Consider Your End Goals When Completing Your Tax Return

Minimizing income taxes - short term strategy or long term mistake?

Many business owners and their accountants are absolutely fixated on minimizing taxes by showing no income.  But this can be misguided planning for trying to get top dollar when selling  the company. 

 

Business owners need to realize valuation is usually determined by a multiple of identifiable cash flow and that banks make acquisition loans based on tax returns. 

 

Not paying taxes can be a short term strategy that might not pay off at the end!

Do you have small business questions you would like answered about this article or others?  Please visit www.LibertyBusinessBrokersofOntario.com or call 519-903-7807. 

William Sivell is the Owner and Broker of Record of Liberty Business Brokers of Ontario; his blog appears every Tuesday.

 

 

The Hard Truth: What Your Business is REALLY Worth

The danger in thinking your business is worth more than it is—plus tips to increase its value

Equipment and inventory are tangible assets required to generate sales and earnings. They are certainly critical to many business operations. But when it comes to determining a business' value, the hard truth about hard assets is that they make no difference.

What really matters is the cash flow generated from these and other operating assets. Yet, so many business owners believe there is some mysterious process that will allow them to add the value of these assets to their grand total when it comes time to sell.

The danger with setting an inflated asking price is that your business may be passed over by good, qualified buyers. The longer it its on the shelf, the less appealing it becomes. You also open yourself up to experienced buyers leveraging an inflated price to get the upper hand during the negotiating process.

Why the "add on" philosophy doesn't make sense

Consider the following examples of two businesses.

The first is a trucking company with $500,000 in trucks and dispatch equipment, all of which it needed to run the business. The second is a roofing company with a small number of employees and only $45,000 in inventory and equipment.

The trucking company generates $200,000 in cash flow, whereas the roofing business earns $800,000. Even though the trucking company has more hard assets, most buyers would find the roofing business much more attractive because of its far stronger cash flow.

Proponents of the "add-on" philosophy would argue that if the above two businesses each had a cash flow of $300,000, the trucking company would justify a higher price. But this doesn't make good business sense. Ask yourself, would you pay more for the same level of earnings?

Knowledgeable buyers are interested in cash flow and cash flow alone. They will insist that the assets needed to generate that cash flow are included in the sale price.

The level of inventory will have virtually no impact on value. Business owners often try to rationalize this "add-on" logic because their inventory fluctuates throughout the year. Unfortunately, this method increases the risk for any given business. The inventory at closing may not be enough to support the cash flow, thus requiring the buyer to invest within to support the business.

At best, adding inventory to the price of a business increases the risk that the buyer won't get their expected rate of return on their investment. At worst, this method could lead to business failure because the firm will be undercapitalized and unable to acquire additional funds to buy the necessary inventory.

The reality for many businesses is that there aren't significant variations in the amount of inventory that they carry throughout the year. Those businesses that do tend to see those fluctuations only during a few months of the year, such as holiday seasons. It's not that difficult to determine the inventory that should be included in the price to support the annual gross sales and cash flow.

Exceptions to the rule

There are some situations in which assets are considered in valuing the business. Equipment, inventory and other assets are considered when a company is being sold under less-than-ideal conditions, such as when it has no profits or cash flow. In those cases, assets would be used to determine the value of the business. Problems then arise in establishing the worth of those items. Typically, buyers aren't interested in these businesses because the seller already has proven that the company hasn't made a profit.

But for the most part, cash flow is crucial to building value.

Three ways to increase cash flow

1. Stay active and focused: Countless owners have watched profitability slip away as they became more interested in the next stage of their life. Get active in the development of key employees, because they will be the catalyst for driving sales, operational efficiencies and customer satisfaction. Plus, stay focused on limiting your role in the day-to-day operations of your business. The less customers need you personally, the better the chance for growth.

2. Build a bigger mousetrap: Size matters. Find ways to add sales volume. By opening new geographic markets, you may be able to take advantage of organizational synergies and build a larger volume of customers and sales. Alternatively, look to introduce new products or services you may sell to existing customers and build some depth with folks with whom you already have a relationship. Finally, similar to many businesses, you may find building market share by adding new customers as the most logical step for sales growth.

