Exit with Style, Grace, and More Money Chapter Two - It's Not Just Your Numbers

There's a lot more to a business and its value than the numbers. There are the:

• Customers
• Employees
• Suppliers
• Technology
• The facility and lease

And a big one is - what does the owner do that's below their pay grade. Things like bookkeeping, make deliveries, making routine sales calls, and more

You can get the complete audio book on Audible/Amazon or on Apple Books.

John Martinka
Jessica Martinka

Contact us via either website or give us a call and be sure to check out our blog pages with new posts weekly.

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Chapter 2. It's not just your numbers. What you're going to hear in the next two chapters and beyond is really an exercise in due diligence. It's something we do with clients, so we get an understanding of the business and can answer 80% of a buyer's questions. Have mock due diligence done for you. Don't do it yourself. You're biased. Look at it as practice for what you'll go through with the buyer. When someone decides to sell their house, what do they do first? They paint it, clean it up, get rid of clutter, fix everything, and make it as appealing as possible. Then they put up a sign, open the doors, and invite the world to come in and take a look. The more, the merrier. Yet too few sellers properly prepare their businesses for sale, which is why we wrote, if they can sell pet rocks, why can't you sell your business for what you want? Sometimes, a business also needs cleaning and painting. Often, the accounting needs work, the growth needs to be proven, and some dependencies removed. Action Plan to Sell a Business. I'm not sure when we created our action plan to sell a business, but we've had it a long time. To maximize price and streamline the selling process, follow this plan. You will set yourself apart from other sellers. Action stands for arrange all the company's affairs. Coach and counsel the company. Ensuring your people know how to best use the firm's processes and systems. Transmit and teach all the good things about your firm. Those things are intricacies that make your company special. Operations and management systems already in place for a smooth transition. Numbers. Ensure all financials are understandable and straightforward with no tricks. This chapter looks at starting to arrange the company's affairs. It is not meant to be a step-by-step guide to business improvement. Think of this chapter as a checklist with descriptions of the primary things you need to illustrate your business's maximum value before selling. A basic tip No matter what type of business you have, from a professional office setting to a factory, take time to make it look good. This may mean a paint job, cleaning or replacing the flooring, spiffing up the outside, etc. I visited a fabrication business and wondered why the employees were eating lunch in their cars. It was because the lunchroom was as filthy as the factory. Contrast that with the machine shop we went to in Bend, Oregon, where the factory floor looked like you could eat off it. Don't forget to think about where the buyer adds value. This is one of the most important questions buyers and sellers must answer. It's actually the key to buyers pursuing businesses. If they don't see how they can add value, they won't get excited. Sellers can help here by not just selling their company's attributes, but by probing buyers to understand their skills and pointing out matches within the business. When buyers feel they can duplicate and build on what the sellers are doing, they'll be more interested in the business. When they understand they can add value, they'll get excited. I like to use the analogy of a server rack. Some slots on the rack have servers, and others are empty. If the buyer and seller fill the same slots, it's good. If the buyer fills the existing slots and some of the empty ones, it's great, and builds their desire to own the business. Here's a short list of some empty slots buyers seek. Most companies do many of these things correctly, but you only need one to get a buyer excited. Adding marketing skills to the seller's duties. In many companies, the day-to-day marketing duties are minimal and often handled by lower-level employees. Many individual buyers have growth-oriented backgrounds, understand marketing, and usually understand newer marketing tactics, online marketing, social media, etc., better than the exiting owners. Private equity buyers definitely have these skills. Creating efficiencies. For example, one buyer changed their website from a brochure to an ordering system, eliminating the need to play phone tag with customers and improving employee productivity. Revenue doubled in the two years after creating these efficiencies, which were seen as the main reason for the growth. Improving processes, especially in operations. Many good process people are out there. They often make great owners, and I've seen many implement tweaks that increased profits considerably. Providing sales, management, and culture strategies. This task may include reducing hierarchy and creating a proactive culture among workers. Being there. This is a common need as many owners get comfortable and just coasts. Buyers add energy, which most employees like. This chapter and the next will outline how to prepare your business for a sale so you don't end up like George, whose story I tell in the opening of our Pet Rox book. It started like this. Nobody is going to buy your business is a statement that can deflate an owner just as sure as a pin to a balloon will send it spinning around the room. Here's the short version of the story. When business was good, George spent his time playing with his horses until business wasn't good. By the time I met him, the balance sheet was underwater, and income was negligible. He didn't have consistent revenue. We implemented a new system around July 4, and by the end of the year, the company was 33% ahead of budget. They hadn't made budget for at least two years. Within a year, George had turned down an offer because his business was now fun. Five years later, the same