Barriers to Exit for Small Business

While we normally talk about barriers to entry when looking at the value of business, we also need to recognize that there can be critical barriers to exit for the seller of a small business. These barriers to exit fall into two groups, external non-controllable and internal controllable. This purpose of this article is to help you recognize some of the major challenges to selling your business and help you focus on those controllable matters that can greatly affect the outcome of your sale.

External (non-controllable) Barriers to Exit

The External barriers refer to the economic conditions and competition from other businesses that are for sale. Without a doubt, we are in and will continue to be in a buyers market when it comes to selling your business.

Some interesting demographics about small business:

  • Baby boomers (born between 1946-1964) in the US will turn age 50 and 60 every six seconds for the next 15 years.

 

  • 50% of business owners are aged 50

 

  • The average age of business owners is 56

 

  • One out of every two company owners plans to sell their businesses during the next ten years.

 

  • About 80% of owners who approach an investment bankers and business brokers to sell to an outsider pull back due to unrealistic business value perception by the owner or lack of planning.

 

  • Only about 25% of businesses that are listed for sale between $750,000 and $5,000,000 actually sell.

 

The above demographics alone point to a huge number of businesses for sale over the next 15 years with most of them sold for a fraction of what their owners expected.

The other major external barriers are all the economic, environmental, regulatory, tax, technology and other external forces that impact you sales and profits. Clearly, you have little input and control over these factors. You can only compete harder, perform better and adapt quicker but you are better served by focusing on what you can change.

Internal (Controllable) Barriers to Exit

The good news is that there are a number of factors you can control that have a huge impact on whether you can sell your business and how much you get for it. The even better news is that by focusing on these factors you will be doing something that most of your business-selling-baby-boomers are not doing thus giving you a distinct advantage.

Business brokers are very clear that the primary reasons small business either do not sell or sell for much less than expected are:

  • The value in the business is way too dependent on the owner. The management team is weak or not in place to successfully run the business in the absence of the owner.

 

  • Bad books and records – i.e. the inability to properly present accurate and complete financial information to potential buyers in a timely manner.

 

  • Systems, processes and controls are inadequate or missing. Tribal knowledge is a poor substitute for documented and tested controls. The company is perceived to be unstable.  This is the inevitable conclusion reached if the above three issues exist.

 

  • The seller’s expectation of the value is unrealistic. The buyer needs to see a clear path to a solid return on their investment.

 

Having been involved in the purchase of many businesses and the attempted purchase of many more, I know the frustration of wanting badly to do a deal but being unable to agree on a value because of the above factors. I have seen month after month go by with deals where you simply cannot get past square one because of the above deal killers.

The sad thing is that these are all matters that can be addressed. Here are some suggestions:

Dependency on the owner

 

This is a hard one. It’s your company. You built it and it is a direct reflection of who you are. You don’t need to abdicate the thrown but you need to work on effective delegation of authority.

Trust your competent mid management tor run more of the operations and administration. If you can’t trust them, then you should start replacing them with people you do trust.

Ensure that your key customers know your organization not just you.

Make sure your organization knows and understands your customers.

Teach your employees the business. Empower them to make decisions and to be accountable for keeping the company performing.

Bookkeeping

If your idea of keeping books is filing your tax returns once a year, expect to receive a fraction of your perceived value for your company.

If you’ve run your whole life through your company’s tax return, expect to do a lot of explaining to support that your “real” income is higher than shown on the tax returns.

If you think books can be cooked to support a higher price, you can expect the deal to blow up or to spend several times what you get paid for the company on legal fees defending yourself.

If you believe the real value of your company is off book expect to have a buyer either severely discount or ignore this value – whether real or not. Intangible assets and goodwill only have value when you can demonstrate that they produce tangible results.

Clean up your books and act like a real company. The standard is that you should have a complete and accurate income statement and balance sheet issued every month within ten days of month end. This should be supported with AR, AP and Inventory details that agree to the general ledger. If you cannot do this, it indicates to buyers that you don’t value financial information and therefore, your financial information is likely incomplete and incorrect.

Don’t just hire a bookkeeper and expect that your accounting will all be correct and don’t just hire your CPA or a CFO and expect them to do all the bookkeeping. You need a B2B CFO

Systems, processes and controls

+ Basic system are the minimum requirement but too often the core systems of a company are a hodgepodge of Excel spreadsheets and databases that have never been reconciled to each other much less the financial reporting systems. Buyers don’t want to buy a company only to find that they have to invest huge amounts of time, energy and money just to get their hands around the operations.

There is a false economy perceived by some business owners that scrimping on systems developments will improve their EBITDA and EBIT and therefore fetch a higher value for the company. Why should I spend money on a system they the buyer will get all the value from?  Because a smart buyer knows the cost of implementing new systems and they will factor that into their offer.

Good systems are a major selling point for a company. Most buyers assume that, given the right information, they will run the company better than you. If they are uncomfortable with the data provided, they lose this confidence and this leads to lower offers.

Good systems help you run your company better. Develop good systems producing useful reliable information and you will not only get a better valuation for your company for its systems, your EBITDA will probably be higher than if you continued to run your company with systems from the 1900’s.

How do you know how much to invest and what systems to use? A good CFO will know how to approach this issue with realism – i.e. what you can afford, what you will get out of it and what it will really cost.

Stable organization:

The expression that “People are our most important asset” is most clearly demonstrated when you are selling your business. Buyers will pay for a stable organization with good management and a hardworking and happy staff. If buyers perceive that he will have to recruit, train and build a new organization after you leave, they will significantly discount their offer.

Note that this is a perception issue. It is critical that you know how to convincingly present your company well so that buyers perceive the underlying stability and strength of your company.

Unrealistic Expectations

Last but not least is aligning your expectations with reality. Some business owner just cannot accept the reality that the value of their business is not calculated like a civil servants pension plan, i.e. based on your three highest earning years. Buyers need to be able to clearly see how they will recover their investment and make a good return. Good cash flow, clean books, sound systems, systems and controls, and a stable organization that can run without you are the basics that buyers need in order to make you a profit.

It also helps to have well informed, experienced and objective advisors that will give you honest opinions and input rather than gratuitous praise.

Jim Bateman is a partner with B2B CFO® the USA’s largest CFO firm focusing on small and mid-market companies. Jim can be reached  by phone at 562.370.0125 or by email at jbateman@b2bcfo.com

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