Uncategorized

The most important document you need when selling your business

Avoid overly optimistic projections and unclear company storyline

The Denver Post |  BUSINESS

Gary Miller, staff photo

By GARY MILLER | GEM Strategy Management

POSTED November 19, 2017, at 12:01 am

It was late on a Saturday afternoon when Don and his management team were finishing up an internal review of their company operations. The company had been on the market for 18 months without much interest from potential buyers. Don wanted to know why. At the end of the day, Don, the founder,  and majority shareholder,  gave up as he and the management team could not reach consensus on the reasons there was such little buyer interest. Don was beside himself since revenues were strong and earnings had continued to improve over the past five years.

The following week Don asked our firm for help. We agreed to conduct a business review and analysis of his company to determine what the company needed to do to attract potential buyers. After an exhaustive review, we found a glaring void in his management systems. There was no strategic business plan — only a hodge-podge of numbers, schedules, and projections that made little sense.

We met with Don and his team (all shareholders) and explained that without a solid business plan, no potential buyer would seriously entertain purchasing their company. We advised that a formal business plan was critical to the process of selling Don’s company.

Writing a strategic business plan can take weeks, even months of intense research, writing and rewriting – particularly if you have never gone through the process before. So you might ask, is it worth it? Absolutely. First, you’ll have a better understanding of your own business as well as your industry. More important, you’ll have a set of clearly articulated goals. This will help you organize and manage your business and give you a benchmark against which you can measure future performance.

Before you can begin to put the plan together, you will need to gather solid information about your industry. Every claim your plan makes will have to be supported by authentic sources and accurate information. Information sources include trade associations, magazines, newsletters, industry research reports and annual reports from publicly traded competitors.

Your plan will include your company’s past financial records, including a quality of earnings report from an outside accounting firm. Your financials should be audited or at the very least, reviewed by an independent accounting firm. Also, your business plan should include marketing plans and statistics from competitors so you can compare your numbers to firms of similar size in your industry. You will need research to identify who is buying products or services like yours and what current trends might be changing buying patterns and behavior. Compare this information to who is buying your own products and services.

In addition, find out who finances companies like yours and the details of the loan structure. Also, identify the kinds of companies buying businesses like yours.

Passion and enthusiasm for your company’s storyline is important for the sale of your company, but your target audience will see through hype and sales speak. Instead, strive for clarity, simplicity,  and thoroughness. Here are guidelines you should follow:

  • Don’t exaggerate
  • Make your sentences short and factual
  • Guide the reader with bulleted lists, numbered sections and clearly named subject headings and subheadings
  • Do not clutter the text with small details that will slow the reading process. Refer the reader to the appendix for more detail
  • Provide a table of contents so readers can skip to relevant sections they are interested in
  • Keep the plan to about 20 to 40 single-spaced pages, plus the appendices. The appendices can be as long as necessary to include significant detail

After you’ve completed this work, you can begin filling in the various outlined sections of your plan. Regardless of your industry, at a bare minimum, your plan should include a table of contents, executive summary, company/product/services analysis, competitive analysis, investment/purchase opportunity, industry analysis, market analysis, marketing plan, operating plan, manufacturing plan, management team, human resource plan, integration plan guidelines, financial plan and projections, buyer’s exit plan and appendices. More may be required depending on your industry.

I have read scores of business plans of companies and I’ve found the same mistakes over and over again. Here are some mistakes to avoid:

  • Rose-colored glasses
  • Unsubstantiated claims
  • Overly optimistic projections
  • Unrealistic cash flow projections
  • Numbers that don’t add up
  • Not understanding the entirety of the plan
  • Not proofreading the plan
  • Unclear company storyline

After all the work you’ve invested, make sure you don’t shoot yourself in the foot with spelling errors or incorrect grammar. Double check the numbers again and again. Produce a professional-looking document.

Remember, you never get a second chance to make a good first impression.

Gary Miller is CEO of GEM Strategy Management Inc., which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies.  970.390.4441     gmiller@gemstrategymanagement.com

 

 

 

To maximize the sale of your company, build business value

The Denver Post | BUSINESS

Gary Miller, staff photo

By GARY MILLER | GEM Strategy Management

October 15, 2017, at 12:01 am

It can take two to three years to prepare a business for sale

Imagine sitting at your desk and reading a registered letter from a potential buyer. The letter states that the buyer is retracting its offer to purchase your company as a result of the due-diligence review and analysis the buyer just completed.

This happened to Nathan White, owner of a small uniform manufacturer serving clients throughout the U.S. This was the second time in two years that a potential buyer had withdrawn its offer. Nathan was discouraged.

Nathan called me to see what he could do to sell his company. His story was one I have heard many times before. Nathan’s company suffered from poor exit planning, a checkered record of revenues and profits, a weak strategic business plan, inaccurate books and records, and the loss of two major clients. As a result, the potential buyer believed that the business was overpriced relative to its business value, therefore, the buyer could not justify completing the transaction.

For many owners, the last 10 years have been a difficult period for growth and profitability. Other companies, however, have done extremely well. What is the difference?

Owners do not plan early enough to sell their businesses. Since many owners have never sold a business before, they fail to realize that it takes time and careful planning to optimize the business value in order to maximize the sale price. As a result, they try to sell their businesses before they have maximized the enterprise value of their companies. This situation leads to a lower purchase price from a buyer, or worse, no sale at all.

The process of selling a business has become more complex as buyers today are more cautious and much more rigorous in their due diligence efforts due to the Great Recession.

Regardless of your personal goals, there are some key issues every business owner must address in order to be ready for a business transaction. The business landscape changes every three to five years, and your company’s exit plan needs to keep pace.