3. Operate on the cheap: There is little glory in finding more cost-efficient ways of doing things, but these often deliver the quickest road to prosperity. You should regularly review and challenge your suppliers to ensure you're getting competitive pricing in areas such as rent, insurance, utilities, wholesale goods and office supplies. Remember: a dollar saved on operating expenses goes directly to cash flow.

Buyers are looking for businesses with positive cash flow. By focusing your efforts to build value through improved cash flow, you will improve the day-to-day operation of your business, enjoy a higher selling price and improve the likelihood of a successful transaction.

Do you have a small business question you would like answered about this article or othersBill Sivell is a Business Broker with VR Windsor Inc., which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. He blogs about selling businesses at Maxbizvalue.blogspot.ca

 

Buyers and Sellers Usually Have a Different View of Value

Most business owners think their business should be priced more than it’s worth – mainly because of all of their hard work over the years.

What they need to realize is there are certain economics and realities that dictate the price.

Besides the various methods of business valuation, the cash flow ultimately must provide the new owner a return on cash investment, ability to service debt and a reasonable salary for the owner and/or manager.

One of the most effective methods of getting to this number is the “cash flow” method, which takes the business’s net profit and combines it with the owner’s salary and personal perks. Plus interest and depreciation. Buyers are typically comfortable with this method because when they are buying a business, what they are really buying is its cash flow.

What can be a challenge is to agree on a multiplier that both the buyer and the seller are comfortable with. To illustrate, consider a recent business deal where the seller was marketing his advertising business that was cash flowing $300,000 for $750,000 which represents a 2.5 multiple of cash flow. The Buyer was prepared to pay a 2.2 multiple for cash flows which would result in a sale price of $660,000. You can see a small variation in multiple can have a dramatic effect on value.

What is common is neither side is necessarily incorrect in their analysis. The seller appropriately considered their diversified customer base, key personnel, market share and longevity in the market place. The buyer correctly reviewed the level of cash invested and rate of return on alternative investment choices, the cost associated with the transition and the type of industry.

In this case there are many ways to bridge the gap, however, too many business owners find major disappointment because the marketplace has not accepted their asking price. They must remember the value of their business is what a buyer is willing to pay and they are willing to accept.

Do you have a small business question you would like answered about this article or other

Bill Sivell is a Business Broker with VR Windsor Inc., which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. He blogs about selling businesses at Maxbizvalue.blogspot.ca

 

Good Profit Margins Are What It's All About

Too many business owners are scared to death to raise prices for fear of losing customers.

In many cases, competition does make it difficult.  But there are many situations if business owners would do some research, they would find out there isn’t as much resistance as they thought.  And when they finally raise prices, they find out they lose very few customers and make a lot more money (also increase the value of the business).

Don’t wait too long.

Start by…

·         Check out you competition, have they adjusted pricing in the past 6-12 months.

·         Connect with a similar business that operates out of town, what sort of adjustments have they made to their prices

·         Do the math, if you are a restaurant owner, have you measured the impact of increases in food costs to your cost of goods sold, if you have vehicles in your business, have you considered how gas prices have impacted your overall expenses.

·         Be creative, many businesses have found ways to creatively increase prices through surcharges, add-ons, and value added services. 

·         Warn your customers in advance.  A well formulated letter can help communicate your future increase, plus can provide a marketable point of contact.  Who says you can’t offer an incentive to your customers for buying now, versus waiting till prices are higher?

·         Do what you say.  Raise prices in an orderly fashion, as you have promised.  Be systematic; ask for feedback from your front-line staff and customers.  You will learn lots from what they say.

·         Be patient and track results.  In a short time you will realize you have made a good decision, and make amendments where you need to.

Bottom-line, healthy profits margins make business owners more money, and help increase a business’ value.  You will make your business more marketable to buyers and increase the likelihood of a successful transfer when the time is right for you to sell. 

