When I was in elementary school, one of my favorite jokes went like this:
What’s worse than finding an apple with a worm in it?
Finding half a worm.
The conclusion is simple – it’s much better to find worms before you bite the apple. Buying (and selling) a business is much the same. Buyers perform due diligence and lenders complete underwriting to make sure there aren’t any worms. Sellers hoping to receive top-dollar for their business are well advised to do the same.
Let’s apply a typical process to buying your business. First, the buyer begins a search and finds yours. After some meetings, discussions, confidentiality agreements, disclosures, etc., the buyer makes an offer subject to due diligence. Finally, upon acceptance of the offer, due diligence begins. Then, the buyer finds a worm.
What are worms?
- Inadequate management/training in place for the business to continue without the seller.
- High customer concentration where the loss of one customer would invalidate the purchase decision.
- Insufficient documentation to satisfy lender underwriting.
- Lack of operational documentation – Policies & Procedures, Business Plans, Marketing Plans, etc.
- Out-dated assets requiring capital expenditures by the buyer in the near future.
- Excess assets inflating the price of the business but not contributing to its performance.
- Preferential contracts or agreements that may not be extended to the buyer.
Wise sellers will do their best to identify worms prior to presenting their business for sale. Once the worm or worms are identified, the seller has two options: correct or disclose. I recently worked with a client who had high customer concentration – two customers represented over 80% of gross revenue. Correcting this was not an option. The seller was doing quite well – taking home seven figures after all expenses. And, adding customers until no single client represented more than 20% of the business would have required the seller to more than double the size of the company.
How did we respond? We disclosed this to buyers up front. In most cases, before we even identified the company being offered for sale. If this is a deal-breaker, let’s get it out of the way before we’ve had six weeks of meeting, three weeks of negotiations, and one week of due diligence. Normally, due diligence is much longer. But in this case, the deal-breaker would have been identified in the first round of document requests by any prudent buyer.
In addition to saving yourself weeks (and weeks) of wasted time, this increases your credibility with the buyer. Ultimately, this is why you should have an intermediary look for the worms before the buyer: there are only three ways for a buyer to respond when he finds a worm – he can lower his offer, change the terms, or just walk away.
What’s the #1 Reason a Business Doesn’t Sell?
The most common response is price. Unless you’d like to just keep lowering the price until someone finally says “Yes,” there is a better answer: the value perceived by the buyer is less than the seller’s perception of value. What’s the difference? When the problem for selling is simply price, there is no course of action except to lower the price. What if the problem isn’t with the price but with the buyer’s perception of value.
- What if the financial statements could be improved to better reflect the performance of the company?
- What if the operations of the company could be modified to better reflect the operational intentions of potential buyers?
- What if the organizational structure of the company could be tweaked to give the buyer more confidence in their ability to take over the business?
Any or all of these could be the difference in whether or not your business sells. Is there any reason you wouldn’t want a better understanding of how your business will be valued by buyers?
Contact us today to schedule a free consultation.