The key to increasing business value is to understand how a potential buyer views your business. Here’s what I recommend to my clients: First, obtain an independent professional valuation from an accredited valuation firm. Next, engage an objective business adviser to conduct a business audit and assessment revealing the strengths and weaknesses of the business.

The adviser can help you pinpoint the value drivers and ultimately increase your business’s value and sale price from 10 percent to 35 percent or more. If the assessment reveals that some of your business drivers are weak, prioritize them and begin work immediately to correct or improve them. Once you understand the current value of the business and the value drivers, you can identify tactics to increase its value.

Key business value drivers may include sales growth trends, balanced and growing customer mix, strength of sales backlog, strength of the market niche, strong products and services brand, highly skilled, efficient and loyal workforce, solid vendor relationships, product differentiation, product innovation, strong management team that can transition to the new owner, up-to-date technology and modern work-flow systems and processes, strong management information systems, continuous growth in profitability, barriers to competitive entry, strong company culture and loyal customer base.

At least two years will be required to increase and improve the value drivers of your business. During this time, you will be able to correct minor cosmetic issues to help build incremental value.

Company culture and existing customer relationships are two critical areas that concern most buyers. Here is where you can add business value. If a business is sold, it is important to ensure that employees will embrace the culture of the buyer. Both these buyer concerns can be mitigated if the seller stays on as an employee or consultant for a reasonable period of time.

After two or three years of focusing on value optimization, your business worth should increase in the eyes of potential buyers. Understanding your company’s value and building upon it leads to a larger sale price and maximizes the wealth transfer to the business owner. If the business value process has been carefully carried out, the added value will stand up under the most rigorous buyer due diligence.

Continued owner involvement and the development of a strong management team have become even more important to buyers in today’s merger-and-acquisition environment. As earn-out requirements are commonly integrated into a sale price, performance stipulations tied to profits and revenue are frequently included in the sale contract to obtain the full purchase price.

If you are considering selling your company, act now. You must allow sufficient time to prepare for a transaction to correct any issues and build incremental value in your business. While the market is strong now, strong markets do not last forever. Time is of the essence. Remember, poor exit planning can erode the value of a lifetime of success.

Gary Miller is the CEO of GEM Strategy Management Inc., which advises middle-market private business owners in preparing to raise capital, selling their businesses or buying companies. He can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.

 

Know the risks when you personally guarantee your company’s debt

The Denver Post

By GARY MILLER | GEM Strategy Management

September 17, 2017, at 12:01 am

Rarely can small businesses grow without needing to borrow money sometime during the company’s life. When businesses borrow money from banks, the banks almost always require a personal guarantee from the business owner or shareholders unless the business is profitable and has $25 million or more in revenues.

Most lenders require a personal guarantee as “added assurance” that the owner is committed to the business and to repaying the loan.

A personal guarantee means that if the company fails to pay its debt, you and/or your shareholders are on the hook. Personal guarantees are not limited to bank loans or lines of credit. They also include commercial leases, car loans or leases, equipment leases and other financing arrangements.

Personally guaranteeing a business loan is putting your personal finances on the line. Therefore, your credit score and assets are at risk. Make certain you fully understand what you are getting into before you sign on the dotted line.

Be aware that many business owners incorporate their businesses as C-Corps, S-Corps or limited liability companies, to ensure they have personal liability protection. But when you guarantee your company’s debt to a third party (such as a bank), you lose personal liability protection.

In addition, your personal guarantee could affect your family. Some banks require a spouse’s guarantee in addition to your own, so assets held solely in your spouse’s name are fair game for the lender. Otherwise, you might be tempted to transfer assets to your spouse’s name. In some cases (e.g., for commercial leases), you may be able to negotiate a guarantee without your spouse’s signature.

If you give a guarantee for company debt such as a business credit card, your failure to pay if the company can’t will hurt your personal credit rating. In most cases, small-business owners are required to provide personal information when their companies apply for credit cards. In some cases, if the company fails to make required payments, this action can appear on the owner’s personal credit report. This could make it difficult to borrow in the future, get a job, buy insurance or rent a place to live.

When selling your business, remember your personal guarantee survives the sale. Be sure to obtain a release from the buyer. Try to obtain a release from your lender or transfer the debt to the buyer.  Alternatively, have the company satisfy the outstanding obligation before selling your interest so there’s no longer anything that you still personally guarantee on behalf of the company.

I recommend that my clients negotiate the structure of the personal guarantee as well as the loan terms and covenants with the bank. They include:

  • If your company has more than one shareholder, negotiate a pro rata share of personal guarantees spread among all the shareholders based on their percent of company ownership. This arrangement limits your exposure to the percentage of the company you own. For example, if you own 60 percent of the stock of your company, you only guarantee 60 percent of the debt.  If another shareholder owns 20 percent of the stock, then he or she guarantees 20 percent of the debt. According to the Small Business Administration’s standards, any individual with a 20 percent or greater ownership in a small business should be part of the loan-guarantee process.
  • If the loan guarantee includes the term ‘joint and several’ – which means that each shareholder guaranteeing the loan is on the hook for 100 percent of the debt should any of the borrowers fail to pay his or her share – get rid of it if possible. If other partners can’t pay their pro rata share, the bank may demand that you pay the entire balance even if you aren’t a 100 percent owner of the business.
  • If you are guaranteeing 100 percent of the loan, negotiate a guarantee with a combination of cash and collateral, which can come in the form of property, home equity, and other investments.
  • If the bank requires a personal guarantee, make sure you sign a “Limited” vs. an “Unlimited” personal guarantee. When you sign an unlimited personal guarantee, you are agreeing to allow the lender to recover 100 percent of the loan amount in question, plus any legal fees associated with the loan – such as the lender’s costs for securing a judgment against you.
  • If the bank loan is a term loan, five years, for example, try to limit the term of the personal guarantee – perhaps for two to three years versus the entire term of the loan.