buyer came back, offering a lot more. Bottom line, be in a business so you'll attract A buyers. The first things buyers and banks will look at are the financial statements because they document the business's story and history. But the numbers reflect the business's actions and policies, which is why we're starting with the top non-financial factors that will allow you to have a large exit for your small business. Before we get into the details, look at Appendix G. It's our initial disclosure form, which we use for our initial analysis of a client's business, or if we're helping a company buy another business. We start with this form to uncover any issues. Use it to ensure you're covered when asked about these subjects. Ownership structure. Let's start with the business's structure. Often, the cleanest way to do a transaction is to have an LLC or an S Corp, or an LLC with an X-corp tax structure. You may have reasons for being a C Corp, and for now, let's assume you don't want the hassle of being a C Corp when it comes time to sell. The main reason is to avoid double taxation, which can happen when you do what's called an asset sale, not a stock sale. More on this in later chapters. A stock sale will scare many buyers because they are buying the company's history and all the potential spooks and goblins that go with it. A CPA friend says start the process six years out to make sure you can handle changes like this. It takes five years to fully become an S-Corp, plus the time to set it up. Too often, I have heard from owners that their CPA or attorney told them to switch, but they never got around to it. If your advisors are encouraging a change, ask why. And, if satisfied, just do it. Reasons for remaining a C Corp exist, a large amount of retained earnings being one. So check into all aspects of the change before taking action. Another factor is the number of shareholders. Having multiple shareholders, especially if some are inactive in the business, may also require some planning. If you're the size where the buyer will use a small business administration, SBA loan, the shares you gave a key employee way back when may cause complications. Current SBA rules say a seller cannot stay on for more than one year. We worked on one deal where, right before closing, the seller had to buy back shares from 19 employees to whom he had given stock, all just a few shares. On another deal, nine family members were shareholders, and they didn't all get along. There were two groups, those active in the business and those inactive. The active group wanted out sooner, not later, but they didn't have a supermajority, 67%, to do it on their own. The inactive group was difficult and did all they could to delay the transaction, creating excess legal bills on both sides. If you have minority shareholders, get an agreement in place about what their shares are worth. I got involved in a negotiation between a founder and their main investor. The founder was down to 20% ownership and wanted to be bought out for 20% of the company's value. The investor wanted to apply what's known as a minority shares discount because minority shareholders don't have many rights other than, usually, timely financial statements and board meeting minutes. My best advice is to start dealing with ownership issues early, very early. If you're the 100% owner of an S-Corp or LLC, you've saved yourself a lot of potential hassle and cost. Know what you're selling. The buyer wanted to talk to the management team before closing on the deal. The seller didn't want him to and made every possible objection. At a meeting, the buyer looked the seller in the eye and said, You may think I'm buying your business. I'm really buying your people. He met the employees, and all went well. This applies to all industries. It's always about the people. One fear common to buyers, sellers, and employees is whether the employees will keep their jobs. Yet all parties want the employees to stay with the firm and are fearful one of the others will kick out their stool leg. Recently, an owner said, I'll only sell to someone who will treat my employees well. He said this after mentioning a competitor who sold to a large corporation and their people just disappeared. A good buyer will want to see an organizational chart and job descriptions. And don't forget cross-training. Your value decreases if one person is so important that if they were hit by a bus, the business would suffer in the short and long term. The most important part of this topic is your management team. The more sophisticated your buyer, the more they'll want to know about management and their roles. Tied to this is how you use your team, or should I say, how you let them run with their responsibilities, which is delegation. Delegating is something many founders and owners struggle with. It's tough because when you know something so well, you just want to do it. But it's important not to do too many things below your pay grade, because engaged, independent workers build value. Delegating also means being a safety net as you let your team stumble a bit and learn from experience. What do owners do below their pay grade? Bookkeeping. Enough said, Bookkeepers are plentiful and inexpensive. Make deliveries. Unless it's to reinforce their relationship with an important customer, delegate deliveries. HR HR experts are plentiful and available to handle the minutiae and regulations. These rules and regulations are traps for the novice, like reception also doing HR. Bidding or reviewing all bids. The goal should be to have enough qualified people doing bids, so the owner is not needed and trusts their people, and the jobs are profitable. Routine sales calls. The owner's role should be to add value and ensure the customer knows how important their relationship is, not to be on the road. Programming the machines. Don't be like Kurt, who continued to do all the programming of the machines to run jobs. His answer to the question, why don't you train others to do it? was always, I can do it in 15 to 20 minutes, and it will take me an hour or two to show them how. Of course, he burned that hour or two multiple times a