Do you have small business questions you would like answered about this article or others?  Please visit www.VRWindsor.com or call 519-903-7807. 

William Sivell is a sales representative of VR Windsor Inc., Business Brokerage; his blog appears every Tuesday.

 

Unlocking the Mystery of the Business Multiple

Establishing a price to market a Business is not an exact science. 

There are many different methods such as the Asset Valuation Method, Critical Factors Method, Debt Capacity Method, etc. whereby different experts can come up with different opinions.

However, if identifying a Business' value is not an exact science, it really should not be too complex?  It isn't! 

The reality is that what motivates most buyers to purchase a Business is the opportunity to earn the income the Business is generating.  We believe that the Cash Flow Method is the most practical way to establish a Business' value.

As part of the Cash Flow Method's calculations, it utilizes a vague and ambiguous term called a Multiple.  Let me explain what this term means.

Most people are familiar with the term "Cap Rate" which is short for Capitalization Rate which is commonly used to help establish the value of income producing Real Property.  For income producing Businesses, a Multiple is the exact same, but only in reverse. 

In laymen's language, the term Multiple means that a business selling for a 1.5 Multiple will generate a 66% Return on Investment for the Buyer.  A Business that sells at a 4.0 Multiple would offer the Buyer a 25% Return on Investment.  A 2.5 Multiple represents a 40% Return.

There are a number of factors that can positively or negatively affect a Business' Multiple. An example of a few are:

Asset or Stock Sale		Barriers to Entry
Cash or Terms being offered		Type of Industry
Customer Base		Demand for Product
Environmental Risk		Excess Earnings
Franchise or Independent		Key Personnel
Length of Operation		Location, Lease and Rent
Market Share		Proprietary Product
Social Desirability		Stability of Income
Stability of Revenue,		Condition of Furniture, Fixtures and Equipment

Like most property owners, many Business Sellers feel that their Business is unlike any other.  They are usually correct.  However, that is not reason enough to justify a higher Multiple.  Most of the time, what generates a higher Multiple is a Business with Excess Earnings, Key Personnel in place, or a Proprietary Product.

Do you have a small business question you would like answered about this article or others?

Bill Sivell is a salesperson with VR Windsor Inc. [www.vrwindsor.com] 519-903-7807, which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. His blog appears every Tuesday.

 

Why Launch a Business When You Can Buy One?

You can minimize the risks associated with starting a business from scratch by purchasing an existing one. Here are four reasons why. 

At one point or another, most of us have experienced the urge to do something entrepreneurial. The chance to be master of your destiny and your investments can be alluring.

It can also be very frightening! We’ve all read about the high failure rates for new startup businesses. 

The reasons for this reality are numerous. Insufficient operating capital, bad management, incompetence, strong competition, weak customer base, poor business concept or even just plain bad luck highlight the long list of things that can be detrimental to any new business. Furthermore, new business owners need to manage a multitude of details, such as product and service positioning, branding, marketing, employee hiring and training, site location, choosing vendors and establishing terms, to name just a few. Even when all the stars are aligned and correct decisions are made, it can be months or even years before a startup begins to see positive cash flow. 

Imagine if the potential pitfalls of a startup could be significantly reduced for you as a business owner. Well, they can! By purchasing an existing business instead of trying to start one from scratch, a buyer can dramatically minimize the risks associated with startups.

Benefit #1 - Make money on Day 1: Successful existing businesses have a proven track record of profits that generally continue long after the business has been sold.

Unlike most startups, you will be making money on your new business the day you take over. Plus, in many cases business buyers have different skills and expertise than the exiting seller. As the new owner, you can take the business to even higher profitability by incorporating new ideas, know-how and energy. This can be advantageous for entrepreneurs who envision opportunities to explore an innovative product, new market or technology. And the existing cash flow can help fund their new ideas.

Benefit #2 – Stay focused on your long-term goals: Taking on a business with a well-known name, location, product mix, knowledgeable employees, etc. will enable a new owner to focus on long-range strategic planning rather than day-to-day minutiae.   

