Justifying Your EBITDA

All too often a business owner decides to sell, only to learn a number of harsh realities. For example, oftentimes a business owner discovers that their lack of financial data represents a major problem. The simple fact is that prospective buyers will dive in and scrutinize every aspect of EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization) when looking at their perceived value of your business.  This will most likely take place through what is called a Quality of Earnings Analysis Report (Q of E). General Accepted Accounting Principles serves as the key basis and language for financial reporting (known as GAAP Accounting).  GAAP Accounting and Reports often represent a marked departure for how many companies handle their general and day-to-day accounting. The end result of all this can be a substantial shift in EBITDA as compared to what the actual number really is.

Potential buyers will ultimately receive numerous documents that outline the financial and operational health of your business during what is called the due diligence process in acquiring a business. This means that you, as a business owner, must be ready to invest a good deal of time in the process of disclosing as much accurate information as you can, in support and defense of the true and accurate EBITDA of your business. In short, preparing your business to be sold is no small affair when it comes to making sure that information is fully disclosed and in defense of the actual quality of financial and operational health to ensure the highest and best acquisition price.

EBITDA is one of the most common ways to value a business based on multiples of that number.  When engaging your business for acquisition in the open market, you should expect that any buyer or potential investor will perform a review of your income statement for adjustments in order to arrive at an adjusted EBITDA that makes sense for THEM. 

You need to be ready and fight back as to what the true Adjusted or Normalized EBITDA is, that serves as the basis for a purchase price of your business creating a value used with a multiple to negotiate a final price and terms that make sense for both parties. Miss out on the correct EBITDA for your business by $100,000 on a 3 multiple and you just gave up $300,000 in acquisition cost of your business – as an example.

There are three common EBITDA adjustments:

  1. First, items related to conversion based on a GAAP Accounting basis; this number can have a considerable range. 
  2. Second, one-time events such as legal expenses, PPP loan forgiveness, insurance settlements, unusual expenses associated with issues/growth of the business can greatly factor into an adjusted EBITDA amount. 
  3. Third, certain personal expenses a business owner takes that would typically not be part of the future cash flow of your business is another potential impact on EBITDA. 

It is important not to ignore balance sheets when it comes to representing the financial health and aspects of your business as well. Smaller businesses typically focus strictly on profit, and this factor can result in balance sheets not being reviewed as often as they should be. A balance sheet needs to be recast in a way that the potential buyer truly understands the assets and liabilities that convey in a sale. It is better to recast the balance sheet upfront to what truly conveys with the business as the end result can be items popping up during due diligence causing hiccups in deal making and negotiations. 

As an example – many times we see that business owners may park large amounts of cash in their business and on their balance sheets – over and above what is normally necessary.  The minute a potential buyer sees a $1,000,000 cash position on a business when a $60,000 working capital position is needed, they are going to want that $940,000 cash to convey with the business.  That’s fine if they are willing to pay $940,000 more for the business but not if they want the sale price of the business on a “cash free, debt fee” basis when the business conveys to stay the same with a reasonable sale price.  

The same is true with liabilities.  If you intend to convey the business without debt –  if $500,000 in liabilities is relieved from the business, the value and burden of debt on the business logically increases by an adjusted amount in cash flow that is not needed by the business moving forward.  This mathematically (and logically) increases the value of the business based on the cash flow used against the multiple used for valuation.  Relieve $100,000 debt service to the business against a 3 multiple for the value equates to an additional $300,000 in value and price that the business should sell.

There are three key points that business owners should keep in mind when they are planning on selling their business: 

  1. Make sure that managers and key employees are able to step in and run the business during the transition period. 
  2. Review your financials, and get ready for GAAP reporting requirements during due diligence with a potential acquisition. 
  3. Consider having a Quality of Earnings analysis performed with your business before going to market so you truly understand the financial health with your business.

As this article underscores, selling a business is a process with numerous moving parts. Well organized and solid financials – defensible EBITDA and operational health, represents to buyers and investors a sound and well-run business with an owner that is professional and realistic in their expectations. 

Bottom line? Even if you believe it will be years before you place your business on the market, it is never too early to begin preparing.

Copyright: Business Brokerage Press, Inc.