week. Running the machines. Some of the best owners don't know how to run their machines. Designing products, being the only creative slash artistic person. It may be fun, it may be the owner's skill set, but it should evolve into becoming a design consultant, not the actual designer. On the flip side, here are things owners should strive to do most of the time. Strategy This means asking, where are we going and how do we get there? Vision This means keeping an eye on the industry, customer issues, the economy, etc. Enthusiasm One of the most important things an owner can do is to keep the employees happy, motivated, and productive. Growth A flat or stable business is a stagnant business. An owner should always be focused on growth strategies. Acquisitions A savvy owner will always be on the lookout for companies to bolt onto to gain new customers and employees, a new location, or any of the other 19 reasons to grow by acquisition discussed in Appendix I. Process improvement. I've noticed many buyers work on improving processes, i.e. efficiencies in the operations. If you can do so or hire someone to do so, do it. Managing the numbers, management reports, KPIs, etc. You don't have to be a CFO or controller to do so, but it's important to understand the key metrics for your business. It's more than the financial statements. Your CFO or controller, not a bookkeeper, should provide you with good management reports so you can see what's behind the numbers on the statements. Use them. Leadership. Many of the items above involve leadership. It's a lot different than management. Be a leader. I realize the owner must do many of the tasks on the first list until the business grows big enough to delegate those tasks. Yet, to get a higher price and provide the buyer with maximum value and a better growth platform, your objective should be to move toward doing the items on the second list and delegate the rest. I was taught that delegating has three components. 1. You and your management team must be willing to delegate. This is often the toughest element. It can be hard to let go, to let people stumble and bruise themselves, and maybe hurt the company a little. But if you don't let them stumble and learn on small things, what happens when they are forced to deal with big issues? 2. Your employees at all levels must be willing to accept delegation. Some people just don't want responsibility. They are easy to sort out. You want to nurture and train the people who want to grow, advance, and contribute. They will rise to the top, volunteer to take on projects, and be willing to learn. 3. The culture of delegation must be acceptable. Pick any business publication, and chances are you will find an article on improving workplace culture, good vs bad managers, or similar topics. You may be willing to delegate, and most employees may be willing to accept delegation, but others may not accept delegating to coworkers and may actually sabotage it. Perhaps they are jealous they weren't delegated to or promoted. In any event, if you can make delegation acceptable, it will impress your buyers, who all want to grow and use your team to do so. He knew how to do it right. Tom did not try to wear all the hats in his business himself. He was a sales guy, and he knew he had to let his management team handle the operations, production, and administration in his eighty plus people company. His six-person management team worked well together. They knew their roles, and their employees loved them. I know firsthand because after I worked with his firm, I had them do some work for me. What a difference it makes when employees at all levels are empowered and respected. Your employees create and become your culture. Culture is a tough thing to communicate to others. It can be shown by the following, which is not close to being an all-inclusive list. Employee feedback mechanisms, how mistakes are handled, how exceptional performance is rewarded, voluntary turnover rate, exit interviews, productivity measures, transparency, regular feedback to employees and interaction with them. Why didn't he treat them better? The company's new owner, Mark, suspected the answer to his question before he asked it to him. Asking the question spelled opportunity, and after closing on his acquisition, he confirmed it by giving the management team a short survey to a person. They all answered the question What is the company's biggest weakness? With a version of this actual answer, the biggest weakness just walked out the door. Employees will be nice when meeting a buyer, but at the same time, it's tough to disguise culture problems. Mark had sensed that the seller, an industry veteran who had worked his way up from the shop floor to owning a business, had a my way or the highway attitude that was stifling the company. He was right. The management team was extremely capable and welcomed the chance to contribute. A very important issue that's grown since the COVID pandemic is employee compensation. Be sure you're paying people at a competitive rate. If not, a buyer will wonder if you have the best possible employees, how productive they really are, and whether they will leave for more money. With so much transparency on websites like Indeed, Glassdoor, and others, it's easy to figure out going rates. One final word on employees. Make sure you're not disguising employees as contractors, which is often done to avoid paying the employer's share of payroll taxes. Plus, the IRS knows contract employees often don't report all their income. State governments want their labor and industries and unemployment taxes. They put out checklists and worksheets to help determine whether someone should be an employee or a contract employee. Believe me, they are not kind and gentle to employers who violate these rules. The IRS wants you. The owner had a specialty service business. He hired dozens of workers as 1099 contractors. Then the state audited the business and levied a fine because they felt the workers were employees, told where to work, when to work, what to do, etc. He still maintained who could pay them as contractors. If he had the burden of FICA, Medicare, L and