There will be no suffering through an extensive startup period as you struggle to attract customers to your business. Existing business owners will tell you at great length the sacrifice they made in the early years as they literally took responsibility for every job in their business. You can avoid months, and sometimes years, of long hours, marketing failures, unpredictable revenue and expenses most typically associated with startups. Existing businesses with a history of success have already identified an ideal pricing model and marketing formula, and boast experienced employees and a company culture which can take years to figure out successfully. While there will be potholes to avoid along the way, as a new buyer you can dedicate most of your time to building new product lines, customers, or technologies.

Benefit #3 – Leverage your buying potential: Existing businesses can be very attractive because buyers are typically able to use the seller’s financing to leverage their purchase.

A major reason for startup failure is a lack of capital, which is often a result of limited available financing and the inability to predict the amount of capital required. Seller financing can resolve both issues. In other words, with only a pre-determined portion of the asking price down, buyers can use the cash flow from the business to pay off the seller over a negotiated period of time. This ensures that the buyer can minimize their up-front investment, maximize the bang for their investment dollar, and share some of the risk with the seller by ensuring they have a vested interest in your success.

Benefit #4 – Get training through a transition period: A new owner can negotiate a time frame within which the previous owner will stick around to ensure a smooth transition.

Whether or not you’re familiar with the industry, the market or the business you are buying, having the support of the one person who knows these things best can prove invaluable. In many cases, business owners recognize they can add value and marketability by providing for a transitional training period. Not to mention the importance of the business’ legacy, which will give the current owners further motivation to help during the changeover. Additionally, the issue of seller financing will ensure the sellers want to do everything they can to ensure the success of the new owner.

Once you’ve decided to buy a business, the question then becomes which one.

After narrowing your choices to a manageable few, take your time to make sure you can comfortably see yourself in the shoes of the former owner. You should be able to get an intimate understanding of the owner’s motivations for selling and have a chance to review information regarding the financial performance, staffing, facilities, equipment, inventory, product lines and customer base of the business.

Then take the next, and often most difficult step: make an offer!

Do you have a small business question you would like answered about this article or others?

Bill Sivell is a salesperson with VR Windsor Inc. [www.vrwindsor.com] 519-903-7807, which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. His blog appears every Tuesday.

 

Excessive personal expenses can lower business value!

It’s not uncommon to find business owners who take advantage of the perks of owning their own business.  Who would blame them?  In many cases the very idea of being able to “write-off” some personal meals, car insurance, travel, etc. is a driving force to being your own boss.

However, burying excessive personal expenses in the business financials can lower business value!

The most popular method of valuing a business uses a multiple of earnings over a period of years.  Business owners should be aware of that while attempting to reduce the bottom line with personal expenses to minimize taxes.  Though there are a number of deductions that may be added back to determine true cash flow, not all add-backs are considered legitimate by buyers or lenders.

Common personal expenses are auto & auto insurance, health insurance, life insurance, meals & entertainment, office supplies, phones, subscriptions, and travel.  Most buyers understand these, and more. 

The difficult challenge is to determine what is excessive. 

First, you must document and be able to corroborate your expenses to buyers.  Recently a seller couriered a shipment of antiquities from South America and expensed the cost in his retail business.  It is not a strong enough explanation to suggest an allocation of freight expense as personal without receipts and proof purchase.  Most buyers will assume freight cost in retail outlet are the costs of doing business.

Second, there must be a clear distinction between personal and business.  It may be difficult for a buyer to rationalize 100% of the meals & entertainment expense being personal.   To suggest that all luncheon expenses are with family and friends when the owners business is wholesale sales of construction supplies may be considered unreasonable to a buyer.  Most buyers will assume that some portion, if not all, of that expense is to meet clients and build relationship with their customers.

Finally, sellers must understand the more difficult they make it for buyers to understand what they are buying, and perhaps more importantly, the more sellers cause buyers to doubt the legitimacy and accuracy of the financial details the more difficult they will find it to maximize their value.  And, make it less likely for a successful transaction.

