For many business owners, that business is their biggest asset, and while they are almost certainly focused on running it as well as they can, they may not realize that there’s an extra set of steps they need to take to maximize its value in the case of a sale or transition – and in some cases, they may actually be driving down its eventual value.
To help business clients steer clear of some of the worst missteps, Stephen Klein, a CPA and partner with New Jersey-based Klatzkin & Co. LLP, put together a list of the 10 biggest value-destroying mistakes he has identified in his 40 years of working with closely held and family-owned businesses.
“Being proactive and taking the necessary steps now to avoid these mistakes will help owners to increase the value of their business while protecting their interests and securing their future,” Klein said.
(You can see a slideshow of this article here.)
Mistake No. 1: Not thinking about a sale -- today. Not running the business like they are going to sell it tomorrow is a big mistake, Klein says. The earlier owners start taking steps to prepare their business for sale, the more they’ll be able to maximize the value they eventually get.
Mistake No. 2: Not planning for trouble.Having a written contingency plan is critical -- if the owner passes away or becomes disabled, their family won’t get as much money for the business or they may have to liquidate it.
Klein suggests preparing a short memo and giving it to a spouse or family members that includes at a minimum whether the business should be sold to family members, key employee(s), an outsider, liquidated or continue to be operated. Owners should also indicate which of the employees are capable of running the business.
Mistake No. 3: Having the wrong entity status. If the business is a C corp, and stays a C corp for tax purposes or doesn’t elect S corp status earlier enough, Klein says the owner will pay more taxes and be left with less cash from the sale of the business. He suggests making an S corporation election for federal and state purposes.
Mistake No. 4: Bad accounting. Not keeping accurate books and records, and not having CPA-prepared financial statements and good internal controls, can kill a sale, especially if the buyer finds material errors when conducting due diligence, Klein notes.
Mistake No. 5: Mis-reporting income and expenses. Not reporting all income, and paying personal expenses through the business, could substantially lower the price that a buyer will be willing to pay, Klein says. Buyers of most businesses pay a multiple of earnings before interest, taxes, depreciation and amortization – not including all income, or including non-business expenses, will lower EBITDA.
Mistake No. 6: Having too many eggs in one basket. Not saving enough in other investments so that the business is not such a large part of the owner’s net worth may leave them without enough assets to retire as comfortably as they would like, Klein warns. Business owners should put as much into their retirement plans as they can, instead of leaving all the earnings in the business. They should also take a salary and distributions if the business is profitable and invest the money outside the business.
Mistake No. 7: Being indispensable. If the business can’t operate without the owner, buyers will be less interested, or want to pay less. As the business grows, Klein suggests cross-training key employees and developing a management team that can operate the business on their own.
Mistake No. 8: Not having an ownership agreement. If a company has partners or co-owners, not having a comprehensive ownership agreement with provisions for the sale of the owners’ interests could leave individual owners (or their heirs) with a lot less value.
Just as important, Klein says, is that co-owners should review the agreement annually and agree on the current value of the company each year, as well as reviewing the buy-sell insurance policies to see that they are sufficient to cover all or a substantial portion of each owner’s interest in the business if their interest had to be purchased.
Mistake No. 9: Not having written policies and procedures. Buyers like and want companies that have written operating policies and procedures that cover the major aspects of the business operations, Klein notes. Not having them may reduce the purchase price.
Mistake No. 10: Not having an exit plan early on. Without creating a written succession/transition and exit plan years in advance, the business owner won’t be able to maximize the after-tax proceeds from the sale of the business, won’t be able minimize the taxes (income and estate), and may not be able to accomplish their non-financial goals or leave on their timetable.
Business owners should engage a professional advisor who specializes in succession and exit planning to work with them and their advisory team (e.g., lawyer, CPA, investment advisor, etc.) to come up with a tailor-made exit strategy.
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