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Leases: Key Considerations That Can Make or Break a Business

Are you selling a business that involves a lease? If so, this will be a factor that has significance to a buyer when you go to complete your deal. If your business relies heavily on its location and you don’t own property, then you’ll find the lease will be quite an important consideration for your buyer. By the same token, if you’re buying a business that involves a lease, you’ll want to carefully examine this document and consider how it might impact you and your business. Let’s take a look at some important clauses and terms you’ll want to be looking for. 

Lease Transfers 

What are the terms for transfer of the lease? This is something you’ll want to know before signing on the dotted line if you think you’ll be selling at some point in the near future. 

Lease Lengths 

How long is your lease? If your buyer can confirm that there are many more years on your lease, he or she will find that to be an advantage. 

In the case of a business owner with a new endeavor, a shorter lease may actually be an advantage. That way the owner can get out of the lease if the business is not successful. 

Competitors 

If you’re planning on a lease in a shopping center, it’s essential to get in writing that the center will not accept other tenants that do what your business does. Otherwise, you’ll be constantly faced with competing with a similar business. 

Unexpected Costs

It’s also important to look for clauses that address what happens in the case of an adverse event. For example, if the property was destroyed by a fire, who will pay in the interim? 

There are other practical considerations to consider in leases that many business owners tend to overlook. For example, how are real estate taxes covered? Will you be charged a fee to cover maintenance of the property and, if so, what is it? Is someone in particular responsible for necessary repairs and who will pay for those? 

It goes without saying that you’ll also want to check out clauses impacting rent changes. Otherwise, you may face unexpected rent increases that negatively impact your business. 

Personal Guarantees 

If you are a new business owner, a landlord may ask you to personally guarantee the rent. This would be quite a different lease from one that accepts a well-established corporation as a tenant. 

As you can see, there is much more involved in a lease than just the amount of the rent. Be sure to read your lease carefully and ask questions. A Business Broker or M&A Advisor can assist you with lease terms when you are buying a business. 

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What Should You Expect from Term Sheets?

If you’re selling your business, at some point you’ll likely be presented with a term sheet. As the name suggests, this document will include the “terms” of the deal including the basic economic terms and conditions of a prospective acquisition. It is a list of conditions to be met if the sale successfully takes place, yet it is not legally binding.  

What is the Difference Between a Term Sheet and the LOI?

Both a term sheet and letter of intent (LOI) will include stipulations and lists for a buyer and seller to agree upon. The major difference is that the term sheet doesn’t require a signature, while the letter of intent does. In many cases, buyers are hesitant to sign before the due diligence stage. In this situation, you may find that the term sheet will precede the LOI. 

How Lengthy are Term Sheets?

There is no standard model or form to a term sheet. Therefore, it may be as short as one page, or it could even be five or more pages. But no matter how many pages it may be, it should explain what is being purchased and a stated price. In some cases, the information in a basic term sheet will lead to a formal letter of intent. 

What Components Should be Included? 

In addition to the price and terms, a term sheet can include other considerations relating to the purchase of the business. For example, it can include employment agreements or non-compete clauses. They can also include conditions to be met upon closing. Often the term sheet will detail plans for the buyer to conduct due diligence and gain additional information. You can expect to find everything from warranties and lists of what is included in the sale to exclusivity clauses within term sheets. 

One aspect of the term sheet that should not be overlooked is the method of payment. Typically, the payment sections are far more complex than just “cash at close.” Instead, they will describe a combination of elements including cash at closing, but also other forms of payments. In some situations, they will include details regarding a loan from the seller.  

The term sheet is quite beneficial as it can expedite the sales process and prevent serious misunderstandings. As a result, this non-legally binding document can initiate a smooth beginning to a successful deal. 

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Is Your Deal Really Done?

Once you get to the stage of your deal where you have a signed letter of intent, you may already be feeling a sense of relief that your deal is near finalization. But remember that the due diligence stage is typically yet to come. This stage includes everything from financial and legal investigations to a review of specific information regarding how a business is run. 

The due diligence process can be quite comprehensive and it often reveals some surprises. Because it is important for sellers to know what to prepare and for buyers to know what to look for, let’s examine some of the categories that are reviewed during this process.

Trademarks and Copyrights

Will assets like trademarks, patents and copyrights be transferred?  This is a point that has certainly interfered with some deals being successful. Due to the fact that trademarks, patents, and copyrights are often essential parts of a business, they cannot be overlooked. 