Since banks almost always require personal guarantees, knowing what you’re undertaking is essential. Try to negotiate better arrangements that limit or even eliminate your personal exposure. Before you agree to anything, protect yourself by consulting an attorney. Make certain you fully understand what your guarantee means and what you can do to minimize your risk.

Gary Miller is the CEO of GEM Strategy Management Inc., which advises middle-market private business owners in preparing to raise capital, selling their businesses or buying companies. He can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.

 

 

To walk or not to walk? In negotiations, go with your instinct but check these signs.

Gary Miller

The Denver Post | BUSINESS

POSTED:  August 20, 2017, at 12:01 pm

by Gary Miller | GEM Strategy Management

Prepare long before you start the negotiation process 

It was late. Time was running out and negotiations weren’t going well. It was Larry’s third trip to the headquarters of his acquisition target to hammer out the final terms and conditions of the deal.

After three days of going back and forth, it seemed that Wayne, owner of the target company, was picking away at the purchase price from every possible angle. Both men were tired and becoming increasingly frustrated with the negotiation process. After some consideration, Larry, having run out of patience, stood up and abruptly ended the meeting and led his deal team out the door.

This is an old and familiar story.

In business, buyers and sellers must be able to know when or when not to walk away from a deal. It is key – whether that means deciding against an acquisition that on paper would create significant synergies, or when the price is becoming unreasonably high. Other reasons to walk away include culture misalignment, a toxic workplace or due-diligence that reveals major problems. For the most part, you can go with your gut instincts. But there are other signs to look for that aren’t as obvious.

Below are six recommendations that could prevent you from walking away from a potentially good deal or signal that walking away is your best option.

  1. Prepare long before you start the negotiation process. Knowledge is power. The more knowledge you have the more leverage you have when negotiating. Research your acquisition target and the industry carefully; learn who are the major players and examine the major trends that might affect your current business strategy — with or without an acquisition. If trends are changing significantly, then an acquisition could be less expensive in the long run than attempting to adapt to those changes without an acquisition.
  2. Establish with your deal team what things are deal breakers before you begin negotiations. Identifying the potential deal breakers early can save everyone time, effort and money, not to mention the stress of a high-stakes negotiation that winds up breaking down. For example, not having a walk-away price might lead to giving away too many concessions during the negotiation process. Be sure to cost out each concession before granting it so that the concessions do not exceed your walk-away number. Having a firm number is absolutely crucial.
  3. Establish a rigorous due-diligence process that goes beyond verifying the financials, operations, customer records, sales and marketing forecasts, disaster recovery, cyber security and other items before you enter into negotiations. Too often, due-diligence becomes an exercise in verifying the financial statements and a few other items, rather than conducting a fair analysis of the company’s strategic value and the logic supporting the strategy. For example, does this acquisition fit my growth profile and strategic business plans? Can the acquisition deliver results on schedule to deliver the value I need? Deal-making is glamorous; due diligence is not.
  4. Develop a binding detailed letter of intent (LOI) subject to a satisfactory due-diligence review vs. a term sheet (TS), which often is more like a skeleton to be filled in later. The LOI is more detailed and focuses almost exclusively on the major business issues vs. the legal issues. Legal issues, business terms and conditions, representations and warranties are addressed in the definitive purchase and sale agreement that follows the LOI. The LOI can flush out major issues early that are going to be difficult.
  5. Determine how much time and effort will be necessary to realize the synergies expected from the acquisition. Ask yourself, is this a cultural fit for my company? Are we in alignment with common goals? Does this acquisition fit our criteria? What am I really buying?
  6. When you do enter into negotiations be constantly aware of inconsistencies during the process. Inconsistencies can be the root of future problems and could be a sign of trouble to come.

Deal-making is as much art as science. If you decide to walk, you’ve said “no.” And “no” is a very powerful word.

But it doesn’t necessarily mean it’s over. By walking away from a potential deal, you’ll learn how much the other party wants to work with you. I’ve walked enough times that I’ve learned to appreciate the power of “no.” If the target is seriously interested in working with you, pulling out will force them to try to get you back. Or they’ll be relieved and let you walk. Either way, you’ll get resolution.

Gary Miller is CEO of GEM Strategy Management Inc., which advises middle-market private business owners how to prepare to raise capital, sell their businesses or buy companies. If you have questions, he can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.

 

How to Negotiate Concessions to Close Better Deals

By Gary Miller, GEM strategy Management, Inc. | Axial Forum August 9, 2017

Strong negotiating skills are often the single most important differentiator between closing good deals vs. great deals — or not closing any deal at all. Negotiation is more art than science, as it involves creatively reading your audience, knowing when to dig in, and when not to. Often, I have been called in to help close a deal or save a deal. Many times, I have found that both buyers and sellers, engaged in trying to make a deal, are so locked in their positions that there is little opportunity for give and take. Feelings are strained, attitudes are entrenched, respective positions are hardened, and therefore opportunities for compromise are lost.

For any negotiation to work successfully, both parties need to feel they are getting a good deal. The deal can’t be lopsided for it to have any reasonable chance for success. Structuring deals means working towards a win-win outcome for both parties.

This brings us to the art of compromising with concessions.

Concessions are almost always necessary to complete any successful transaction. You have to be willing to make concessions to get concessions in return. But the process isn’t easy.

