Business Operations

You should invest a substantial amount of time to ensure your operations are running as smoothly as possible, which minimizes risk for the buyer. Here are several suggestions for doing just that.

Systems

Standardize, document, and systemize the primary processes in your business. Establish internal controls, create systems, and produce a short operations manual for all key procedures. Developing systems involves streamlining, automating, and documenting your processes. By documenting your key processes, you increase the chances of selling your business. 

Here are the major benefits of building systems in your business:

• Attract valuable employees to your company with well-documented processes and clear job descriptions. 
• Streamline the management of your business with well-documented processes.
• Increase the value of your company by having systems already in place.
• Improve the chances of maximizing your price by having detailed processes.
• Enhance the scalability of your business by documenting your processes.
• Simplify the integration process for the buyer by building systems.

Suppliers

Consider your supplier base and determine if you need to diversify. Buyers don’t want a key supplier to hold them hostage, so consider ways to reduce your dependency on any single supplier. Ask yourself the following: 

• How are my relationships with my suppliers? 
• How long have I worked with them? 
• How much leverage do my suppliers have over me? 

If you’re at all dependent on any one supplier, create a strategy for diversifying your supplier chain. This will likely involve shopping for backup suppliers and having them ready to go at a moment’s notice.

Online Presence

If you own a business-to-consumer (B2C) business, check your online presence to make sure you don’t have any poor reviews. If you do, work to clean them up or push them lower in the search results. Poor online reviews can be a deal killer for many businesses, especially B2C businesses or those that rely on a strong online presence. If an online presence is important to your business, make sure your online image is as pristine as possible before you go to market.

Premises

You know what they say about curb appeal. I’ve had several deals die over the years because the buyer’s first impression wasn’t positive. Unfortunately, it’s difficult to change someone’s first impression. Don’t let this happen to you. Implement cosmetic enhancements to help increase your business’s value. Perform quick and easy improvements, such as cleaning up the physical space and improving online reviews. You may also consider hiring a commercial interior designer to do a light makeover of your business, but keep it simple and practical. A pretentious facility sends the wrong message to buyers. You want to convey a clean, trustworthy corporate image.

Real Estate

If you own the real estate your business occupies, ensure the real estate is owned by a separate legal entity (the “Real Estate Entity”) from your business (the “Business Entity”). Your Business Entity should pay the going market rate to your Real Estate Entity to rent the premises. This ensures your financials are representative and allows your business to be valued independently from the real estate. You should also have a draft lease prepared that’s based on current market conditions. Sign the lease and conduct business as if you were working with a third-party landlord. You should only run real-estate-related expenses through your business that the buyer would continue to pay. This will simplify the process of valuing your business because business valuations are performed independently of the value of the real property, and the rental rate and terms must be adjusted to current market rates.

If you’d like to lease your real estate to the buyer instead of selling it, retain a commercial real estate appraiser or broker to perform a comparables analysis to determine an appropriate rental amount and terms. Hold onto this documentation so you can provide it to buyers to substantiate the amount you’re asking.

Invest a substantial amount of time to ensure your operations are running as smoothly as possible, which minimizes risk for the buyer. 

The Lease

Informing your landlord early carries the benefit of allowing you to pre-negotiate the terms of the transfer, in some instances. Landlords are accustomed to businesses being bought and sold, so the news is unlikely to shock them. Your landlord may also potentially have a buyer in mind. 

But landlords can be opportunistic and difficult to predict. Buyers like options, so don’t sign or renew a long-term lease if you think a buyer may consider relocating your business. On the other hand, buyers also like stability, especially if your location is important. The best of both worlds is a lease that contains options to renew that are assignable. This gives both you and the buyer stability and flexibility. Still, there are downsides. Options to renew aren’t always assignable and don’t usually specify the amount of rent. 

Regardless, pre-negotiate an option to renew your existing lease if you can. If the location is vital to your business, the buyer will feel more comfortable if a long lease term is guaranteed in the form of an option to renew, even if the amount isn’t specified. Buyers are uncomfortable with verbal assurances, so be sure to get an option to renew in writing. You may consider talking to your landlord to obtain this option prior to selling your business, but make sure the option is assignable.

Finally, ensure the landlord is willing to renew your lease on favorable terms and that they won’t opportunistically ask for a higher rate. I recommend taking the assumptive close when you’re asking the landlord about the qualifications for a new tenant. You can say something to the effect of, “I assume the same terms I’m under now will apply.” If the terms were to change, your landlord will likely let you know. If there will be material changes to your lease terms, your M&A advisor should know this so they can indicate these terms in the confidential information memorandum (CIM) and not surprise the buyer with a change in lease terms later in the transaction.