Products and Industry 

Due diligence will likely include analysis of product lines and the respective percentage of sales that they make up. If the business in question is a manufacturing business, then all aspects of the process will be examined. For example, buyers will be looking for age and value of the equipment, information about suppliers, etc. 

Financial Statements

It goes without saying that financial statements should be poured over during due diligence. Current statements and incoming sales should be carefully reviewed.  Review of financial information will also include balance sheets. Is there bad debt? Is there work in progress? These kinds of issues will be evaluated. 

Customer Lists

If you are selling a business, you should be prepared to share lists of major customers. Buyers may also want to compare your market share to that of your competitors. 

Key Employees

Buyers should be looking for information on key personnel, as well as data on any potential employee turnover. If you are selling a business, it’s important to try to fix any staffing problems that might interfere with a buyer’s ability to properly run the business. 

A key goal of the due diligence process is to find potential problems, such as liabilities and contractual issues. But on the upside, due diligence also includes investigation into assets and benefits. The end result should be that the selling price of the business is justified and both parties walk away satisfied. As stated above, it is very common for problems and issues to pop up during due diligence, so it’s important to stay proactive and be open to negotiation until the deal is finalized.

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Questions to Ask When Negotiating a Deal

Almost every sale of a business involves a high degree of negotiation between buyers and sellers. In this article, we share some of the questions you can ask yourself to prepare for this part of the process. After all, optimal outcomes are typically only achieved through proper negotiation strategies. Keep in mind that one of the key strengths possessed by Business Brokers and M&A Advisors is expertise and skills in negotiating deals. 

Can Both Parties Split the Difference?

If the buyer and seller can’t agree on a number, one negotiating tactic is to have them split the difference. This is a tactic that is simple to understand, and it shows both parties that the other is willing to be flexible. This reveals a good degree of goodwill and can serve to not only keep both parties talking, but also lower any pre-existing tensions. When both parties are still at the table, there is still hope that a deal can be reached. This tactic serves to continue the discussions and can often be highly beneficial.

Can the Buyer and Seller Better Understand One Another?

When it comes to good negotiations, one of the goals is for both parties to seek to understand one another. Sometimes a buyer or seller’s needs don’t even involve the numbers on paper. Instead, they may be seeking to adjust terms to make them more conducive to their overall goals. If you can keep an open mind and seek to better understand what the other party is ultimately looking for, it can go a long way in making the deal happen.

Can You Bring in a Professional?

There is an old saying that says “Never negotiate your own deal.” One of the benefits of bringing in a brokerage professional is that this third party won’t have the same level of emotional investment. This means that he or she can keep a neutral perspective and be more apt to see things from both sides. Sometimes a new perspective can work wonders. Further, a brokerage professional will understand the myriad of complex factors that must be successfully resolved before the deal is finalized. A Business Broker or M&A Advisor will have tips and techniques that can only be gained from years of first hand exposure to making deals happen. 

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Current Insights Regarding the Labor Shortage

BizBuySell’s Insight Report is filled with key statistics and information on a range of topics, including the labor shortage and hiring problems that many businesses currently face. Visit BizBuySell for more information about the findings that they recently reported for the third quarter of 2021. This website also offers an archive of past quarterly reports dating back to 2013. 

The pandemic has “reshuffled the deck,” causing many to reassess their positions in corporate America. At this point in 2021, businesses are recovering, but the pandemic continues to play a role in business operations. 71% of business owners surveyed noted that they are facing higher costs than before the pandemic. Most respondents indicated that labor shortages have been having a significant impact on their businesses. There are issues both in hiring and retaining employees. 

As the report explains, “According to the U.S. Census Bureau, retail spending in September increased 13.9% over the previous year. However, many businesses still struggle to attract or retain employees. In fact, 49% of owners say the labor shortage is impacting their business, while Business Brokers see it as the number one concern facing small businesses.

Some of the problems related to the issue of labor shortage are not immediately obvious. As it has become common knowledge that employers are having trouble filling positions and are having to increase pay in order to attract new employees, existing employees are taking note. Since existing employees realize that new hires are being hired at higher wages, they are themselves often expecting raises. In turn, operational costs are going up for many businesses.

The fact is that the business owners are still selling and for a variety of reasons. BizBuySell’s statistics also indicate that of buyers who are planning to sell, 20% cite retirement as their main reason for selling, whereas 38% cite burnout as the primary reason.