First, don’t assume that your actions will speak for themselves. Often, concessions go unappreciated and unreciprocated. Unless you establish that you have made a major concession, your counterparts will be motivated to overlook, ignore, or downplay your concessions. Why? They want to avoid the strong social obligation to reciprocate.

Emphasize the benefits of your concessions to the other side. My own research suggests that negotiators reciprocate concessions based on the benefits they receive, while ignoring how much others are sacrificing. One way for an owner to highlight the benefits he is providing is to contrast his offer with those made by similar firms (assuming they were lower).

Second, don’t give up on your original demands too hastily. Timing is important in any negotiations. Every deal has a life of its own. If the other side sees your first offer as frivolous, your willingness to move away from it too soon will not be seen as concessionary behavior. By contrast, your concessions will be more powerful when your counterpart views your initial demands as serious and reasonable. So when you give a concession, let it be known that what you have given up (or what you have stopped demanding) is costly to you. By doing do, you clarify that a concession was, in fact, made.

Third, demand and define reciprocity. Establishing the fact that you have made a major concession in itself helps trigger an obligation to reciprocate, but sometimes your counterpart is slow to act on the obligation. To increase the likelihood that you get something in return for your concessions, try to explicitly — but diplomatically — demand reciprocity.

Consider the following negotiation between an IT services firm and a client. The client suggests that the IT firm’s cost estimates are unreasonably high; the IT firm believes that the cost estimates are accurate (even conservative) given the complexity of the project and the short deadline. If the IT project manager is willing to make a concession, she might say: “This isn’t easy for us, but we’ve made some adjustments on price to accommodate your concerns. We expect that you are now in a better position to make some changes to the project deadlines. An extra month for each milestone would help us immeasurably.”

Notice that this statement achieves three goals:

  1. It establishes that a concession was made (This isn’t easy for us, but we’ve made some adjustments . . .”).
  2. It tactfully demands reciprocity (“We expect that you are now in a better position to make some changes . . .”).
  3. It begins to define the precise form that reciprocity should take (“An extra month for each milestone . . .”).

Remember that no one understands what you value better than you. If you don’t speak up and define what reciprocity means to you, you’re going to get what your counterpart thinks you value or, worse, what is most convenient for your counterpart to give.

Ideally, negotiating parties establish an environment where they do not nickel and dime one another throughout the process. Rather, each side learns about the interests and concerns of the other and makes good-faith efforts toward achieving joint gains. Unfortunately, this is not always possible because one side or the other is not negotiating in good-faith. When trust is low, or when you are in a one-shot negotiating scenario, I recommend clients make contingent concessions. A concession is contingent when you state that you can make it only if the other party agrees to make a specified concession in return.

Contingent concessions are almost risk-free. They allow you to signal to the other party that while you have room to make more concessions, it may be impossible for you to budge if reciprocity is not guaranteed.

A final negotiating technique I use is giving concessions in installments. Extensive research by the late Stanford University professor Amos Tversky and the Princeton University professor Daniel Kahneman indicated that while most of us prefer to get bad news all at once, we prefer to get good news in installments. This finding suggests that the same concession will be more positively received if it is broken up into parts and offered at different times in the process.

There are other reasons to make concessions in installments. Most negotiators expect that they will trade offers back and forth several times before the deal is finished. Installment concessions may lead you to discover that you don’t have to make as large concessions as you thought. When you give away a little at a time, you might get everything you want in return before using up your entire concession-making capacity. Whatever is left over is yours to keep.

The above strategies are aimed at guaranteeing that the concessions you make are not ignored or exploited. Effective negotiators ensure not only that their own concessions are reciprocated, but also that they acknowledge and reciprocate the concessions of others.

About the Author

Gary Miller is the CEO of GEM Strategy Management, Inc., an M&A business consulting firm, advising middle-market private business owners on how to sell their businesses for the highest valuation, buy companies and source capital for growth and expansion. He is a sought-after consultant/speaker on M&A issues, strategic business planning, business valuations, exit planning, what buyers are looking for in acquisitions & how to prepare for due diligence. He can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com

 

In negotiations, making concessions and reciprocating can lead to great deals

The Denver Post | BUSINESS

Posted on July 16, 2017, at 12:01 am

Negotiators should reciprocate concessions based on the benefits they receive

By GARY MILLER | GEM Strategy Management

Strong negotiating skills are often the single most important differentiator between closing good deals vs. great deals, or, not closing any deal at all. Negotiation is more art than science, as it involves creatively “reading” your audience, knowing when to dig in, and when not to. Often, I have been called in to help close or save a deal. Many times, I have found that both buyers and sellers are so locked in their positions that there is little opportunity for give and take. Feelings are strained, attitudes are entrenched, respective positions are hardened and therefore opportunities for compromise are lost.

For any negotiation to work successfully, both parties need to feel they are getting a good deal. The deal can’t be lopsided, for it to have any reasonable chance of success. I advise clients that structuring deals mean working towards a win-win outcome. This brings us to the art of compromising with concessions.

Concessions are almost always necessary to complete any successful transaction. While most business owners understand that negotiation is a matter of give-and-take, you have to be willing to make concessions to get concessions in return. But the process isn’t easy. Often, concessions go unappreciated and unreciprocated. Don’t assume that your actions will speak for themselves. Unless you establish that you have made a major concession, your counterparts will be motivated to overlook, ignore or downplay your concessions. Why? Your counterparts want to avoid the strong social obligation to reciprocate.

Emphasize the benefits of your concessions to the other side. My own research suggests that negotiators reciprocate concessions based on the benefits they receive while ignoring how much others are sacrificing. One way for an owner to highlight the benefits he is providing is to contrast his offer with those made by similar firms (assuming they were lower).

