How to Plan an Exit StrategyPosted 11 Nov 2015 Trevor Johnson reveals some tricks of the trade
What’s one of the first things anyone planning a business start-up should do? Plan an exit strategy that will give them the best possible return when they decide to call it a day.
It might sound odd to plan to sell a business before it’s even started, but it makes good financial sense, according to entrepreneur Duncan Bannatyne, formerly of Dragons’ Den, who says: “All my businesses are always for sale at the right price.”
If you’re buying a business, how can you be sure you’re getting something that will be profitable in the future? And will you get value for money? One way is to seek out what the experts call soft due diligence - often neglected data that can provide a much clearer picture of whether a business is worth buying.
These are just a few of the tricks of the trade you need to know before plunging into the small business market.
Management consultant Alan Pritchard says: “Once you could buy a small business with a look at the books and a handshake, but those days h ave long gone. Today specialist help is essential if you’re buying or selling, but you’re the one putting your name on the contract and it’s only good sense to know as much as possible about what’s going on.”
IF YOU’RE BUYING
How do you know if the price is right and the deal is a good one? Of course, due diligence is important, but you should also look beyond the hard indicators of sales, profitability, price-earnings ratios and discounted cash flow.
Usually, buying an existing business is less risky, but more costly than starting from scratch, although it’s easier to borrow money to buy a going concern. On the downside, you could get stuck with obsolete equipment, uncooperative workers and outdated methods.
Alan says: “Accountants tend to look at the health of the business and how good things have been in the recent past. But what about the future? The vendor may be selling at an absolute peak and has had time to make the figures look good. All you can see is a rising profit curve, but for all you know, from here on it may be on the way down.”
Consultants believe that examining alternative data can give a much clearer picture of the long-term health of a business. Good indicators to examine are things like brand share, footfall, customer retention and staff retention rates.
“This soft due diligence is as important as the traditional hard type, but is all too often neglected,” Alan says.
Although valuing a business often boils down to what the buyer can afford and the vendor is prepared to sell for, you can get an idea of current market values from databases that contain information on deals done and calculations of sales in terms of multiples of profit.
If by now you feel you need professional help, you can hire a business broker who will charge 5-10 per cent of the purchase price. For this they should screen potential businesses, help you select the right one, negotiate the sale and guide you through the jungles of paperwork.
Now is the time for a detailed look at what you will be buying and here are the most important items to check:
- Inventory. That’s all products and materials used in servicing the client. How old are they? What is their condition and quality? Will they fit your target market? You don’t have to accept the vendor’s evaluation, so do some hard bargaining.
- Buildings, fixtures and fittings. Are they up to standard or will repairs and improvements be necessary? What are the maintenance costs? How much has equipment depreciated from its original value?
- Tax returns and financial statements for the past five years. These will show you what the actual net worth of the company is and how much it has been used for personal needs, like cars and holidays. A close study of the books should show the true earning power of the business.
- Sales records for the past two or three years will show business cycles and current and past activity. Look at the 10 largest accounts for the past 12 months. Are sales up or down?
- Location and market area. Research the economic outlook, demographics and competition. Are there any difficulties getting the product to market? How much future potential is there in the area?
- Business reputation. Speak to customers, suppliers and banks, as well as owners of other businesses in the area, to find out what people think of the company you might buy.
IF YOU’RE SELLING
Plan well in advance. Some consultants even advise clients to include an exit strategy in their initial business plans. This should include a second tier of management, which will run the business when you have gone. Without this in place, you may find that the only way to sell the business is to stay on for months, or even years - something you will probably not want to do.
Michael Bowes had this very much in mind when he sold his five-shop West Country furniture business.
“I had been planning to sell for three years,” he says. “One of the key strengths was that we had a good management team, so the business didn’t rely on me.”
Michael now runs an organic beef farm and spends his spare time fishing. “I feel sorry for people who have hung on too long and had to sell up in a hurry because they need the money,” he says.
Consultants advise you to update your exit strategy every two or three years. This will give you a chance to optimise your tax planning. Next, make your company as attractive as possible. Sort out your accounts and deal with any liabilities, legal claims or difficult leases.
Your accounting must be immaculate, according to corporate financial adviser Baker Tilly, which also says you need to be able to demonstrate exactly where the profits of the business are coming from, so having quality financial information is vital if you want to sell.
Make sure potential buyers are genuine. Business consultant Tim Cooper says: “One of the main reasons deals fail is that the vendor is reluctant to share information with the inquirer, fearing that they are competitors fishing for confidential information. “Vet potential buyers before they see confidential information. Ensure they have funds and get them to sign a non-disclosure agreement. If they’re genuine, they should go along with this.”
Raise the profile of the business in the run-up to a sale with promotions and press releases. Appearance is vital - premises in need of painting or shabby furniture will give the impression that you’re selling because you have to.
Don’t forget that employees have a keen interest in the business’ future and should be kept informed of exit strategies - and so should your customers. You want to hand on a profitable client base, while assurances that valued customers will give the new owners a try will help you get the best possible price for the business.
Getting good advisers on board is also important. Tim says: “Look for first class negotiators with a good track record in similar-sized transactions. Make sure you like your advisers personally, because you’re probably going to have a very close relationship with them over the coming months.”
USE THESE POINTERS TO PLAN YOUR SALES STRATEGY:
- Write an action plan and choose experienced advisers.
- Draw up a list of possible buyers.
- Tidy up your accounts and deal with any black holes.
- Keep employees and customers in the picture.
- Decide how involved you want to be in the company after you’ve sold it.