A few years ago, based on our team’s collective decades in guiding M&A transactions, we wrote a white paper on vital mistakes to avoid when selling a business:
Since it has been quite some time since we reviewed them here in our Insights articles, I thought I would dust the white paper off and briefly cover these five critical mistakes and how you can dodge them. They are:
Although each of these is serious and needs to be avoided, in order to keep this post from becoming a booklet, I am going to focus my attention on the first one listed, because if you make that mistake, you will most likely make all the others. They all tend to flow from the fact that far too many business owners have no idea what their companies are worth before going to market.
(Read about all five mistakes in detail by downloading our complimentary white paper)
The author Lewis Carroll once said, “If you don't know where you are going, any road will get you there”.
Although this applies to many things in life, it is really demonstrative of this primary exit planning mistake. We hear horror stories all the time from former business owners that accepted the first (and only) offer they received for their company, then realized after the deal closed that they undersold the value of the business and literally, in many cases, left millions on the negotiating table.
The only way to avoid this from happening is to have your company valued by a professional M&A advisory firm BEFORE talking to any buyers. I cannot emphasize this enough.
Your business is the single largest asset you own. If I were to ask you how much your car is worth, you would be able to give me a pretty good idea of it. Same goes for your house – you probably even have a good idea of what your neighbors are getting when they sell.
But do you have any idea what your business is worth? If so, how did you determine that? Most folks rely on uninformed guesses and you don’t want to do that when selling your business.
The Importance of Recasting
Here is what most business owners don’t realize: You have to recast your historic earnings BEFORE doing any valuation calculation. When I meet with clients post-deal close and tape their testimonials, nearly all of them have told me that the most valuable thing they learned at our exit planning conference was the concept of recasting.
So what exactly is recasting and how does it impact your value?
Technically, recasting is the accepted accounting principle of removing or adjusting items on your financial statements that are unrelated to the ongoing business.
It’s likely you have worked hard over the years with your accountants to under-report your earnings for tax purposes, which is perfectly legal and acceptable. But this practice also understates the true value of your company.
Keep in mind one key principle: Professional buyers are buying your future, not your past. The only way to accurately highlight your future profitability is by recasting your historical financials and then project out five years using the new recast baseline as your starting point.
Items removed or adjusted via recasting can be superfluous, excessive, or discretionary expenses, as well as non-recurring revenues and expenses. The recasting process can be quite time-consuming and tedious – but it is vital to the eventual sale of your company.
Let’s take a look at two examples of this in action. We’ll look at Company A and its earnings under two scenarios, one without recast earnings and the other after recasting.
Company A – Non-recast Earnings
Base Year EBITDA (earnings before interest, taxes, depreciation, and amortization) = $350,000
Pro Forma EBITDA Projections over 5 years:
Year 1 = 400,000
Year 2 = 450,000
Year 3 = 500,000
Year 4 = 550,000
Year 5 = 600,000
Using the non-recast pro forma projection, Company A is expected to generate $2.5 million in earnings over the next five years. Not bad. But what happens if we are able to recast $100,000 in non-recurring, non-business related expenses off the base year? Here is how it looks then:
Company A – Recast Earnings
Base Year EBITDA = $450,000 (after recasting)
Pro Forma EBITDA Projections:
Year 1 = 500,000
Year 2 = 550,000
Year 3 = 600,000
Year 4 = 650,000
Year 5 = 700,000
So the recast version of Company A’s earnings depicts the company generating $3 million in earnings. Over the five years, that is an additional $500,000 in earnings for the buyer.
Which of these two scenarios will generate the most interest and which will provide the seller with a better value? Obviously the recast earnings version will.
As you can see, recasting is vital to your sale. You will need help to do this accurately. If you are not using the services of an M&A advisor, you will need the guidance of a CPA that has experience in recasting financials (and not all do).
At a minimum, ensure that any items recast are adequately documented and can be proven to be realistic.
I have bolded this last statement because obviously if your documentation is not in order and defensible, you will naturally fall into the second mistake we listed above: Not having your documents in order!
Hire the Best!
That is why we recommend from the outset of your exit journey that you hire a very reputable, dependable, experienced M&A firm. They will understand the first step they should take is a complete and thorough evaluation of your business and a deep dive into your recastable items.
Avoid the M&A firms out there that say they don’t do an evaluation first because “the market will tell us what your business is worth”. Although this statement is technically correct and valid, how will you know if your company is being valued correctly by buyers if you have no baseline at the outset to work with?