Second, timing is important. Every deal has a life of its own. Don’t give up on your original demands too hastily. If the other side sees your first offer as frivolous, your willingness to move away from it too soon will not be seen as concessionary behavior. By contrast, your concessions will be more powerful when your counterpart views your initial demands as serious and reasonable. So when you give a concession, let it be known that what you have given up (or what you have stopped demanding) is costly to you. By doing so, you clarify that a concession was, in fact, made.

Third, demand and define reciprocity. By establishing the fact that you have made a major concession helps trigger an obligation to reciprocate; but sometimes your counterpart is slow to act on the obligation. To increase the likelihood that you get something in return for your concessions, try to explicitly – but diplomatically – demand reciprocity.

Consider the following negotiation between an IT services firm and a client. The client suggests that the IT firm’s cost estimates are unreasonably high; the IT firm believes that the cost estimates are accurate (even conservative) given the complexity of the project and the short deadline. If the IT project manager is willing to make a concession, she might say: “This isn’t easy for us, but we’ve made some adjustments on price to accommodate your concerns. We expect that you are now in a better position to make some changes to the project deadlines. An extra month for each milestone would help us immeasurably.”

Notice that this statement achieves three goals. It establishes that a concession was made, it tactfully demands reciprocity and it begins to define the precise form that reciprocity should take. While each of these elements is critical, negotiators often overlook the need to define reciprocity. Remember that no one understands what you value better than you. If you don’t speak up, you’re going to get what your counterpart thinks you value or, worse, what is most convenient for your counterpart to give.

One hallmark of a good negotiation is to establish an environment among the negotiating parties of not nickeling and diming one another through the negotiating process. Rather, each side learns about the interests and concerns of the other and makes good-faith efforts toward achieving joint gains. Unfortunately, this is not always possible because one side or the other does not negotiate in good faith. When trust is low, or when you are in a one-shot negotiating scenario, I recommend clients make contingent concessions. A concession is contingent when you state that you can make it only if the other party agrees to make a specified concession in return.

Contingent concessions are almost risk-free. They allow you to signal to the other party that while you have room to make more concessions, it may be impossible for you to budge if reciprocity is not guaranteed.

A final negotiating technique I use is giving concessions in installments. Research by Amos Tversky and Daniel Kahneman indicates that while most of us prefer to get bad news all at once, we prefer to get good news in installments. This finding suggests that the same concession will be more positively received if it is broken into installments.

The above strategies are aimed at guaranteeing that the concessions you make are not ignored or exploited. Effective negotiators ensure not only that their own concessions are reciprocated, but also that they acknowledge and reciprocate the concessions of others.

Gary Miller is the CEO of GEM Strategy Management Inc., an M&A consulting firm advising middle-market private business owners. He can be reached at gmiller@gemstrategymanagement.com.

 

 

Business owners often cheat themselves by not getting a business valuation

Every business owner should obtain a professional valuation

The Denver Post | BUSINESS

By Gary Miller | GEM Strategy Management

June 18, 2017

Gary Miller

Your local assessor’s office has a record of what your house is worth. The popular automotive Blue Book tells you what your car is worth. Articles in Consumer Reports and personal finance magazines provide the pricing data you need to find the best deals on refrigerators and BBQ grills, how to compare the cost of mutual funds and even where to find the best values in college education. So why is it that most small-business owners don’t know what their businesses are worth? The answer is simple: Most business owners don’t want to spend the time or money to obtain a professional, independent, third-party valuation.

This is a big mistake.

Every business owner should obtain a professional valuation, especially at the time he or she decides to sell the business. Valuing your business accurately is essential if you don’t want to risk leaving money on the table by valuing it too low or scaring away potential buyers by valuing it too high. But there are other important reasons for having an up-to-date business valuation on hand. It should be conducted at least every two years. Here are the main reasons:

  1. A major event could happen to the owner. If the owner dies, faces health issues or becomes incapacitated, major changes in the business operations are affected. Having a current business valuation would help the family deal with the potential sale of the business.
  2. An opportunity to sell or merge could come unexpectedly. Often owners are faced with having to make a decision to sell quickly.  An up-to-date valuation allows you to take advantage of that opportunity and will help you negotiate the transaction with potential buyers.
  3. A partner or family members could join the business.  This situation necessitates knowing the value of your business to determine the buy-in price.
  4. A partner or shareholders could leave the business. You will need to know the value of your business to determine the value of the departing partners/shareholders’ membership interests/shares in order to pay them out.
  5. An exit strategy could be on the horizon. You may be reaching a time when you are considering retirement. Knowing the value of your business will help you construct an exit strategy, examine estate plans and minimize tax obligations. In many cases, the value of a business represents a sizable percentage of your net worth, so working on an estate plan is impossible without an accurate valuation.
  6. A loan could be needed for expansion of the business. Often, banks require an up-to-date business valuation as a part of the loan decision process.
  7. A weather disaster could interrupt the business. After a business disaster — like the storm damage that closed Colorado Mills in Lakewood in May — it is very useful for insurance purposes, particularly if you have business continuation insurance.
  8. A divorce could occur. If you are dealing with divorce settlement issues, you will need an independent valuation of the business to assure both parties that the value has been obtained fairly.

While all of these are compelling reasons to seek a business valuation, it’s still easy to put it off. After all, valuing a business is much more complex than thumbing through a Blue Book to value your car.  I often find that business owners don’t know where to go to find valuation experts. I recommend that they look for those with certifications such as Accredited Business Valuation (ABV) and/or Certified Valuation Analysts (CVA).