I, and unemployment, it would eat up half his profit. I'm guessing he got jobs based on price. Recently, we were referred to an owner who paid everyone as contractors. Some seemed legitimately classified. They were professionals, had their own businesses, got work from other sources, etc. But paying your administrative staff as contractors probably won't fly if you're audited. Be careful in this area. It can be a huge trap. Owner dependency is a huge issue. While we covered delegation above, it's worth talking about some more. Whatever you do, don't be an owner who is the answer to the question. Who is the only person who can do blank? Don't be a bottleneck. Don't think you have to be a part of everything. Let others do their jobs. This is a major issue in too many companies, not just very small ones, and it will affect price and deal structure if your contribution remains key to the business's success. Don't get in your company's way. We did five projects for a company. The second one was figuring out why their profits were so Low. We conducted multiple sessions with employees, always telling them their responses were confidential, but we had to report what they said without revealing the source, and an off-site session with the management team. Employees and management alike said the owner was the bottleneck because everything had to cross his desk. And he was slow. We worked with him on delegation, and after one year, profits quintupled. A final word on employees. I don't know your personal or financial situation, but if you can do it, consider retention bonuses for your key people when you sell. As one client said about his employees, they're the ones who built the company with me. He announced 15% of the sales price would go to employees using a formula based on salary, title, and tenure. It's being paid at the end of years 1, 2, and 3, not at closing. A client we're working with now is discussing a retention plan for their key people with the buyer. Again, the benefits will be distributed over time to ensure they stay post-close. Other key factors. Human resources. HR is a necessary evil in today's world because there are so many rules and regulations regarding employees, their rights, how you treat them, etc. It can be an overwhelming subject if you're not dealing with it all the time. It's the same for payroll, given how many taxes and fees have entered the system, especially here in Washington, which seems to pride itself on being California light when it comes to rules. There's way too much to cover in this short overview, so I'll make some recommendations. If you don't have a full-time HR professional, get an outsourced, fractional HR service. Get an HR audit to make sure you're in compliance. Consider using a third-party payroll service so you don't get tripped up by the payroll minutiae. And be careful with exempt from overtime pay versus non-exempt hourly employees. Salary thresholds dictate when someone can be classified as exempt and not get overtime. The limits are $844 per week as of July 1st, 2024, and $1,128 per week on January 1st, 2025, although there are lawsuits challenging this. There is also a highly compensated category. It has a threshold of $107,432 in 2024, going up to $151,164 in 2025, plus duty requirements, like directly managing two or more people. Check this with your HR expert because you don't want to find out you owe a low-level manager overtime because their salary is under the threshold. Your sales and growth plan. All buyers want to grow the business they buy. No matter what your marketing and sales plans are, be ready to show them to buyers and discuss why you do things the way you do. Given how all businesses are different, we can't go into detail, but don't hesitate to get a sales professional in to help you if you need it. Suppliers. Earlier in this chapter, we talked about a banker doing due diligence on a dominant supplier. It's an issue. I once worked with a sales organization that had one major product line. As their supplier grew, they felt they had outgrown my client's company, so they dropped him and went with a larger firm. Lesson learned, right? Nope. Five to seven years later, my client called because the same thing happened with his latest dominant supplier. We've all experienced supply chain issues. Some are ongoing, others in isolated situations. Part of supply chain management is having choices. Don't get caught with limited suppliers because buyers will note that. And make sure you have good terms with your vendors. There's a story in chapter 6 about a deal that almost collapsed because the buyer assumed, didn't ask, the seller paid vendors in 30 to 60 days. The seller did everything cash on delivery. Know when to be quiet. Be careful what you say to suppliers when selling and when you say it. An owner told me he told a supplier he was thinking about selling. The vendor changed his payment terms to cash on delivery. When I told a group of accountants about this, a woman in the back squirmed in her seat with her hand in the air. I thought I'd missed the time for the break. She wanted to tell me her firm sold through distributors, and if they knew one was selling, their policy was also to switch them to COD. Your space. Although often overlooked until late in the process, the lease can be a critical consideration. If you rent rather than own the property where you do business, realize a bank may not give your buyer a loan for a term any longer than the buyer's lease, including fixed options. A couple of exceptions exist for office-based businesses like accounting or consulting. It's expensive to move, and the bank and buyer don't want the business uprooted in the middle of the loan. A landlord's willingness to assign the lease or give a buyer a new lease at a fair rate is also important. Supply and demand for the type of space your company needs is one of the biggest factors in determining if you'll be given a new lease. If supply is tight, a landlord can play tough. If supply exceeds demand, the landlord will do everything possible to keep the business as a tenant. A cheap lease now, expensive in the future. The shareholder agreement