There is a reason why our firm is one of the leading middle market investment banks in North America, having won multiple industry awards including Investment Banking Firm of the Year in 2018, 2017 and 2016, Valuation Firm of the Year in 2015 and 2014, as well as M&A Consulting Firm of the Year in 2013 and 2011.
Being named Valuation Firm of the Year twice is indicative of the quality work our evaluation associates do when valuing a business via the recasting process. There is no room for guessing and cutting the recasting process short. We have skilled folks who are not only well-trained, but also have countless years of experience in valuing businesses.
Again, if you want to learn even more about how to avoid all the mistakes listed above you have two options: Download the entire whitepaper and/or attend a Generational Equity exit planning conference. Our full-day meetings will guide you to a new understanding of not only avoiding mistakes, but doing the process the professional way.
Use the following links to learn more:
Carl Doerksen is the Director of Corporate Development at Generational Equity.
© 2019 Generational Equity, LLC All Rights Reserved
We are extremely pleased with the way Generational Equity handled the sale of our company. Your associates, Tom and Chris, did an outstanding job of getting us (me) through the process.Michael J Polarek, President, Paragon Packaging
We thank you Eric and Generational Equity making our dream come true.Larry Moore, Owner, A Company Portable Restrooms
Bruce and I wanted to take this opportunity to thank Generational Equity for assigning Musa Jagne to our transaction. In Bruce’s words, “Musa did one hell of a job for us!”Karen S. Williams, CFO, BW Manufacturing
Greetings Mike. Thank you for the captivating and compelling presentation you made at the Phoenix presentation last week. Over many years in business yours was the most informative and well-presented presentation, on any subject, that I have ever attended! Your energy and enthusiasm combined with your concise and captivating support of your positions with easily understood examples and data was compelling.Pete L.
Generational Equity educated and informed us – so that we could be on the upside of a good decision (to sell).Bil MacLeslie, CEO, ipHouse
The process was much more involved than I expected and your help, experience and advice was a big factor in making the negotiations go as smoothly as possible.Terry D. Wickman, President, Keytroller
We knew it would be a difficult task to have someone really understand our business and our market, prior to researching a possible buyer, so it was imperative that we found someone of your caliber, with definite proven experience in this area.Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
Thank you again for all your guidance and support. Any company will achieve what they intend, if they have you on their team!Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
We were happy to see the interest in our company and what we cherished has not just a valuable company but an important company to the communities we served in.Larry Moore, Owner, A Company Portable Restrooms
Michael worked tirelessly, He followed every lead meticulously and urgently to make sure nothing was missed.Robert Evans, President and CEO of Mealtracker Dietary Software
I would like to thank you and your firm, Generational Equity, for being our valued advisors in our journey.Bil MacLeslie, CEO, ipHouse
The help you provided us during each step of this process made us feel very comfortable and confident we were selecting the right approach to transition our Company.Andy Graham, Vice President, Modern Heating & Plumbing
I quickly recognized that Don was working for Sharpe Mixers above all else, and held our interests above others.Jay Dinnison, Owner of Sharpe Mixers
I must say that I have never worked with a more driven, competent and focused individual as Don Ho.Jay Dinnison, Owner of Sharpe Mixers
We will highly recommend Generational Equity and Musa Jagne to any business owner about to embark on the same process.Karen S. Williams, CFO, BW Manufacturing
Your wisdom and experience were invaluable to me during this once-in-a-lifetime transaction.Ralph Noblin, President of Noblin & Associates
Generational Equity’s assistance was invaluable in compiling and marketing our business.Bil MacLeslie, CEO, ipHouse
I couldn’t have asked for a better team than Michael and Deborah. We couldn’t have done it without them.Robert Evans, President and CEO of Mealtracker Dietary Software
Tom Staszak is one of the most professional people I have dealt with in my last forty years of business. You’ve got a great group of people and you have built a truly professional organization.Michael J Polarek, President, Paragon Packaging
Thanks again Phil and feel free to have a future client call me if they would like a referral. You are a true professional!Andy Graham, Vice President, Modern Heating & Plumbing
We are very happy with the end result, and are very happy to be able to move forward with all of our future growth plans.Rick Nowak, President/CEO, Kurz Electric Solutions, Inc.
I wanted to write you a quick letter to express our appreciation and our delight on the outcome of helping us through the process of our recent sale. We are very happy with the end result, and are very happy to be able to move forward with all of our future growth plans.Terry D. Wickman, President, Keytroller
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