According to the data collected by BizBuySell, transactions are up 17% over the last quarter, but are still 7% below pre-pandemic levels. However, it is expected that the number of transactions will grow to be well above their pre-pandemic levels in 2022.

Buyers and sellers alike should remember that the pandemic has changed business and will continue to do so in the near future. In short, the business landscape continues to evolve. 

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3 Overlooked Areas to Consider When Buying a Business

Without a doubt, there are a multitude of factors that go into buying a business. Since there are so many variables involved, it is easy to potentially neglect some important aspects. In this article, we will explore some of the key areas that can be overlooked when buying a business. Three areas in particular warrant special attention.

#1 Legal Documents

Upon first glance, it might seem obvious that all legal documents should be evaluated; however, many buyers forget that all legal documents are important and should be given weight. In short, there is no such thing as an irrelevant legal document, as one never knows what problems could be lurking within any given legal document. 

For this reason, you’ll want to carefully examine any legal document before making a purchase. The stakes are simply too high to not evaluate everything from trademarks and copyrights to leasing agreements.

#2 W-2 and 1099 Forms

It is important to note whether or not 1099 forms were given out instead of W-2 forms. The reason is that the IRS has very specific rules regarding these forms. The last thing that any buyer of a business wants is to sign on the dotted line only to discover that there are problems with the IRS. Taking ownership of a new business only to learn that there are IRS issues is something that should clearly be avoided.

#3 Retirement Plans

Just as it is vital to look over all financial documents, including W-2 and 1099 forms, the same holds true to evaluating retirement plans. You shouldn’t buy a business unless you know if the business’s qualified and non-qualified retirement plans are completely up to date with the Department of Labor. A failure to properly evaluate a given company’s retirement plans can be a very costly mistake.

Ultimately, there are many potential topics that can be overlooked when buying a business. In this article, we outlined three areas, but in reality, there are many more. This fact underscores the tremendous importance of working closely with a business broker, as well as other trusted professionals, such as lawyers and accountants, in order to properly vet any business that you are considering. One of the key steps in buying any business is to take every possible step to perform due diligence. No business is a flawless enterprise, but a seasoned business broker or M&A advisor can help you to successfully chart a path forward.

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The 5 Must-Do’s When Considering Buying Any Business

There is no doubt that buying a business can be a very exciting idea; however, it is critical that prospective buyers don’t lose track of what is truly important. Let’s explore the five most important steps that any buyer needs to take when evaluating a business. The simple fact is that as a buyer, you have no choice but to look beyond the sizzle and work to find the steak. In other words, it’s essential to determine the true worth of a given business.

#1 – Evaluate What is Actually Being Sold

No buyer should assume that he or she understands everything that is, or is not, being sold when buying a business. One of the most important tasks for any buyer is to carefully evaluate the business under consideration and invest the time to understand what the business does and what is included in the sale. This is a task that your Business Broker or M&A Advisor will perform as well. 

#2 – Understand Business Performance

Understanding the performance of a business can be more complex than it initially appears. On one hand, the numbers don’t lie, and it is possible to quickly evaluate the bottom line. 

However, in the process of evaluating the business, you and your Business Broker or M&A Advisor might discover that there are many flexible factors that could quickly alter how well the business performs. For example, you’ll want to take into account the number of hours the current business owner is working and if key employees are contributing enough to the business. These are just two of a wide variety of factors that could influence overall performance.

#3 – Look at the Financials

Ultimately, there is no replacement for understanding the current financials of a business. Perhaps a business has all the potential in the world, and you can easily see that potential. However, remember that almost all buyers must obtain financing; this means that it is usually critical that the business has strong financials in its current state. Before considering any business, you and your team of professionals will want to carefully evaluate profit and loss statements, tax returns, balance sheets, and other important financial documents.

#4 – Evaluate the Business Plan

Understanding the current owner’s goals and what steps they’ve outlined to achieve those goals is a key step. As a new owner, you’ll want to know that there is a path forward for growing your business, and a business plan is essential for achieving that goal.

#5 – Look at the Demographics

One of the single best ways to grow your business is to understand your customers. For this reason, it is important that you have a clear understanding of the demographics of the business and why customers should remain loyal. If there are challenges on the horizon, such as an expanding competitor or new competitor entering the arena, then you’ll want to know this information as well.

Evaluating a business is not a simple process. Working closely with a brokerage professional who has years of experience in evaluating all types of businesses is essential. This is an excellent first step towards buying the right business for your needs.