Some owners turn to their accountants or their lawyers for valuation advice. In my experience, accounting firms tend to be too conservative and undervalue their clients’ businesses. Law firms, on the other hand, tend to be too optimistic and overvalue their clients’ businesses. They may fail to properly estimate qualitative factors including the general economy, industry conditions, company size, financial performance, management experience and business drivers.

Keep in mind that if you sell to a larger company, you’ll probably be dealing with an acquisition team that uses sophisticated financial analyses and modeling. The company will be much more impressed with your management ability if you have a detailed valuation prepared using earnings-based valuation models. The models include comparing your company to publicly traded companies in your industry; comparing your company to previous mergers and acquisitions transactions (much like “comps” in the real estate industry); a discounted cash-flow analysis analyzing future cash-flow streams; and a leveraged buyout model that computes the value of your business based on how much acquisition debt your business can support.

On the other hand, remember that value is in the mind of the beholder. A professional valuation can tell you the price that an average buyer might pay for your business. When it comes to negotiating with an actual buyer, the valuation is just a starting point. A particular buyer might have a strong strategic reason for acquiring your company and might be willing to pay a premium over what the average buyer might offer. Another buyer might simply be looking for certain assets to augment his or her own business and might not be willing to pay for your company’s enterprise value (total value) at all.

The final excuse for not securing a business valuation is that you’re “too busy” running the business to concentrate on the valuation process.

Think about that.

Remember, you have spent years, even decades building your business. It is your life’s blood. If you don’t take care of it, you could lose much of the value you’ve built.

Gary Miller is the CEO of GEM Strategy Management, Inc., an M&A consulting firm, advising middle-market private business owners prepare to raise capital, sell their businesses or buy companies. If you have questions, he can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.

Business owners often cheat themselves by not getting a business valuation

Alternative online lenders can be a good option for small businesses, but mind the details

Gary Miller

The Denver Post | BUSINESS

Pitfalls can include much higher interest rates and hefty fees, but some options are doable

By GARY MILLER | GEM Strategy Management

POSTED:  May 21, 2017, at 5:00 am

It was Friday afternoon when Bob received the call from his bank telling him that he had been turned down for his $250,000 loan request. He had purchased a second location as part of his business expansion plans and needed the bank loan to purchase inventory for his new location.

Bob was devastated.

Why had it taken over two months for the bank to say no? The bank’s reason for turning down the loan request was that they were not comfortable making an inventory loan of that size. He couldn’t understand why the bank wouldn’t work with him. He had good credit. The business was profitable, and it had shown solid growth for over 10 years.

Worse still, time was running out to purchase the inventory at a steep discount from a competitor going out of business. He needed the money in a week to close the deal. Where could he turn to get a $250,000 loan in a week?

Small businesses are core to America’s economic competitiveness. According to the Small Business Administration, small businesses make up 99.7 percent of U.S. employer firms. Yet in recent years, small businesses have been slow to recover from the Great Recession and credit crisis that hit them especially hard.

For decades, small businesses could only look to traditional banks, credit unions, the SBA, credit cards, or in a few cases, factoring firms, (who purchase your receivables in exchange for immediate cash) to meet their capital needs. Recently, however, a massive wave of new national and highly scalable alternative online lenders (non-bank companies) has entered the market. These alternative lenders offer higher acceptance rates and faster capital deployment (one to 14 days) than traditional lenders, and as a result, have seen tremendous growth in the market over the past five years. The alternative lending industry now stands at $1 trillion dollars, according to CrunchBase, which monitors public and private companies globally.

In a recovering economy where big banks are restricted by complex regulations (Dodd-Frank), small businesses are turning to alternative lenders that are upending banks’ conservative lending standards by automating loan approvals. Instead of relying on collateral and credit scores, these cash-flow lenders use software that reviews online sales, banking transactions and comments on social media sites among other criteria, to make loan decisions within minutes instead of weeks or months.

With most alternative lenders, borrowers apply for loans online and usually receive an answer the same day. If approved, funds are available anywhere from a day up to a couple of weeks, depending on the size of the loan.

Alternative lenders generally fall into two categories: (1) peer-to-peer lenders like Lending Club, Funding Circle and Prosperous, which raise funds from groups of investors that lend money to businesses from individual investors or (2) direct lenders like On Deck, Kabbage and Balboa, which lend money to businesses from funds raised by institutional investors.

Alternative lenders make loans from $2,000 to $5 million for all kinds of business needs. Loan types include purchase order financing, export financing, inventory purchasing, equipment purchases or leasing, credit insurance, cash advances, working capital, lines of credit and growth and expansion plans.

While specific statistics are hard to pin down, there are about 1,300 alternative lenders. They compete for about 1 percent of the overall credit market, compared to about 6,500 traditional banks competing for the remaining 99 percent. Banks decry these loans and insist that the alternative lending industry is serving what traditional banks call “unbankable loans” – loan requests that commercial banks will not consider.

Since the alternative lending market is becoming overcrowded, it is hard for these companies to differentiate themselves. In turn, it is easy for a borrower to become overwhelmed when searching for the best provider. Nearly all the alternative lenders inundate potential borrowers with a strikingly similar array of direct mail, email and online advertisements. Most of these lenders make credit decisions and approve loans in the same amount of time, have similar costs of capital and charge roughly the same rates. Moreover, most lenders have nearly identical customer acquisition costs, ranging from around $2,500 to $3,500 per loan. All alternative lenders position themselves for fast approvals, fast funding, flexible terms, little paperwork and loans that can be unsecured.

