the situation. For example, if an asset is underutilized, it makes more sense on the balance sheet to sell the asset, pay down debt, and outsource that work.
Buyers dislike bad debt, which falls into three categories:
- Debt financing of underperforming assets or real estate, as detailed above
- Large credit card debt used as working capital because the business does not have adequate lines of credit
- Debt with high interest rates.
While these loans can be convenient and easy to take out online, loans with interest rates of 20% per annum or even more are a disadvantage for a new buyer. While bad debt can keep the business afloat, it indicates that the business may be difficult to finance.
Having the right kind of financing ensures that the business operates efficiently and has real, repeatable cash flow that will continue after the sale. For example, taking out a large loan to upgrade machinery in a way that will boost sales enough to pay off debt makes sense for a business as an ongoing concern, but doing it right before a sale will reduce the profit from that sale to less. that cash flow is generated. increase accordingly.
Avoid year-end tax and accounting maneuvers that reduce income.
Anyone wishing to sell their business should also be careful to avoid any tax evasion schemes such as invoicing customers after year-end, paying bills early, or purchasing additional equipment or vehicles for write-off. depreciation. Such actions reduce revenue and increase costs artificially, and can prevent the buyer from understanding your business and how they can make it profitable. It is never a good thing to try to sell a business.
Entrepreneurs who have taken an outside investment too early, be it venture capital or elsewhere, and have had to give up too much control of the business in exchange for that money, may find it difficult to get the price they want. want years later in a sale because they are also owners. small of a percentage of their business. Such businesses would have been better off raising a smaller amount of funding from friends and family or angel investors to start the business and maintain control.
Owners who have engaged partners in exchange for cash early on should have a written agreement to avoid any problems later when selling the business. Imagine, for example, a great chef with a partner who provided money to open a restaurant. In this type of professional marriage, a prenuptial agreement can prevent many headaches later on.
Over the next decade, approximately 10 million small business owners hope to sell their business to retire. Businesses that get good reviews will have good processes and methods that generate profits and will have financial statements showing positive equity, goodwill being established, and sufficient cash flow to pay off debts and pay a good salary. to the new owner.