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Important Points for Selling to a Family Member

Eventually every business owner will have to turn over control of their business to someone else. There are many options for how this can play out. They range from selling the business to a prospective buyer or selling to a competitor, to turning your business over to a family member. It is key that you start thinking about these options years before you end up in a situation where you actually have to sell. 

Working with a Business Broker or M&A Advisor is one way to determine what sales options are optimal for you based on your specific situation. Let’s explore some of the variables you’ll want to consider when you decide to transfer your business to a family member.

Tax Advantages

There are some significant advantages to transferring your business to a family member. No doubt topping the list of advantages of going this route is the fact that the transfer can be considered a gift. One advantage of this approach is that you’ll reduce your real estate taxes. Depending upon how the agreement is written, you also may be able to maintain some control over the business. For many business owners, this factor can be a big advantage. 

Seller Financing

One issue you’ll want to explore when opting to transfer your business to a family member is seller financing. Seller financing is a common practice when it comes to buying and selling businesses in general. This type of financing is even more common where transfers to relatives are concerned. 

Seller financing opens up the versatile option of implementing a private annuity. A private annuity can serve to spread payments out across a long period of time. This could be a win-win situation for both you and your relative. You would receive a long-term stream of income as a result of ongoing payments. In turn, this decision may very well make ownership more financially realistic for your relative. 

Legal Agreements 

Keep in mind that if you sell your business to a relative, this in no way negates the need for a buy-sell agreement. Even when you are dealing with your most trusted family members, legal agreements must be firmly in place. A buy-sell agreement is an invaluable tool that protects everyone involved. 

This contract clearly outlines all aspects of the arrangement. Your buy-sell agreement should include such key information including the value of the business, amount being paid, information on which employees will be retained, the current business owner’s level of future involvement, and much more.

Working with Professionals

Ultimately, there are a range of potentially powerful benefits associated with transferring a business to a relative. While it is true that you can expect the IRS to closely evaluate the sale, this should not dissuade you from considering this option. Business Brokers and M&A Advisors are experts at buying and selling businesses, and they understand the specifics of transferring a business to relatives. Working with professionals early in the selling process can help you gain tremendous insight into the best way to proceed. 

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How to Circumvent Three Legal Mistakes Sellers Make

After decades of hard work, selling your business can be an exciting and rewarding time. Yet, many business owners overlook the importance of focusing on the legal matters associated with sales. In this article, we’ll explore three of the most significant mistakes sellers make. 

1. Use an NDA

The first critical mistake that business owners should be guarding against is skipping the use of a non-disclosure agreement. Simply stated, a business owner should always make sure that a non-disclosure agreement is in place before disclosing to any buyers that a business is on the market.

NDA’s stand as an invaluable way to restrict who does and does not know your business is for sale. After all, the last thing any business owner looking to sell his or her business wants is for competitors or employees to learn confidential information. 

2. Hire an Attorney

The second critical mistake that many business owners make is they skip working with an attorney. There is no way around the fact that if you are selling a business, or for that matter anything of significant value, you need to work with a lawyer experienced in the area of sales. 

Business owners become accustomed to doing a great many things themselves and learning on the job. There is no doubt that this is a personality trait that has served them well over the years. However, when it comes time to sell your business, there is zero room for “on the job training” or relying on your own instincts. One of the best ways that you as a business owner can protect your future is to work with a lawyer when selling your business. In fact, a Business Broker or M&A Advisor can be a vital resource for helping you to find a proven lawyer with a background in the buying and selling of businesses. 

3. Get a Letter of Intent

A third significant mistake that business owners frequently make when selling their business is that they fail to get a letter of intent. Much like an NDA, a letter of intent is a key legal document in the process of selling a business. All too often business owners will skip requesting a letter of intent out of fear of slowing down the process and potentially disrupting a deal. 

The letter of intent is designed to both clearly spell out expectations, while simultaneously protecting your interests as a business owner. When a buyer signs a letter of intent, it indicates that he or she is taking the process seriously. This will protect you from wasting your time. 

The process of buying or selling a business is complex in many different ways. Whether it is dealing with human psychology, organizing your books, thinking about what information prospective buyers are likely to want to see, or addressing a wide array of legal issues, it is a complex and time-consuming process. Working closely with a Business Broker or M&A Advisor is one of the fastest ways that you can increase your chances of a successful sale.

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