Most loans come with hefty fees and high-interest rates that can carry effective annual percentage rates (APRs) from 20 percent to 60 percent, according to USA Today. By comparison, bank interest rates for similar loans average 4.5 percent to 6 percent. However, some alternative lenders will lend at rates as low as 11 percent. Many of these loans can be subordinated to other debt the business is carrying and require no personal guarantees. Also, less-than-perfect credit is rarely a deterrent to receiving a loan.

Repayment and other terms and conditions are often quite flexible, ranging from three months to three years. Loans can be repaid on a daily, weekly or monthly basis.

Lending alternative companies are emerging as a dynamic and disruptive force using sophisticated technology to address the needs of the small-business lending market. Though small compared to the traditional bank market, these new competitors are providing fast turnaround and online accessibility for customers, and are often using data to create more accurate credit scoring algorithms than traditional banks.

There are pros and cons in seeking a loan from an alternative lender, so I advise clients who are having problems with traditional lenders to examine alternative lenders carefully. Examine the details of the loan terms, conditions, and covenants. Make sure your company can service the debt. If cash flow is a problem, seek professional advice from your accountant or other advisors before signing the dotted line.

That’s what Bob did. I advised him to find an alternative lender for the $250,000 he needed to purchase the inventory for his new location. All ended well for Bob. The alternative lending market is one answer to filling the credit gap for small businesses like Bob’s.

If you need a loan, alternative lending sources are worth a serious look.

Denverpost.com http://dpo.st/2qrM3iE

Gary Miller is the CEO of GEM Strategy Management, Inc., an M&A consulting firm, advising middle-market private business owners prepare to raise capital, sell their businesses or buy companies. He is a sought-after business consultant and speaker on M&A issues, strategic business planning, business valuations, exit planning, family transfers, what buyers are looking for in acquisitions and how to prepare for due diligence. He can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.

denverpost.com http://dpo.st/2qrM3iE

 

Planning is key when passing the family business onto a new generation

The Denver Post | BUSINESS

POSTED:  April 16, 2017, at 5:00 am

Advisers can help these businesses thrive in the future 

by GARY MILLER | GEM Strategy Management

Gary Miller

Over the past year, I have been working with a number of business owners who would like to transfer their businesses to their next generation. Yet, fewer than a third of family-owned businesses survive into the second generation, 12 percent to the third, and only 3 percent to the fourth generation. In many cases, the poor survival rate is simply a reflection of economics. Not all businesses are destined to survive.  In some cases, however, otherwise successful family-owned businesses fail simply because they had no plan for business continuation. By employing advisers to help them develop a plan, these businesses have an opportunity to thrive throughout the generations.

There is a myriad of challenges in transferring a family-owned business.  This is why no one professional discipline (law, accounting, tax, wealth planning, and exit planning consultants) has become the profession of choice for business owners seeking exit planning advice. Because of the disparate issues that must be grappled with in business continuation planning, an owner needs the help from all of the professional disciplines named above.

For a successful business transfer, three major strategies must be in place.

  1. Both the business owner and the business itself must survive financially; 2
  2. The owner must have a transfer plan in place before exiting the business; and, 3.
  3. The exit plan must be adequately funded.

To successfully transfer the company, the transfer plan cannot carry financial provisions that strap both the children and the business to the extent that the business cannot survive. Similarly, if the transfer plan financially devastates the owner and family, the transfer plan is a failure.

Several steps need to be taking well in advance of executing the transfer of the business. First, when the business owner decides to create a transfer plan, it is important that the books and records (typically five years of income statements, balance sheets and cash flow statements) are “clean” and follow reporting standards similar to publicly traded companies.

Next, an outside, third-party valuation firm should be engaged to provide an independent valuation of the business. The valuation of a family-owned business is not simply a task of updating the company’s financials. There are several adjustments that are commonly necessary. For example, a valuation adjustment is needed to reflect excess compensation if the owner is receiving compensation above market standards.

Another adjustment is warranted if the owner is not paying market leasing rates for a building that person owns but has put that real estate in a separate LLC, to house the business. Similar adjustments may apply to benefits, travel, company cars, boats, airplanes, country club dues and other discretionary expenses.

Typical analytic methodologies used in a professionally produced valuation include the market approach, the income approach, and the asset approach.

Even though the goal is to transfer the business internally, a truly independent valuation is a key step in the transfer planning process. Some reasons include:

  1. If any kind of financing will be involved in the transfer plan, the financing entity will likely demand an accurate valuation. The valuation may not only be an issue for underwriting the loan, it may also determine the source of the loan and interest rate charged. Whether the loan comes from a commercial bank or nontraditional financing sources such as mezzanine lenders or private equity firms, most will require an independent valuation.
  2. Federal income, gift, and estate taxes may require a defensible independent valuation. For example, estate tax challenges from the IRS under IRS code 2704, Discount for Lack of Marketability (DLOM), can be overcome with a valid independent valuation.

An accurate valuation of a going concern is typically dependent on both a look back and look forward of earnings. The intent of the business analysis is to acquire an accurate valuation of assets and a reasonable assessment of future earnings and goodwill.

Another major consideration for business owners thinking about transferring their businesses to their children is what I call the “Family Dynamics Analysis.”  Throughout my career, I have consistently heard from business owners about “how close their families are.” But often, this “closeness” falls apart when transfer issues are discussed among family members.

For most family-owned businesses, these are the major family dynamics that should be considered

  1. Who’s in charge, in both the family and the business?
  2. How will family members be treated equitably when they have different positions in the business?
  3. Jealousy and loyalty.What are the family and business politics?
  4. Conflicts and disruptions.What situation could cause confrontations, and how can they be avoided or resolved?

Finally, funding the transfer plan is critical to the success of the ongoing business for the children. The plan may be based on maximizing value or minimizing taxes but has to include maximizing flexibility to address economic downturns, unanticipated events and capital needs for future growth.