By securing the services of a good business broker to help the seller navigate through these issues can be good preventative medicine.  A qualified facilitator will help to ensure these potential potholes are covered. 

Do you have a small business question you would like answered about this article or others?

Bill Sivell is a salesperson with VR Windsor Inc. [www.vrwindsor.com] 519-903-7807, which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. His blog appears every Tuesday.

 

 

How much is your business worth?

There are many methods for establishing business value. But only one gets to the heart of what a buyer is willing to pay

When you decide to sell your company, establishing fair market value is one of the most difficult issues a small business owner must face. There are so many options involved in valuating a business—the capitalization rate method, the debt capacity method, the critical factors method. But the reality is a business is worth what a buyer is willing to pay and a seller is willing to accept.

One of the most effective methods of getting to this number is the “cash flow” method, which takes the business’s net profit and combines it with the owner’s salary and personal perks. Plus interest and depreciation. Buyers are typically comfortable with this method because when they are buying a business, what they are really buying is its cash flow.

When a company’s cash flow is identified, different multipliers can be applied to then determine a fair market range for the business. A business multiple is a measure of return on investment.  Most people are familiar with the term “capitalization rate,” which is commonly used to establish the value of income-producing real property (the land and anything attached to it).

For income-producing businesses a multiple is the same, but inversely related. A business selling for a multiple of 1.5 would generate a 66% return on investment for a buyer, while a business selling for a multiple of 4 would offer a 25% return. A manufacturing facility, for example, would likely have a higher multiplier than a service business because it’s often easier to enter into many service sectors than to open a manufacturing facility.

One key factor affecting the multiplier is excess earnings.  If you look at two businesses in the same industry, each will have dramatically different multiples if one has a net cash flow of $100,000 and the other has $1,200,000. A good general rule of thumb is that the higher a business’s net cash flow, the higher the multiple.

Many other things can also affect the multiplier, in both positive and negative ways. New product development, strong market share and a diversified customer base (i.e., having no one customer represent more than 10% of sales) can positively impact the multiplier. Conversely, outdated inventory, declining market share and risk that key personnel could leave the business and disrupt operations might have a negative impact.

In addition, business owners frequently don’t give enough consideration to the impact the transaction terms can have on a deal. An all-cash deal or one with a large down payment will give the buyer a reason to expect a discount on the sale price, while a smaller down payment will cause the seller to expect a higher sale price.

For many owners, one of the most troubling aspects of the cash flow method is assets, such as furniture, fixtures, equipment or inventory, are not taken into consideration. While those items do contribute to establishing cash flow, they have limited individual value. There is an exception to this rule: assets are considered when a business is being sold that has no profits or cash flow. Typically, buyers usually aren’t interested in buying these businesses because the seller has proven that the company isn’t profitable, but, in those cases, assets would be used to determine the value of the business.

When an owner is considering selling his or her business, looking at different evaluation methods may have some merit, but the cash flow method tends to be the most practical. Many even find understanding the impacts on value can improve both the desirability and the worth of their business. 

Do you have a small business question you would like answered about this article or others?

Bill Sivell is a salesperson with VR Windsor Inc. [www.vrwindsor.com] 519-903-7807, which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. His blog appears every Tuesday.

"You can't always get what you want"

The title to the 1969 song by the Rolling Stones seems to echo what the market is telling many business owners these days. 

There is no question that prices for many businesses are down and for various reasons.  But if there are offers on the table, a business owner must take a hard look at any offers and be realistic as to what has to change in the business or the economy for the price to go up.

In a recent evaluation of a local  clothing apparel retailer cash flows were $50,000 in each of the past 3 years.  This small business has been in the area for well over 15 years and has branded themselves a bargain retailer with a strong local following and low cost overhead. 

The more recent economic times have hurt this business; however, the owner is 65+ and wants to be able to sell for $300,000.  At that level the sale will fund his retirement plus, based on the capital investments he has made over the past few years, this seems reasonable to recoup some of those investments.

