Is that shocking? Many business owners have never considered needing that kind of ramp-up time before closing a sale, and it goes without saying that many businesses have sold in far less time. According to veteran business broker Christopher George, there are lots of compelling reasons why a three-to-five-year time horizon makes the most sense.
Do you have 3-5 years of clean financial records?
When someone is looking at a business for sale, once they get past the basics in the listing and they're ready to start their due diligence, they're going to typically look back at least three years of financial records, some as much as five.
There are several reasons for this:
- An intelligent buyer is going to be looking for a verifiable history of financial success, not just the artificially spruced-up version the current owner has put together over the last few months.
- They're going to want a solid record from which to determine any seasonal trends or outside economic factors that have a significant impact on the business.
- They’ll want to be able to make some educated projections of profit growth, staff requirements and other important considerations, and their projections will usually include the one-, three- and five-year marks.
- Beyond just the buyer's peace of mind and decision-making process, all of these factors will figure heavily in the amount, type and terms of whatever financing they're able to obtain.
So, for the sake of attracting and holding the interest of qualified buyers, it's vital for business owners looking to sell to have squeaky-clean books that go back three to five years.
Don't all businesses keep clean financial records?
The reason it can take up to five years to get the business ready to sell is that the overwhelming majority of small business owners don't keep their financial and business records in anywhere near the condition a prospective buyer wants to rely on.
That's not to say that most business owners are completely neglecting their financial record keeping, or routinely trying to get away with something unethical or illegal. Rather, many of the day-to-day financial decisions that make good business sense for an owner looking to maximize current profits aren't necessarily the best choices for an owner hoping to maximize the salable value of their company.
"A lot of small businesses use accrual bookkeeping," George said, "meaning they handle their accounts as if every transaction is cash. In some cases, that makes no difference. But it also offers the business owner the option to be legally creative with how and when income and expenses are recorded in order to optimize their tax responsibility."
An example of where a business owner may use accrual bookkeeping to their advantage is in the time period surrounding the first of the year. Let's assume the business has done fairly well in the fourth quarter and is heading into the end of December with no outstanding bills. The owner receives a few checks in the mail during the last two weeks of the month that total $250,000 of income that technically arrived during the current tax year. However, since there's no dire need for that money at the moment, she waits until Jan. 3 to deposit those checks, shifting a quarter of a million dollars of income into the next tax year, lowering this year's taxes.
On the expense side, business owners often make the same type of strategic swap when planning big purchases for the following year and using excess cash in December to pay for supplies, inventory or other necessities that would normally have been purchased during the first quarter of the next year. By recording those expenses in December, the owner can maximize their write-offs for the current tax year.
A lot of these little tricks that you use to help in the short term can really skew the true record of your company's financial history. When a buyer is looking over that record, it's not necessarily going to tell the most accurate (or advantageous) story of your company's value.
So what should a business owner do with all that time?
Based on over 40 years of experience appraising businesses for sale and brokering optimal deals for his clients, George offers the following recommendations for how a business owner should handle accounting and business record keeping during the three to five years leading up to a sale:
1. Make sure you're regularly (at least annually) normalizing your inventory.
Any "stock on the shelves" is going to be a significant portion of the company's value at closing, and buyers will want to know exactly how that stock has moved in the past. Clean up the books to remove any sort of perk expenses that artificially deflate the income or inflate the expenses that are actually attributable to the company.
2. Maintain accurate and verifiable accounting records based on actual dates of receipt and/or payment.
Any tax benefits or other perks that come with creative accrual bookkeeping pale in comparison to the higher value your buyer perceives when reviewing clean books. Above all things, be ethical and honest. Not only is it the smartest long-term plan for business success, but tricks or outright lies stick out like a sore thumb when reviewed by a trained accountant or business broker. Your buyer will likely have both reviewing everything in detail before the sale, so don't shoot yourself in the foot.
It's important to stress that businesses go up for sale for many different reasons, and a lot of business owners simply don't have the luxury to plan their sale three to five years in advance. If you need to sell your business soon, don't hesitate to contact a business broker and let them help you achieve the best business valuation method for you.
But if you do have the luxury of time, take full advantage of it to make sure your business sells for every penny it's worth.