Updated: Jul 15, 2020
By Tsu-Li Liew
Whether business owners are already planning on selling their business or whether COVID-19 played a role, below are some valuable tips that any business owner should know when preparing his or her business for sale, highlighting how the pandemic could affect everyone’s expectations.
Tip #1 – Identify Potential Buyers
Any plan to sell a business should start with finding a prospective buyer. A business owner should also find a few potential back-ups, in case a deal with the first buyer falls through. The process of finding potential buyers should start as early as possible, even before preparations to sell begin. According to Forbes, it is important to know what these potential buyers want when they buy a business. These reasons can range from the desire to grow their own business, to expand their market, to reinvent their business or as a response to a disruption. Therefore, even during a pandemic where many businesses have been closed, people might be looking to buy up other businesses in order to respond to their own businesses’ needs. That being said, it is also important that a business owner take their time to carefully consider each opportunity instead of hastily making a bad deal.
To find these potential buyers, a business owner can look at their own community as well as interested outsiders. Buyers can be and are not limited to business partners, key employees, family members, venture capitalists and strategic investors. Business partners may include people, with whom the business owner had previously worked on other business ventures, or with whom they are currently working. In addition, a business owner’s own network might be able to refer to some interested parties. However, selling a business is not as quick and easy as selling a car or some furniture. It is important that no matter where the seller and buyer meet, they should cultivate a trusting relationship before a sale goes forward.
A business owner should also consider how these potential buyers will pay for the business, whether by cash or loans. According to the NFIB, a majority of small business sale transactions are paid using third party loans backed by the Small Business Administration (“SBA”). Sometimes, banks will also want the business owner to provide a loan for the transaction. This is to ensure that he or she will have a stake in the new business under its new owner. Therefore, it is important that a business owner finds a buyer who understands the nature of the business and can connect with the customers. By doing this, a business owner ensures that their former business will not go under once it changes hands and will continue being successful.
Tip #2 – Appraise the Value of Your Business
The SBA recommends setting a specific price when marketing a business to prospective buyers by either doing a self-evaluation or finding a qualified business appraiser (more information here). By doing this, a business owner can weed out the people who were not serious about buying and attract buyers who can afford the price. However, depending on the difficulty and the details of the appraisal, the average cost of hiring an appraiser can range from $3,000 to $35,000, according to Inc. Depending on the nature of a business, an owner might opt for a self-evaluation instead.
A business owner should appraise all assets of the business, such as real estate, intellectual property, brand presence, customer information and future revenue projections. There are three different ways a business owner can figure out how much his or her business is worth: 1) income approach, 2) market approach, and 3) asset approach.
For an income approach valuation, a business owner should subtract the value of any potential risks from the projected revenue of the business. A business’ projected revenue is what the owner would have expected to earn in a year. On the other hand, risks could include many different factors, such as changes in the law, employees leaving, or damage to inventory. This is the most commonly used method to appraise commercial real estate. However, during COVID-19, this method might not accurately reflect a business’ value since the business’ revenue might be significantly different from what was projected. Even so, business owners should still not just ignore the impact of COVID-19 on their business.
For a market approach valuation, a business owner should look at what similar businesses have recently sold for. Since COVID-19 disruptions started in March 2020, a business owner could consider what similar businesses have sold for before the stay-at-home orders. However, it is important to remember that those numbers might not accurately reflect the value of a business once stay-at-home orders are lifted.
Lastly, for an asset approach valuation, a business owner should subtract total liabilities from the total value of the business’ assets to get the value. A business’ assets can include things that belong to the business, such as property or inventory. Liabilities are usually what a business owner owes to another party, such as wages or loans. Again, a business owner should consider how COVID-19 has changed certain numbers. For example, liabilities might be different since COVID-19’s impact, such as reduced work hours for employees or unpaid bills from customers.
