5 Ways to Get the Most From the Sale of Your Business
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If you’re thinking about selling your business, there are a number of different buyers you can approach, from equity investors to competitors. No matter who the buyer is, consider these five points as you approach the large and important task of selling your business.
1. Choose the right time of year
What we are talking about here is the right time in your Financial Year. Most businesses we sell are valued on a multiple of after-tax earnings — but the question always comes up, “To which earnings will the multiple be applied?”
If, for example, your year-end is February (2018 financial year), and you consider selling your business anytime in the six months after that, then there can be little dispute that a buyer will apply a multiple to your 2018 after-tax earnings to arrive at a value.
But what if it’s now, say, October 2018 (2019 financial year)? And you are having a markedly better year than 2018?
Even though you have not completed your 2019 year, there is definitely a case to be made that the value should be based on the results you expect for 2019 rather than those you achieved in 2018.
Given that it generally takes anywhere from four to six months to sell a company, by the time you are getting close to completion chances are that you will have 90% certainty on what your 2019 result will be anyway.
So, our advice is always to try and ensure that the multiple agreed is applied to future earnings where you can make a case for their being achieved (usually within the last six months of a financial year), and then to provide for an adjustment (either up or down) where the actual 2019 result comes in slightly different to your forecast.
2. Normalise your profits
When we sell private companies, we generally find that multiples fall within the range of five to seven times after-tax earnings. Clearly this is a generalisation, and many companies are also valued using a multiple of pre-tax profits, EBITDA or even a multiple of revenue.
The point is in valuing a company, and where a multiple is applied to ‘profits’ rather than revenue, for each and every rand you can add back to ‘profits’ you will receive multiple times that in sale consideration. Adding back certain costs to your profits is called ‘normalising’ your earnings.
In most private companies, there are numerous expenses that go through the books that frankly the business could do without. Some are once-off expenses, and some could relate to the employment of a family member who really does very little in the business.
Before you present your after-tax earnings to any prospective buyer, it is vital that you go through all the costs in your business and review whether these could in fact be excluded. Ask yourself — are these a ‘normal’ recurring business expense?
If you can make a case for their exclusion, then remove them from your profit calculation and note down the reasons why. When the time comes to apply the multiple you both agree is appropriate for a business such as yours (and which is a science in itself) you will be sure you are then extracting maximum value.
3. Opt for an earn-out
When you sell your business, many buyers might be nervous about simply paying the full asking price up-front. They know little about your company, they don’t have the relationships with your suppliers or customers — let alone your staff.
By the same token, many sellers might be disappointed by the price they can achieve for their business when sold for a once-off consideration. The risks the buyer perceives as outlined above can often translate into a lower multiple being applied — below what you would consider as fair.
The answer to the above conundrum is to consider an earn-out — a solution that can work equally well for both parties. Essentially an earn-out requires the buyer and seller to agree on an up-front value for the company, and then for the buyer to agree to only pay a percentage of this immediately.
The balance of the consideration can then be paid over a one or two-year period (or longer depending on what is agreed), and will be calculated by applying a multiple to the actual profits earned in those years. Needless to say, there is no vanilla way for an earn-out to be calculated, and many refinements can be made to the calculation of the future consideration.
For example, we often see buyers prepared to offer increasing multiples for future years, or even increasing multiples where profits exceed certain agreed bands. There are also often caps and collars applied to the consideration — the collar to ensure that the consideration never falls below a certain agreed amount, regardless of actual profits earned (to protect the vendor) — the cap to ensure that the consideration payable is never greater than a certain agreed amount (to protect the buyer).
There is no doubt that an earn-out is the best way to extract maximum value for your business — but beware the complications of such mechanisms. There has been many a fall-out between buyer and seller particularly over the calculation of profits during the earn-out period — thus impacting the consideration that both parties feel should be paid.
The ‘rules’ of how the business should be run during the earn-out period, and who gets to decide on levels of expenditure need to be written extremely carefully into the purchase and sale agreement.
4. Sell your company not your business
When buyers are considering making an offer for your company, what they actually mean is that they like your business — but don’t necessarily want to purchase the actual company in which it is housed.
Many companies that come up for sale have been trading for many years, and it’s possible that there are certain ‘gremlins’ (such as hidden actual or contingent liabilities) within the company that the buyer might not be aware of — despite the warranties and representations that the company owner will be required to give at the time of sale.
We often find that buyers prefer to make an offer to buy the business out of your company, rather than take on the company itself. Whereas this might at first sight seem to make no difference to the vendor, the reality is that they could end up paying considerably more tax than if they simply sold their company.
At the time of writing, where an individual simply sells his company, he will suffer capital gains tax of 18% on the gain. If, however, he sells his business out of his company, then the proceeds of the sale will not go directly to him, but rather to this company instead.
The proceeds of the sale will thus attract corporate tax within the company (say at 28%) and the vendor still has not got the cash into his own hands. To do this the company will now need to declare a dividend for the proceeds of the sale, and this in turn will be taxed at 15%.
The result of the above is that the vendor might only see just over 60% of the gross consideration from the sale compared to over 80% had he simply sold the company. Obviously, tax positions vary for companies and individuals (and also trusts), but there is no doubt that the prospective vendor should seek advice before accepting any offer to make sure he nets the most out of the sale he can.
5. Remove excess cash
This might seem like a fairly obvious one, but it’s surprising the number of company owners who potentially leave too much cash in their business on sale. When a buyer makes an offer for a business, their expectation is that the vendor is leaving sufficient working capital in the business to earn the future profits for which the buyer is paying.
So, one of the key calculations that must be done prior to sale is a review of historical working capital to see what this ‘sufficient’ level actually is. What we often find is that the cautious company owner runs his business with a good deal of cash sitting in the bank — mostly to help him sleep at night and so not to have to worry about the peaks and troughs of day to day cashflow.
The danger is that the buyer comes to view this level of cash in the business as ‘normal’ — and hence their expectation is that this level of cash will also be sold with the business. The reality, however, might be that the company could actually run on much less working capital, and any troughs in the cashflow could be covered through a small overdraft (without threatening the value of the business or adding to its risk).
Before considering the sale of your company, it is therefore worthwhile having a look at your working capital position, seeing whether you could apply for a small overdraft, and then removing as much excess cash as possible prior to the sale by way of dividend. As long as you can make a case for the business having sufficient access to working capital to deliver the future profits that you have promised, then this step should not be an impediment to the sale.
And the excess cash you withdraw is of course more cash in your pocket when you come to add up the total value you extracted from the sale.