Inventory

Your inventory is also a key asset of your business and will be examined by buyers during the sales process. The following are suggestions for ensuring there are no problems related to your inventory:

Purge Your Inventory

Liquidate any old, unusable, or unsalable inventory. You’re unlikely to get paid for it, so liquidate it now. Stale inventory includes obsolete, out-of-favor, or overpriced items that can deter buyers, so purge your inventory before you put your business on the market. Doing this also simplifies the inventory count at the closing and helps tidy up your facilities. 

Prepare an Inventory List

Compile a preliminary list of inventory that will be included in the sale. This helps eliminate last-minute surprises, such as underestimating the amount of inventory and, therefore, the value of the working capital that’s included in the purchase price.

Equipment

A similar rule to inventory applies to equipment. Here are my suggestions for addressing any potential issues related to your equipment. 

Prepare an Equipment List

Prepare a list of all hard assets included in the sale, including furniture, fixtures, equipment, leasehold improvements, vehicles, and any other hard assets that will be included in the purchase price. Keep the list in an easy-to-update format. There’s no need to include values for each piece of equipment. In fact, this can work against you because the buyer can dispute the individual values of each piece of equipment or argue that the purchase price should be allocated to the equipment based on your estimated values.

Perform an Inspection 

Hire a third party to perform a preliminary equipment inspection to ensure all equipment is in proper working order. Repair equipment that isn’t working properly or liquidate it if you no longer need it. This reduces any concerns a buyer may have regarding the condition of your business’s physical assets. Keep a copy of the equipment inspection report to show to potential buyers during the sale process.

Purge Your Equipment 

Liquidate or sell any equipment that’s inoperable, outdated, or that you don’t use in your business. Repair or replace broken equipment. Remove any assets from your premises that are excluded from the sale, such as the basketball you have on your desk that’s signed by Michael Jordan, or the Persian rug in your office that’s been in your family for generations. If the buyer sees them, they’ll assume these assets are included, so it’s best for the buyer to never see these assets in the first place.

Equipment Leases

Consider paying off any equipment leases, but do the math first. This is a financial decision requiring developing a financial model to determine if it makes sense to keep the leases and have the new buyer assume them or to pay off the leases at closing. Deciding to pay off your equipment leases before selling your business is primarily a mathematical decision with one unknown variable – the multiple. Here’s an example to illustrate the math behind the decision.

• Example:
  • EBITDA = $4 million
  • Multiple = 5.0
  • Business value = $20 million
  • Equipment lease payment = $50,000 per month
  • Paying off the lease will save the buyer $600,000 per year ($50,000 per month x 12 = $600,000 per year).
  • EBITDA will increase to $4.6 million from $4 million if the lease is paid off.
  • The value of the business will increase to $23 million if the lease is paid off.
  • The difference between the two business values is $3 million.
• Conclusion:
  • If the payoff is less than $3 million, it’s worth considering paying off the lease.
  • The example above assumes the multiple will be 5.0. If the multiple changes, so will the formula. 
  • Don’t pay off your equipment lease until closing. You don’t want to pay off the lease and then not sell your business. Instead, inform the buyer that you’ll pay off the lease out of the proceeds at the closing.
  • Consult your CPA to take the tax implications into consideration.

The bottom line is that if paying off your equipment leases will increase the value of your business by more than the current payoff of your leases, it makes sense to pay them off. The reverse is also true – it doesn’t make sense to pay off the lease if paying off your equipment leases will increase the value of your business by less than the current payoff amount.

Action Steps

• Systems: Standardize, document, and systemize the primary processes in your business. Develop internal controls and systems and draft a short operations manual for all key procedures.
• Suppliers: Diversify your supplier base if you’re dependent on any one supplier.
• Online Presence: Work to improve your online presence if you own a B2C business, especially if you have any negative reviews online.
• Branding: Prepare a list of any positive mentions of your company that you can present to the buyer.
• Premises: Perform quick and easy improvements, such as cleaning up the physical space or hiring an interior designer to do a low-cost makeover of your premises.
• Real Estate: If you own the real estate, ensure the real estate is owned by a legal entity separate from your business and pay the going market rate to the “Real Estate Entity” to rent the premises. 
• Lease: Don’t sign or renew a long-term lease if you think a buyer may want to relocate your business. Pre-negotiate an option to renew your existing lease. Contact the landlord early and ask about their financial and experience requirements for approving a new tenant and ensure the landlord is willing to renew your lease on the current terms.
• Inventory: Prepare an inventory list and liquidate any obsolete inventory.
• Equipment: Prepare an equipment list and remove any equipment you don’t use. Have the remaining equipment inspected to ensure it works properly. Finally, consider paying off equipment leases.