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Ask About Selling Your Service Business

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By | May 25, 2012

Dear Toolkit,

For years I've been building up a personal service business based on helping the elderly manage health insurance claims as well as assisting them in paying their household bills every month. This service is often subsidized by the adult children of my clients. I receive many referrals from both generations so the business has grown to the point where I had to hire an employee to help me. Now I'm ready to retire and I need some advice on how I might go about selling my little business. Can you give me a list of steps to follow?

Senior Service Provider

Dear Senior,

Before you can hang up your spikes (or rather put them on and retire to a golf course), you'll need to do some serious planning. Valuation of your business, identification of potential buyers, timing the sale, and hiring a lawyer and/or business broker are only some of the major projects you're about to undertake. But careful planning at this stage will pay big rewards in just a few weeks or months.

Valuing your business is the first step. What exactly are you selling? Well, you may be selling hard assets such as a computer or file cabinets, but—as a consulting or service business—the core value of your enterprise comes from the goodwill and market contacts you've created over time rather than from the inventory, trademarks, or physical facilities that characterize other types of businesses.

You need to consider (and document) your past track record, your present performance, and the future market potential of your firm and develop a dollar value for the intangible aspects of your operation. And your buyer's emphasis will be on the future component of that mix. A buyer isn't paying for a history lesson!

A good way to start this phase of the project is to clean up your financial statements to maximize value to the prospective buyer's eye. Positive cash flow is the greatest incentive for a buyer, so see what you can do to eliminate from your statements expenses that are particular to yourself. For example, you may draw a big (and well deserved) salary, drive a luxurious company car, or otherwise enjoy perks that a new owner might not find necessary or desirable. Eliminate these items retrospectively to see how much cash flow value may be in danger of being overlooked when a buyer reviews your statements.

Do not concern yourself that your recast statements won't match your tax returns. A careful buyer will want to see both but will understand that small business owners focus on paying the least possible amount of tax while enjoying the maximum benefits of self-employment. Each owner's circumstances and objectives will be different. A new owner must evaluate financial statements based on his or her individual goals. For example, a buyer of your business may have outside income and not need or want a salary or draw, but may wish to enjoy the tax benefits of putting children on the payroll, leasing a fancy office with a dazzling view, or just reinvesting in the growth of the operation itself.

Recasting your financial statements will take care of documenting your past and present, but how will you illustrate future value? The way to attack this challenge is to prepare a formal, written business plan with a succinct executive summary section. This plan should outline future opportunities and how they might be exploited, and it might also include a marketing plan.

In addition to these planning documents, you should consider preparing job descriptions as well as outlines of your business systems and processes and an inventory of equipment as well as any leases or contracts. And, once you've assembled a working draft of these plans and lists, it would be a good idea to run them past your accountant for his or her review and suggestions. And as long as you're doing this clerical housekeeping, tidy up your office, too—wash the windows or buy a nice plant so you'll present a sharp image.

The next logical step is to identify potential buyers. Small business buyers often fall into one of three general classes. Asset-only buyers seek to acquire equipment, inventory, locations, customer lists, touch-and-feel type things at current market value, which is generally far less than your original cost. (A consulting business is not sold on this basis, of course.) Future income stream buyers seek to acquire positive future cash flow based on their confidence in their ability to turn your business plan into reality. Strategic buyers are the most desirable as they seek to acquire an existing going concern that fits into and complements an operation they already have, thereby giving them added value and giving you a higher sales price.

Make a list of potential strategic buyers—small financial planning firms that could use your client base to expand into a new specialty to offer their existing clients, for example. Make a list of potential future income stream buyers—perhaps an individual who was downsized from a corporate career and would like to be in business for him- or herself and who enjoys working with the elderly. An employee might be a future income stream buyer because they would see the value of the business from first-hand knowledge.

Mum's the word, however! Don't be tempted to discuss your intention to sell with your employee, your competition, or your clients. Wait until you've developed your strategy, refined it, discussed it with your accountant and, ideally, retained an experienced lawyer or business broker. Whatever you have to pay these professionals to do it right will be worth it in the end, but be sure to negotiate their fees in advance.

When a buyer appears on the horizon, qualify him by learning as much about him and his financial resources as possible before giving him the details of your business. You don't want to give your confidential data to just anyone. And you need to insist on their confidentiality. You'll be disclosing valuable proprietary information about your clients, fee structure, and operating methods, which your competitors could use to your disadvantage. And if word of a proposed sale gets out prematurely, employees and clients alike may feel insecure and leave for a more stable harbor, thereby decreasing the value of your deal.

Once potential buyers have been identified, you will need to time your exit and decide on a few other issues before going into negotiations. What if a buyer wants you to stay on to consult or run the business for awhile? Are you willing to do that? Are you willing to sign a non-compete agreement promising you won't go into competition with the buyer for a certain number of years? Would you finance part of the purchase price or agree to an earnout deal?

For detailed guidance on how to go about the important and often once-in-a-lifetime process of selling your business, refer to our discussion of Selling Your Business.

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