Since most owners can work through maximizing value or minimizing taxes through their professional advisers, I want to address the need for “flexibility” in the exit plan for both the owner and the children. For example, a wait-and-see buy-sell is a common technique in which the agreement among owners provides that the corporation has the first option to redeem the exiting shareholder’s stock; the other shareholders have the second option to purchase remaining shares; and, to the extent any shares remain unsold, the company must redeem those shares. This gives the family the flexibility to determine which course of the sale will minimize taxes.

Regardless of the general information that I have provided in this article, all business owners considering transferring their businesses to their children should seek the professional advice of counsel on all matters pertaining to legal, tax, accounting or exit planning to avoid the pitfalls inherent in family transfers.

Gary Miller is the CEO of GEM Strategy Management, Inc., an M&A consulting firm, advising middle-market private business owners prepare to raise capital, sell their businesses or buy companies. He is a sought-after business consultant and speaker on M&A issues, strategic business planning, business valuations, exit planning,  family transfers, what buyers are looking for in acquisitions and how to prepare for due diligence. He can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.

 

8 tips for avoiding an IRS audit

The Denver Post | BUSINESS

By Gary Miller/GEM Strategy Management

POSTED: March 19, 2017, AT 5:29 AM

Gary Miller

Do not round out your numbers, the IRS views this as “sloppy” reporting

It’s tax season. Most business owners have either filed a 1040 tax return or an extension. Still, the question looms: Is this the year I get audited?

Every year the IRS sends notices to thousands of taxpayers informing them they have been selected for an audit. An audit can be a scary situation, one most small business owners try to avoid. Audits involve the government prying into your personal financial affairs, requesting sensitive financial information, and at times making you feel as if you’ve done something wrong. Audits are time-consuming and can be expensive — you may have to pay penalties and interest assessed on a tax liability and the cost of professional tax counsel to help you through the process.

How can you minimize your chance of being audited? It helps to understand how returns are selected. Since the IRS doesn’t have the budget to audit everyone, the agency assigns a numeric score from two scoring systems to every tax return. It is looking for under-reported income and overstated deductions. The higher your score, the higher your chances for an audit. Here’s how it works.

All tax returns are entered into a computer. The IRS uses one computer program called the Discriminate Inventory Function system and another program called the Unreported Income Discriminate Index Formula to determine the probability of inaccurate information and under-reported income. Each score is evaluated in conjunction with the other.

Different formulas are used for different types of tax returns. The IRS does not reveal the exact criteria and formulas used to score tax returns, but some information is known. It is important to note that complex tax returns have a higher chance of being audited – because complex tax returns usually are filed by high-income earners.

There are eight common audit triggers that you should keep in mind as you work on your tax return.

  1. Higher than average income.Taxpayers with incomes exceeding $200,000 have a greater chance of being audited that taxpayers of average income. If this applies to you, keep meticulous financial records in case you are audited.
  2. Disproportionate deductions.The IRS uses schedules to determine how much is too much for various income brackets. For example, if you claim charitable deductions that are out of line with your income bracket, watch out. The IRS will want proof.
  3. Rounded or averaged numbers.If your total deductions are $15,998, don’t report the deduction as $16,000. The IRS agent reviewing your return tends to believe that rounded or averaged numbers are “sloppy” and that the rest of your return may contain inaccuracies.
  4. Home office deductions.These are often abused by business owners. Even though the IRS has simplified the home office deduction method, requirements necessary to take the deduction have not been relaxed. You can still only claim a portion of your home office if it is exclusively dedicated to your business.
  5. Claiming business losses year after year.The agency knows some people claim hobby expenses as business losses, and under the tax code, that’s illegal. If your business claims a net loss for too many years or fails to meet other requirements, the IRS may classify it as a hobby, which would prevent you from claiming a business loss. If the IRS classifies your business as a hobby, you’ll have to prove that you had a valid profit motive if you want to claim those deductions.
  6. Filing a Schedule C.The IRS looks closely at this form. A Schedule C (Form 1040) is used to report income or losses from a business you operate or a profession you practice as a sole proprietor. An activity qualifies as a business if your primary purpose is for income or profit.  You have to be involved in the activity with continuity and regularity. Make sure that you have careful documentation to justify all of your deductions.
  7. Excessive deduction for business entertainment.We all know stories about someone who takes friends out to dinner and then writes it off as a business expense. So does the IRS. Don’t take your family on a business trip and try to write off their expenses. If your return has higher-than-average entertainment expenses compared to your income, you could find yourself sitting across the table from an IRS agent. You will need receipts for all expenses greater than $75 when traveling for business.
  8. Claiming your vehicle as 100 percent business use.Deducting both the IRS standard mileage rate and actual vehicle expenses will cause the IRS to come knocking. In addition, if you claim 100 percent business use on the depreciation form for your vehicle, you’ll need precise records that include mileage logs, dates and the purpose of every trip.

Your best defense against these eight triggers is keeping complete and detailed records. If you have questions about filing your return, seek tax counsel or ask a professional tax preparer. If you have already filed your return and think there could be problems with it, consider amending your return.

Gary Miller / GEM Strategy Management

Gary Miller is the CEO of GEM Strategy Management, Inc., an M&A consulting firm, advising middle-market private business owners prepare to raise capital, sell their businesses or buy companies. He is a sought-after business consultant and speaker on M&A issues, strategic business planning, business valuations, exit planning, what buyers are looking for in acquisitions and how to prepare for due diligence. He can be reached at 970-390-4441 or gmiller@gemstrategymanagement.com.