Financing mistakes that kill Business Valuations
Having a well-financed business that doesn’t rely on bad sources of debt goes a long way to making a company attractive to buyers and ensuring that it fetches an attractive valuation. But, the choices that produce a good balance sheet don’t happen overnight; it takes years of preparation to ensure the best possible sale years later.
It’s a good time to sell a small business: according to BizBuySell’s Insight Report, however, only one in five listings on the online marketplace for selling small businesses closed a deal in 2016. Having good financing is among the most important factors that leads to successful sales. At its simplest, attractive businesses are financed by good debt while unattractive businesses are built on bad debt. Often, decisions about finances made early in the life of a business determine whether or not a business can be sold successfully years later.
Good debt falls into three categories:
Financing to acquire fixed assets that improve workflow and efficiency or that facilitates 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.
Working capital loans and lines that help the business grow.
Start with a review of the financing and utilization of fixed assets
Companies should have good, permanent financing in place for at least three years to create the most efficient, cash-flow positive organization. That planning starts with a review of the financing for fixed assets.
For example, printing and construction companies are known for buying high-end equipment that is often underutilized. If that equipment is only used 20 percent of the time, it creates a fixed debt cost associated with variable revenues that does the business a disservice by creating a balance sheet where cash flow doesn’t justify debts. Since buyers only care about repeatable cash flow, the end result will be a lower purchase price.
Entrepreneurs that want to sell should review all such balance sheet assets to ensure the company is in good financial health. A business using debt to finance assets that are under-utilized, including machinery and real estate, should rectify the situation. For example, if an asset is being underutilized, it makes more balance sheet sense to sell the asset, retire the debt and sub-contract that work.
Buyers dislike bad debt, which falls into three categories:
Debt financing under-performing assets or real estate, as detailed above.
Significant credit card debt being used as working capital because the business does not have adequate lines of credit.
High interest rate debts.
While those loans may be convenient and easy to sign up for online, loans with interest rates at 20 percent annually or even higher are a turnoff for a new buyer. While bad debts can be keeping the business afloat, they signal that the business may be difficult to finance.
Having the right type of financing makes sure that the business is operating efficiently and has real cash flow that is repeatable and will continue after the sale. For example, taking on a large loan to upgrade machinery in a way that will boost sales enough to service the debt makes sense for a business as an ongoing concern, but doing it just before a sale will lower the profit of that sale unless cash flows increase accordingly.
Avoid year-end tax and accounting maneuvers that drive down revenue
Anyone hoping to sell their business should also take care to eschew any tax avoidance schemes such as billing customers after year-end cutoff, paying invoices early, or buying extra equipment or vehicles for the depreciation write-off.
Such actions drive revenues down and push costs up artificially, and may make it difficult for the buyer to understand your business and how he or she can make it profitable. That’s never a good thing when trying to sell a business.
In the coming decade, millions of small-business owners hope to sell their company to retire. Businesses that fetch good valuations will have good processes and methods that create profits and will have financials showing positive equity, goodwill being created, and cash flow that is sufficient to service debts and pay the new owner a good salary.
What we do:
Malahat Valuation Group is boutique valuation and appraisal firm specializing in providing valuation services to owners of private companies.
Why does it matter?
Business owners need to know the true value of their business and its assets to make critical decisions that are based on fact not speculation. We answer the age old question “what is it worth”?
Smart business owners, who know the true value of their assets, make better decisions about the future of their companies. We provide them certainty...and certainty is what separates market leaders from the rest of the pack.
Malahat Valuation Group