Common Financial Mistakes Business Owners Make Before a Sale — and How to Fix Them
Issues with financials can quickly become a roadblock to a successful sale
By Bob House President, BizBuySell@bizbuysell
They say there is no better time than the present — and for small business owners looking to exit, now is an especially good time to enter the for-sale market. Increasing consumer demand, coupled with lower taxes, helped the U.S. economy grow 4.2 percent in the second quarter, suggesting further gains for the remainder of the year. In addition, BizBuySell’s latest Insights report found a total of 5,383 businesses have sold in the first two quarters of 2018, putting this year on course to break 2017’s record-setting number of transactions.
For small business owners hoping to cash out, however, issues with their financials can quickly become a roadblock to a successful sale. A disorganized record book can turn away potential buyers, who expect complete transparency in order to know exactly what they are getting into. Common financial mistakes that can derail a transaction include:
Tampering with inventory reports. Tasked with managing day-to-day operations and not always held accountable to a partner or stakeholder, a small business owner’s primary focus can be to minimize taxes. “When business owners artificially lower inventory so the cost of their goods increase, it can cause tax issues at the end of the year,” says Andrew Cagnetta, CEO of Transworld Business Advisors, a business brokerage firm with 39 years of experience and over 10,000 businesses sold. Overreporting or underreporting inventory stock, for example, can lead to owners misreporting their taxable income.
Not using a professional bookkeeper or system. With a limited number of resources available, some small business owners try to be their own bookkeeper — despite being unqualified. “[One mistake] is when sellers don’t have a proper accounting system in place to track their income and expenses on a daily basis,” says Steve Zimmerman, CEO and principal broker of the Restaurant Realty Company. Zimmerman operates California’s largest restaurant brokerage firm, whose agents have completed transactions with over 2,000 clients and selling and leasing over 1,000 restaurants in its 22-year history. Without proper book-keeping, it is difficult to get a good understanding of the earning potential of a business opportunity, which buyers will surely want to assess.
Failure to report all cash sales. Sellers can further hurt their value if they intentionally hide any cash transactions, such as pocketing cash from sales to avoid paying income taxes. Ron Johnson, chairman of ABI Business Sales, Mergers and Acquisitions, remarks: “Some business owners neglect to include all income on the revenue line because they won’t report any cash they’ve received.” ABI has managed over 400 transactions in industries like manufacturing and retail, while Johnson has been the intermediary in over 100 transactions since 1991. Since businesses usually sell for a multiple of cash flow (or SDE), it’s in an owner’s best interest to report all income for a multi-year period ahead of sale. A multiple received on that cash flow will generally offset any taxes paid on the higher reported income.
Buyers are becoming more sophisticated and empowered in their search process; like any other big purchase, they want to know the business they buy will generate a return on investment. Beyond attracting potential prospects in an increasingly crowded market, organized financials can help current owners identify what parts of their business need additional work to prepare it for a sale.
The good news for sellers is many of these mistakes are fixable — but getting the record books into shape for a sale takes time and due diligence. “Correcting these records, for a buyer’s comfort, will take at least one to two years to fix, unless any financial variances can be proved immediately,” says Johnson of ABI Business Sales, Mergers and Acquisitions. “Some sellers will need to remove their personal expenses from their business financials and work to ensure their financials match their tax returns.” Business owners should consider hiring an experienced bookkeeper and waiting a minimum of six months for business books to be credible enough for a prospective sale.
Well-kept books can also help prospective buyers qualify for a Small Business Administration loan. “If a business doesn’t have straightforward tax returns or financials, it won’t qualify for an SBA business acquisition loan,” says Matt Coletta, co-founder and managing partner at M&A Business Advisors. Specializing in the confidential sale of privately owned businesses and operating in California, Nevada and Colorado, Coletta also adds: “[Disorganized records] can force sellers to offer seller financing to buyers, prolonging a seller’s exit from complete ownership.”
All signs are pointing to a healthy for-sale market, from a growing economy to baby boomers leaving ownership en masse to a growing economy. On the other hand, financial mistakes and inaccurate bookkeeping can quickly stall a sale as buyers expect transparency from sellers before they invest in a major purchase. If owners are serious about listing, there is no time like the present to begin cleaning up their record books and accounting practices to ensure their small business attracts potential buyers the minute it hits the for-sale market.