Most business owners, when they prepare their businesses for sale, are really not sure exactly what that means. They probably know they need to have a bit of a cleanup both literally and also in terms of documentation, such as client records and files, but they’re not sure what else needs to be done. Story by Craig West.
It’s important for the seller to ensure that the buyer sees the purchase as being attractive and simple
rather than complicated and painful.
In my view one of the first things that should be undertaken is a structural review. Is your business in the most appropriate structure, both in terms of capital gains tax and family wealth planning, to ensure the capital proceeds from the sale attract the minimum capital gains tax and also end up in the most appropriate structure for the future?
For example, business owners over the age of 60 can earn tax-free income inside their superannuation. However limits apply to the amount that can be contributed into superannuation in any given year, and the tax treatment of super death benefits varies depending on whom they are paid to. Therefore, it’s important your Business Succession Plan takes into consideration your Family Wealth and Estate Plan. We always aim to achieve the best outcomes for clients by working closely with Family Wealth Advisers to ensure a comprehensive and holistic strategy underlies everything we do.
Making your business more attractive
It’s important for the seller to ensure that the buyer sees the purchase as being attractive and simple rather than complicated and painful. And importantly the buyer will want to make sure the transaction is designed to make the “takeover” transition as easy as possible and retains value in the business.
For example, following the sale of a Real Estate business, a reasonably high percentage of Property Management clients can be lost in the process of transferring to the new owner. If, however, you have an appropriate structure that avoids this step the buyer will be able to retain more of those clients, making your business more attractive.
Accountants are often reluctant to advise their client to purchase an existing trading structure (and rightly so, as they can contain hidden skeletons, tax debts, audits, claims by third parties etc. which dramatically increase the risk), but they are generally okay with purchasing the entity described above as it does only one thing; hold the asset.
Reducing you capital gains tax
Capital gains tax is an inevitable part of any business sale. There are however, significant concessions available for small business owners specifically designed to reduce your capital gains tax liability. Access to these concessions is conditional on meeting several criteria and it’s a complicated area of tax law. The best solution is to get proactive advice well prior to the potential sale and not to leave it until the business is sold to discuss the implications with your accountant or tax adviser.
Increasing your business’ value
What else should be done to prepare the business for sale? Well, I can tell you that buyers are prepared to pay more for businesses that have documented systems, policies and procedures. They will pay more where they see no need to substantially upgrade equipment, IT systems and infrastructure, as well as when the business has clearly documented sales, marketing, budgeting and cash flow plans going forward at least two years. They will also pay more where clients are engaged with the business formally as in signed retainer agreements or fee arrangements. Certainly any kind of ongoing passive income stream attached to the business is highly valued by buyers as it reduces the risk and increases the likelihood of the overall financial success of the business.
In Real Estate businesses this may well be as simple as the ongoing income stream from your financial services referrals. We have one client who generates nearly $400,000 per annum in this area. This is a solid established passive income upon which a buyer could easily rely to cover overheads and costs of the business going forward, and therefore dramatically reduce the risk of the purchase.
John Encina of Macquarie Commercial Finance (specialist business finance brokers) says that correct structuring of the sale and quality information will not only help a seller get the best price but also assist the buyer’s capacity to finance the purchase. Most buyers will require some form of debt finance and by providing quality information and having a flexible deal structure, you can ensure the best result for all parties. We see many deals fall over due to the lack of information and flexibility from the seller. The buyers and their lender just cannot get their heads around the deal. Be prepared to provide detailed information on things like non-recurring expenses so the buyer can work out the true adjusted profit of the business.
The exercise of ensuring all documentation is up to date and easily accessible will add value to the business without a doubt. The process will also ensure it’s easy for you to find any issues in the business which will appear during due diligence – the business equivalent of a pest and building report – used by the buyer to negotiate a better price.
Client case study
Prior to a recent Real Estate business sale, we restructured and transferred all of the Property Management customers of our client into a separate entity designed purely to hold the asset. This asset, the Property Management client base, was then leased back to the trading entity. This meant clients were not required to transfer management contracts upon sale and therefore loss of clients was limited to less than one percent.
On average, loss of clients (and therefore loss of value and real cash in the sale transaction) can be as high as 12 per cent – leaving significant value on the table – compared to the costs of a proactive restructure to maximise the value upon sale.
Craig West is a strategic accountant who has built a specialist advisory practice focused on small business owners. Craig has written three critically acclaimed books educating SMEs on employee incentives, succession planning and asset protection and has recently been invited to undertake a PhD in Business Succession Planning. www.successionplus.com.au