dictated that if one of the equal owners of a food manufacturing business wanted out, the other had to purchase their shares, using a prescribed process. During the valuation process, we discovered the owners had no lease, and the landlord was elderly and quite ill. He wanted to replace all the small tenants in the building and find one big tenant. The cost of a forced move with 30 days notice was equal to one year's profit. The value of the company declined by 30%, lowering the price the buyer owner paid. The buyer owner started planning to move the day after closing, which allowed him to make an orderly, planned move at a reasonable cost. Financially, he was way ahead. Emotionally, he was even further ahead as he didn't have the worry about getting a 30-day notice to move. Any smart buyer, whether getting a bank loan or not, will want lease protection. Technology and Cybersecurity. Today, all businesses use technology. Let's step back and ensure you can answer the question How does your business benefit from the technology you've invested in? A lot of tech savvy buyers are out there looking for legacy businesses where they can improve productivity through technology and systems. Of course, you might not get as high a price if this is the situation, but as far as technology goes, three areas need to be kept current hardware, software, and the internet. Hardware is the most obvious. You must have up-to-date hardware, no ancient servers or dying computers. Software is often in the background, but it can be your place to shine. Make sure you know what you use and that it's all up to date and legal. If you have proprietary software, a buyer may want to know the costs to keep it current and increase its productivity. Ensure you can explain why you chose your particular software. A website is a necessity for almost all businesses. A few don't need or want one, but they are the exceptions. Buyers will want to know where your website is hosted, who maintains your website, what it costs, what domain names you have registered, where they are registered, and when any registrations expire. Be sure your website is mobile friendly. If it's not, you will drop in search rankings. ADA compliant has an easy ordering system if you sell or take orders on your website. Security issues are at the top of the list on technology due diligence, especially if you deal with secure information. Ensure you can explain your security protocols, protection software and firewalls, off-site access, and anything else that could be an issue. Why weren't they more careful? The business held sensitive information and had a breach when their managed service provider was hacked and the MSP's customer login information was taken. The business was hacked, and this lack of protection, like a good firewall, led to a ransomware attack. It cost the owner $500,000 in legal fees, fines, and costs to reclaim the information. Worse, it disrupted a sale to a larger firm willing to pay more than a fair price. The bottom line is, if you can show a buyer your systems are up to date, adequate for growth, and your people know how to use them productively. Technology is one item you can check off the due diligence list. Customers Customers are the lifeblood of every business. No customers, no business. The first question about customers is always about any concentration issues. Customer concentration measures how a business's revenue is distributed across customers. At www.markinblog.com, it says it's seven times more expensive to sell to a new customer than to an existing one, which is consistent with what we've seen over the years. A common question is, do any customers account for more than 10% of your annual sales? If so, it requires a deeper dive into why. Some experienced buyers told me they assume a small business will have a dominant customer, but to see that customer generating 20% or more of the company's revenue is worrisome. Then they ask if it's the same top customer every year. When it's too easy. As I write this, we have a client on hold. 62% of their revenue came from one customer. The owners finally realized, after hearing from us and others, that it was a serious issue. They concentrated on diversifying their customer base, and after eight months, the primary customer was down to 25% of overall revenue. When they get it between 10 and 20%, we can go to market. The loss in sale price with a dominant customer like this is significant. Buyers should also want to know how long customers have worked with you, what their pricing and margin models are, and what top customers think of you. The first two items are data driven. The last is more intangible and usually discovered by talking to your customers, which isn't as scary as it sounds. For smaller deals, say an individual buyer, the buyer or an advisor will probably do a reference check kind of call. I'm thinking of doing business with XYZ company. What can you tell me? If your buyer is a private equity firm, don't be surprised if they hire a due diligence research firm to handle it. One study discussed with customers the importance of your management team, account team, ease of doing business, products, brand, price, customer service. The study showed that the company's view of why customers buy is usually vastly different than the top reasons the customers give. Don't be surprised when the price is not as important as you think. Your people are often the main reason customers stay with you. Again, this chapter is not a how to improve chapter, but more a checklist of important things to handle pre-sale. Conclusion It's more than the numbers. People are the most important part of your business. Don't do little things to save a dollar when it may cost you hundreds. Customers are your lifeblood, and buyers will investigate them. Technology can be a Pandora's box of trouble if you don't watch it closely. All the little things matter, the lease, HR, etc. Avoid dependencies, especially if you're the dependent. Growth hides a lot of operational warts, so always be growing. Non financial factors are the key to your business, its future, its attractiveness to buyers, and the price you get.