No one knows for certain, but there is general agreement among business brokers that more than half of all businesses with annual sales below $10 million that are offered for sale will not sell.
The principal reason the majority of small and mid-sized businesses on the market do not sell is because they are not properly positioned to sell. The owners of these businesses have failed in one way or more likely, a variety of ways to make their businesses attractive to buyers.
Here are the leading reasons that render a business difficult or impossible to sell:
1. Long-term history of operating losses.
2. Long-term down-trending sales revenue.
3. Long-term down-trending earnings or cash flow.
4.Highly volatile sales revenue, key operating costs and earnings.
5. Skimmed cash.
6. Poor-quality bookkeeping or confusing financial statements.
7. Little time left on the lease of the premises.
8. Problematic lease-assignment clause.
9. Problematic franchise-agreement assignment clause.
10. Business and real property owned within one legal entity.
11. Existence of non-operating assets that the seller expects the buyer to buy.
12. Owner's unrealistic expectation of what the business is worth.
13. Owner's unrealistic expectation of the terms of sale, such as a seller who wants all cash at closing.
The process of positioning a business for sale can take a great deal of time sometimes years if no prior effort has been devoted to this task. Although the ideal time to begin positioning a business for sale is the day you go into business, the next best time to give some consideration to this process is today.
The best way to approach the positioning task is to look at your business from a buyer's perspective. By far, the single most important consideration business buyers make, and the first thing they want to know about a potential acquisition, is the businesses' historical financial performance. Buyers want to see three to five years of consistent profitability, preferably trending up. Approximately flat is acceptable. Buyers will generally pass on companies with down-trending profitability. Buyers also are wary of companies where annual sales, key operating costs and profitability are highly volatile because it becomes more difficult to make reliable estimates of what the company's future performance will be.
Admittedly, to some degree, a company's trend in sales revenue and earnings are attributable to forces beyond the owner's control. These uncontrollable forces notwithstanding, to a significant degree, the reported historical financial performance of small businesses reflect the conscious decision of their owners to intentionally under-report earnings and/or the owners' failure to institute and maintain high-quality bookkeeping and accounting practices.
Small business owners' propensity to intentionally distort the true profitability of their companies is widespread. It is a common practice for business owners to extract income from their companies in the form of a variety of perquisites "owner perks," such as purchasing and charging all cost of operation for a luxury automobile as a cost of doing business. Much travel, entertainment expense and meals are not really a necessary cost of doing business even though they are frequently reported as such. Indeed, the creative ways that business owners find to conceal personal or family economic benefits as necessary costs of doing business, is almost limitless. In retail businesses, it is a practice among some business owners and completely illegal by the way to simply skim cash. That is, owners put the customer's cash payment for merchandise directly into their pocket and never record the sale on the books.
What business owners fail to realize when engaging in these practices is the hidden cost associated with them when it comes time to sell. Think about it. If you conceal and thereby under-report your businesses' earnings by $1 and your combined state and federal income tax is, say, 30 percent of earnings, then you have really only improved your net income by 30 cents that is, the tax you would have paid. The other 70 cents would have been yours in any case. But, almost all businesses sell for a multiple of their cash flow, generally ranging between one and four times either recent historical or expected future annual cash flow. So, assuming for this discussion that the market value of your business is 3 times cash flow, then, by under reporting $1 of cash flow, you have "made" 30 cents but have devalued your company by $3! That's a 10-to-1 tradeoff.
It's true that business buyers will make some reasonable allowances for this type of behavior and pay a price based on "adjusted" financial statements. However, there are limits to how far buyers will travel down this path. Buyers, however, draw the line at skimmed cash. Seldom will a buyer pay a higher price for a business based on the seller's representation of additional sales revenue that was never recorded on the books and not reported on their federal income tax return.
Based on years of experience examining the financial statements of small businesses, it is clear to me that establishing excellent bookkeeping practices is not a high priority for many owners. Unfortunately, poor quality financial reporting is not OK with business buyers. Simply put, excellently prepared financial statements for the last three to three five years make a business much more marketable or stated in opposite terms, poorly prepared financial statements can render even a very profitable business un-saleable.
Toby Tatum, a business appraiser and broker with Alliance Business Appraisals and Alliance Business Transfer Services in Reno, is the author of "Turning Black Ink Into Gold: How To Improve Your Company's Profitability and Market Value Through Excellent Financial Performance Reporting, Analysis And Control." Contact him at 775-847-7481 or through www.tobytatum.net.