Since COVID-19 impacted many businesses across the country, business owners should take into account how this pandemic has and will change the value of their businesses. Depending on the industry or type of business, these values could have increased, but they could have also decreased, especially if a business was considered non-essential. Either way, a business owner should be realistic about the changes in the value when asking for a specific price to prospective buyers.
Tip #3 – Take a Step Back
Sometimes, small businesses develop a lot of their value from their owners, since they are the ones who have built it from the ground up or continued to build off an existing business. Therefore, when the business owner sells the business, it might lose some of its value if the owner is actively involved. An owner should try to remove himself or herself from key aspects of the business before selling it. The Washington Post names these steps an owner should take to scale back his or her role: 1) Develop new key employees within the business, 2) create a system for critical operations to eliminate customer service issues, 3) develop operation manuals and employee handbooks, and 4) create teams within the business to limit the need for an owner’s input.
Training employees to become the new key personnel will make it easier for an owner to depart from his or her business without decreasing its value. Essentially, the business owner is passing his or her value to these key employees. Therefore, these employees should take on some of the owner’s roles of managing the business. This allows the business to continue running smoothly, even when the owner eventually sells the business. It is important to remember that once the owner leaves, the key employees should stay with the business since they have been trained to take over some of the owner’s roles and will be valuable to the new owner.
Similar to the step above, creating a system for critical operations will help the business continue to run smoothly when the owner departs. What is considered critical will differ from business to business. Critical operations are the core of any business and will differ from business to business. For example, restaurant businesses rely on fresh food to be delivered before opening and their employees to cook the food and serve the guests. It is important to have a procedure to prevent any interruptions of such operations. If a critical operation is not working as it should, it could create a domino-effect that could cause the entire business to fail. That is why the owner should pass along any knowledge to his or her employees on how to manage critical operations and avoid a crisis.
Creating operation manuals and employee handbooks tie together with the previous two steps. Not only is it important to train employees on how handle the business’ day-to-day operations with less oversight, but it is also important that these steps are well-documented. A manual will help the new business owner and new employees learn about how the business runs.
The last step will mostly depend on the number of employees a business has. When there are more employees, it might be better for a business owner to slowly create small teams that will rely on each other for answers, rather than the owner. Doing this will let the owner take a step back from his or her role as the head of the business, but let the employees work with the key employees instead when a problem arises. Of course, a business owner should still have some oversight when it comes to important matters. However, the less involved a business owner is, the easier it will be to sell the business.
Tip #4 – Keep Good Records
This tip is not exclusive to the sale of a business, but it also applies at any stage of managing a business. The SBA and the IRS recommend keeping good records because it will be easier to sell a business if the records are easy to find and do not have any significant gaps. While a good business owner might hire an accountant to organize and maintain records, it is not required by law. A business owner should keep any documents that relate to the financials of the business as well as employment records and any assets. The IRS has more information on which records to keep here, while the SBA has a guide on how to properly keep records here.
It is never too early for a business owner to start keeping his or her records in an organized way. However, even if the business owner has not done so since the start of the business, going forward, he or she should ensure that the financial records are well-kept and easy to find. After all, if the owner is transparent about the business’ financials and other records, any prospective buyer will not have to worry about any surprises that might appear, and therefore might be more willing to prepare a deal.
Even if the business is interrupted during this pandemic due to the state’s stay-at-home orders, it is important that the business owner continues to keep good records of any changes in the business, whether there were lost sales, layoffs, and other types of interruptions of the business. These records will show a buyer what the management of the business looked like during the pandemic. After all, depending on the nature of the business, an owner might have found ways to continue operating, whether through online stores, delivery or other methods. Therefore, even if the owner managed to find another method to keep the business going, these changes should still be documented.
While there is a lot of uncertainty going on during this time, business owners can start following these four tips to make preparations for selling their business. Since people are waiting to see how the pandemic will impact the small business industry, owners can start preparing now so that they can be one of the firsts to sell when the economy starts growing again.
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