One of the most important steps in getting a business ready for sale is preparing for a valuation.
An important step in this process is making sure that the proper Cash Flow adjustments, or “add-backs,” have been made to your annual Net Profit.
While we see lots of questionable cash flow adjustments. This article will focus on three we see very often: Owner Compensation, One-Time Expenses, and Legal Fees.
Cash Flow Adjustments
There are three abuses we frequently see here:
Owner pays him/herself nothing.
Sometimes this is done simply to avoid paying additional taxes. However, any buyer is going to want to account for owner compensation and will wonder why a business couldn’t pay the owner a salary. A buyer will need to account for a salary and unless the seller is 100% absentee, $0 isn’t going to work.
Owner has a relative in the business who either takes no salary or an unreasonable one.
If it’s the former, it may be because he/she is trying to keep the business afloat. That additional salary will harm the company’s profitability. If it’s the latter, it’s simply an inefficient method of taking/distributing additional income.
Remember that buyers are going to want to continue the business after you’re out of the picture. They will probably not get a spouse to work for free nor will they necessarily want to pay a child or relative above market rates. Correct this before a sale.
Owner uses the business as a slush fund…just one or two steps short of (or far beyond) tax fraud.
Alas, this is very common. While new business owners may decide to go wild and “expense everything,” the sign of a mature business is one in which benefits exclusive to the owner are modest.
Season tickets for a sports team that your sales staff use with clients? Reasonable. A private box for your family that none of your staff have access to? Unreasonable.
Excessive personal expenses could give a potential buyer pause in making an offer and could negatively impact your value.
Some sellers like to think of R&D, Marketing, or Advertising for their business as a “one-time” expense. Maybe they tried a new campaign but it didn’t pan out.
To survive, businesses need “one-time” new products or services developed by research and development. They constantly need to be thinking about how to continue to be relevant in the marketplace.
This doesn’t mean big spends or new products or new campaigns every quarter. But it does mean that these should be a regular part of your business expenses and not something you can claim as a one-time expense.
As with the example above, legal fees often have to be accounted for. Now, we aren’t referring to the big ugly case that maybe took a couple of years to get through and was with “that one event” in 30 years.
We’re talking about the fact that your business may need regular legal consultations, whether it’s launching a new product, auditing old business practices, or discussion about future ventures.
Sure, for something out of the ordinary, a “one time expense” is very much appropriate. But legal fees in general? The longer you own a business, the more you realize it’s as regular as rent. And please, don’t let the business pay for your personal legal problems.
Did this article make you uncomfortable? That’s okay! Give us a shout. We’ll help talk you through positive changes you can start making today to make your business more valuable.