We recently hosted the first of our “Value Forum” events and one of the great questions that came up from the floor was whether or not businesses only need to think about the “Due Diligence” process when you’re in the process of selling.
For those not familiar with the term, Investopedia defines “Due Diligence” as:
“Due diligence is an investigation or audit of a potential investment or product to confirm all facts, such as reviewing all financial records, plus anything else deemed material. It refers to the care a reasonable person should take before entering into an agreement or a financial transaction with another party. Due diligence can also refer to the investigation a seller does of a buyer; items that may be considered are whether the buyer has adequate resources to complete the purchase, as well as other elements that would affect the acquired entity or the seller after the sale has been completed.”
Here are a couple of tips / good practices for entrepreneurs to consider to make the Due Diligence process more attractive /easier for a potential buyer down the line:
Beware the bully
Sellers will often find themselves facing an array of experienced legal and financial experts who are hell-bent on securing the best price for their client (the purchaser). Considering that a business is probably a significant asset / portion of your wealth, make sure that you have a solid team who will be able to negotiate and push-back against professional advisors to protect your interests.
The buyer and competition
Understand why a buyer is looking to acquire you and whether it will give rise to competition authority intervention. What are the implications post transaction for you, your staff and your clients?
Keep your accounts and taxes up-to-date and clean
As a going-concern, the “core” of your valuation is likely to be based around the status of your finances. If your accounts are not being run professionally and you have outstanding tax liabilities, you will find yourself beat down on price as the purchaser will argue they are making contingencies for matters which might arise down the line. Be confident in the quality of your accounting work.
Are you putting school fees through the business as “training expenses”? Do you have an infrequent drawings / bonus policy where cash exits the business? These are flags which could be held against you during the sales process.
Consider tax implications of your decisions
Sales of assets, pre-sale dividends / distributions, transfers of Intellectual Property (IP) and IP rights assignments can make a material difference to the sale price. While it can be a hard slog, you as the seller would do best to take advice on the tax implications of each decision to help you secure the best price.
Establish and maintain a data “war-room”
How are records stored in your business? How do you prove that you have the clients you claim to have? If your personal computer packs up or is stolen from your car, does your business stop functioning? Where does your CRM and accounting system sit? Do you have details of documentation between you clients / staff / stakeholders?
Some of the tools that many small businesses can consider include Prosper / Copper (CRM), Xero (accounting), SME Snapshot, Atlassian / JIRA boards or other solutions.
Establish an Intellectual Property (IP) strategy early on
If you ask any entrepreneur what their business is worth, they will quickly come up with their dream number which is typically many multiples of current earnings. An unlisted technology business will tell you that they can command a multiple of between 10 and 15 times earnings in some cases but let’s quickly dispel that myth. Technology businesses on the JSE currently trade on the following multiples:
- EOH (4 times forward earnings)
- Silverbridge Holdings (3.2 times earnings)
- ISA (10 times earnings but paying out a 10% dividend yield)
- Capital Appreciation (8 times earnings paying out 4% dividend yield)
- Cognition (7 times earnings with a 13% dividend yield)
Each of these are good solid businesses with proven track records, cash-flows, dividends and institutional shareholder support and in-house IP.
It might be an unpopular for entrepreneurs looking to exit their businesses, but very few will be able to command multiples of earnings greater than 3 once they have netted off transaction fees.
If you are looking to exit on a multiple greater than this, you are going to need to have a clear and documented strategy around Intellectual Property (Trademarks, Patents and proprietary software development).
If you are building proprietary software, a great tool to look at here is BitBucket which allows you to store iterations of your software and record the development landscape.
Document how decisions were taken
More haste and less speed. One audience member commented that in a young business, many decisions were taken off the back of a telephone discussion or a “board meeting” was held over WhatsApp.
If your intention is to be treated like a big business, then try and act like one from the word go. Document and record your board meetings and keep regular records of how decisions were taken. It’s a simple thing but it immediately shows you are serious about good governance.
Time is a factor
There is very little appreciation of the amount of time needed to finalise a transaction. In our example from our Value Forum event, we pointed out that that particular transaction took 18 months from the initial approach to finalization. That requires a lot of time and energy during which the entrepreneur is focusing on the “exit” but needs to keep his eye on the ball with keeping the local operations running squeaky clean.
Need advice around selling a business?
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