An offer of $115,000 is quickly dismissed without much thought. 

Unfortunately, what needs to be considered are the terms and the prospects of meeting the owner’s expectations. 

The terms of the offer were positioned favourably for the owner who needed only to provide minimal transition training and carry a very small vendor note.  More importantly, if you consider the $300,000 asking price this business would need to increase cash flow by nearly 3 times for buyers to make sense of the rate of return. 

Combine that with the fact that buyers typically take a 3-5 year view of historical performance, makes a successful transaction unlikely.

With the prospect of needing to continue to work a number of years and (perhaps more daunting) work at a pace that will triple current results this business owner might be best suited to work with the offer he has in hand.

Do you have small business questions you would like answered about this article or others?  Please visit www.VRWindsor.com or call 519-903-7807. 

William Sivell is a sales representative of VR Windsor Inc., Business Brokerage; his blog appears every Tuesday.

My business is a Gold Mine!

The statement “with a little sales and marketing, a new owner could make a fortune with my business” has been heard over and over by prospective buyers.

The question of course is: “Mr. Business Owner, why haven’t you made that effort?”

Buyers are not willing to pay the business owner for their future efforts and investment necessary to grow the business.  Business owners must take these steps themselves, which not only will increase their revenues and profits in the short term, but will greatly improve the value of their business. 

Every business owner wants to know, “What is my business worth?”

The short answer is, “Your business is only worth what someone is willing to pay you and what you’re willing to accept.”

The long answer is a little more complicated.  Start by establishing the business’ true profitability.  Buyers typically are comfortable with this method because, at the end of the day, although they are buying a company, what they really are buying is its cash flow.

With an understanding of a business’ actual cash flow, different multipliers can be applied to determine a fair market range of value for the business.  Multipliers vary depending upon the type of business, market share, customer base, and many many more factors.

Therefore, when an owner is considering selling they should turn to a good business broker for assistance.   By allowing a skilled business broker to do their job, owners will get help evaluating their business’ value and be able to concentrate on their job – making their business as profitable as possible.

Do you have small business questions you would like answered about this article or others?  Please visit www.VRWindsor.com or call 519-903-7807. 

William Sivell is a sales representative of VR Windsor Inc., Business Brokerage; his blog appears every Tuesday.

Raise my prices? You gotta be kidding me!

Don’t be a business owner who is afraid of raising prices.

Good profit margins are what it is all about.  Too many business owners are scared to death to raise prices for fear of losing customers.  In many cases, competition does make it difficult.  But there are many situations if business owners would do some research, they would find out there isn’t as much resistance as they thought.  And when they finally raise prices, they find out they lose very few customers and make a lot more money (also increase the value of the business).

Don’t wait too long.

Start by…

·         Check out you competition, have they adjusted pricing in the past 6-12 months.

·         Connect with a similar business that operates out of town, what sort of adjustments have they made to their prices

·         Do the math, if you are a restaurant owner, have you measured the impact of increases in food costs to your cost of goods sold, if you have vehicles in your business, have you considered how gas prices have impacted your overall expenses.

·         Be creative, many businesses have found ways to creatively increase prices through surcharges, add-ons, and value added services. 

·         Warn your customers in advance.  A well formulated letter can help communicate your future increase, plus can provide a marketable point of contact.  Who says you can’t offer an incentive to your customers for buying now, versus waiting till prices are higher?

·         Do what you say.  Raise prices in an orderly fashion, as you have promised.  Be systematic; ask for feedback from your front-line staff and customers.  You will learn lots from what they say.

·         Be patient and track results.  In a short time you will realize you have made a good decision, and make amendments where you need to.

Bottom-line, healthy profits margins make business owners more money, and help increase a business’ value.  You will make your business more marketable to buyers and increase the likelihood of a successful transfer when the time is right for you to sell. 

Do you have small business questions you would like answered about this article or others?  Please visit www.VRWindsor.com or call 519-903-7807. 

William Sivell is a sales representative of VR Windsor Inc., Business Brokerage; his blog appears every Tuesday.