A solid exit planning strategy involves much more than hanging a ‘for sale’ sign on your door.

Whether you are passing down your business to a family member, targeting a strategic buyer, or putting your business on the open market, you’ll want to make sure it’s sustainable without you and buyers can readily see its value.

Just because your business has served you well for many years doesn’t mean a buyer will see it the same way. To get the highest possible sale price, you’ll have to put yourself in the buyer’s shoes. Often that involves shifting the way you think about your business.

Buyers will want to see a profitable revenue stream and consistent cash flow, not just how the expenses you claim reduce your tax liability. They’ll be less impressed by how your hands-on approach has made you the sole storehouse of company information, and more interested in whether you have systems and management in place to run the business once you’re gone. They’ll want to know, not just about how your product line sells, but how it measures up to the competition.

Ideally, you’ll want to start planning your exit strategy at least three years before your anticipated exit date. That timeframe might seem long, but you’ll need the time to:

• Make sure market conditions are working in your favor (or wait until they change)
• Implement any changes needed to increase revenues and profitability or cut expenses
• Gather documents and clean up financial recordkeeping
• Groom employees who can keep operations running smoothly without you
• Systematize and memorialize your company’s procedures and processes

Timing is Everything When You’re Selling a Business

As noted, it’s best to give yourself a three-year window, not just to ready your business for sale, but also to make the most of market conditions. If the acquisitions market is strong, you’ll want to strike while the iron is hot. If it isn’t—if the economy is weak, if banks are reluctant to lend, or consumer trends don’t favor your product or services—you might consider waiting for a shift in the cycle that’s more favorable to your goals.

The three-year window will also allow you time to implement changes you might need to improve your bottom line.

Some businesses might need more than three years. Some might need less. Exactly how much lead time you’ll need will also depend on the reasons behind your exit planning.

• When you’re retiring or seeking a lifestyle change. Owners who want to retire, relocate, or have health concerns will be especially sensitive to the price their business can fetch. Timing a sale to market conditions is especially important to these sellers because they want to get maximum value for their business to finance their future.
• Has boredom set in? If you feel you’ve conquered the challenges that once sparked your enthusiasm, or you’ve become distracted by a new idea you’d like to pursue, it’s best not to wait until boredom gets the better of you and your business starts to go downhill.
• Are you facing a down market? If newer trends are overshadowing your products or your business, and sales are trending downward, you’ll want enough time to revamp your product line, restructure, or introduce new technology.

Understand Your Valuation

Businesses are priced based on a multiple of earnings, EBITDA (earnings before interest, taxes, depreciation, and amortization), or, as is the case for most small businesses, seller’s discretionary earnings (SDE).

SDE is the profit a company generates after discretionary expenses (those that a new buyer wouldn’t be required to spend), such as travel expenses or the seller’s personal expenses, are added back to the bottom line.

The multiple used depends on the industry your business is in, your company’s size, and other factors. Most small business sell at a multiple that ranges from one- to three-times SDE.

The bottom line is that you can’t simply assign a price to your business based on what you think it’s worth. If you do the math, and you don’t like the result, you’ll have to put in the time to improve your earnings.

For example, suppose you’ve planned out your retirement on the assumption that your business will fetch $500,000. After you’ve cleaned up your books, your SDE shows earnings of $200,000, and the multiple for your industry and company size is two, establishing your company’s value at $400,000. Unless you can increase your revenues or cut expenses to bring your SDE to $250,000, you’ll be hard pressed to convince buyers to pay the extra $100,000 for your business.

(To get an idea of average earnings multiples different types of businesses will fetch, see our business valuation multiple tables.)

Tighten Up Your Sales Strategies

One way to make buyers feel confident that your business’s future prospects are strong is to show that your sales come from a wide variety of clients. If you’ve been relying on one or two major clients for revenues, look for ways to expand your client base. Strategies to drive repeat business will also show buyers that your revenue streams are dependable. Some examples are printer companies that use subscriptions for toner purchases and cosmetic companies that offer automatic refill plans for products. Consider implementing these types of strategies if your business allows.

Shore Up Your Expenses

Cutting expenses will obviously make your bottom line stronger, but when you are planning your exit, it’s more important to make sure you are getting a return on the money you’re spending.

Are your marketing expenditures paying off in increased business? Do you maintain a roster of advisors because of longstanding relationships, or are they adding value? Have you kept a tight lid on your accounts receivable, or do your books show significant monies owed? Are you overspending on nice-to-haves like lunches for employees? Is your travel reimbursement policy excessive? More than how much you’re spending, buyers want to see that your expenses are well-managed, and they contribute to your company’s success and growth.

Put Your Books in Order

Before you can begin to market your business for sale, you must make sure your financials are clear and understandable to potential buyers, and the documentation to support your records is readily available. Buyers, not to mention their lenders, are going to look closely at your financials, and your recordkeeping must be up to the task.

Keep in mind too that SBA lenders will require three years of financials to approve a loan.

Some changes that can strengthen your financial picture include:

• Switch your accounting methodology. Instead of posting revenue when it’s received and expenses when they are paid (called cash basis accounting), start using what’s called the accrual method—match revenues with the expenses involved in earning it. The objective is to make sure a buyer can look at your books and clearly see and understand what you’ve spent money on and the effect of those expenditures on revenue.
• Recast your financial statements to SDE. Using seller’s discretionary earnings (SDE) is not only the generally accepted accounting method for small businesses, but it also provides buyers with a clear picture of how much money they can pocket from the business.
• Make sure your P&L statements match your tax returns. Nothing raises red flags for buyers more than financial accounting that looks different from one report to the next. SBA lenders require that your P&L statements match your tax returns.
• Conduct a professional audit. A CPA can advise you on the best methodologies and give buyers confidence in your financial reporting.

Put a Management Plan Into Place

The best way to assure prospective buyers that your well-oiled machine will continue to run efficiently is by showing that you have management ready to step in when you’re gone. Identify team members that can take over day-to-day operations and implement any training they might need.

If your business is one that relies on standardized processes and procedures, consider developing manuals for your systems. Written manuals are not only valuable tools for training new employees, they’ll also help prospective buyers better understand your business operations.