What Should I Fix Before Selling My Business?

We all say in this industry that the best time to prepare is three to five years before you want to sell. The reality is that’s often not something owners do. They’re busy running their businesses. Usually, they come to the realization that they aren’t having fun anymore, they want to do something else, and they’re ready to go.

That doesn’t mean nothing can be done. Even a few months of focused work can make a big difference. The first question is how much time the owner has. Is the timeline required, or is it a preference? If the owner has to sell, waiting to fix an issue may not be an option. If there’s more flexibility, it may make sense to work on the business before going to market.

The three areas I look at first are the financial performance of the business, its customers, and the management team. Those are the big three.

Start with revenue and profit

A declining sales trend is probably the number one thing that kills deals, prevents a business from being sold, or hurts its value. Even if profits are holding up, declining sales send a lot of bad signals.

The flip side is an increasing sales trend. Steady sales are okay, but increasing sales a little bit every year is what you want to see. Buyers also look at the level of profitability, not just the trend. Are profits below industry standards, in line with them, or above them?

Something new can also make the company more valuable in the long run. That could be a new customer, a new product, or a new technology. Timing matters, though. Buyers need to see that the improvement has produced results.

We worked with one business that had long-term contracts that were priced incorrectly. The company had good qualities, but those contracts weren’t profitable. We went to market, and the results weren’t good enough.

The owners waited for the contracts to expire and put new contracts in place at the right prices. The business reached a profit level that made sense for its sales. Once that happened, the number of interested buyers increased, the quality of the buyers improved, and the offers were much better. That led to a successful exit.

Look at what customer concentration actually means

Customer concentration comes up often in the lower middle market. We see businesses where one customer represents 30% of sales, and sometimes 60% or 70%.

It can be difficult to add enough new customers in one to three years to eliminate the concentration. The business may still be sold, but the concentration can affect value and almost certainly affect the terms. An earnout may be tied to that customer staying with the business for a period of time. The deal gets stickier.

It’s also worth looking below the surface. We have had cases where one customer represented a large percentage of the business, but six, seven, or eight independent locations of that customer were purchasing from our client. It was still customer concentration, but it wasn’t as risky as it first appeared.

The right buyer can also change the picture. If one customer represents 50% of a seller’s sales, that’s a serious concentration issue. If the buyer is in the same industry and is ten times larger, that customer’s share of the combined business may be roughly 5%. Finding the right buyer can mitigate a problem that the seller may not be able to fix alone.

Make the business less dependent on you

Owner dependence comes up all the time. Buyers want to know what the owner does now, when the owner wants to leave, how the owner will be replaced, and whether someone inside the organization can step into the role.

For some buyers, it’s not a problem because they plan to bring in their own person. Other buyers won’t make an offer if there isn’t a clear plan and someone already in the wings to replace the owner. Owner dependence affects value, terms, and the number of buyers interested in the business.

We recently looked at a company where the owner was both the lead engineer and the lead salesperson. Other engineers worked in the business, and other people were somewhat involved in sales, but the owner was the reason customers called the company. That business could still be sold, but the owner’s involvement would affect the value and terms.

In a one- to three-year window, the owner should first look inside the organization. Which responsibilities can be handed to other people? If customers call the owner even though the staff handles the transactions, start directing those calls to the staff. Spread the organizational knowledge and relationships among the management team. Bring in new people if needed.

Sometimes owners aren’t willing to give up part of their current profits to solve this problem. For instance, I’ve seen owners act as their own accountant instead of paying $60,000, $75,000, or $80,000 for an in-house accountant. Maybe they don’t even need to spend that much, but the buyer probably isn’t going to perform that work. The buyer will account for the cost of hiring someone and deduct it from the purchase price anyway.

There’s a lot an owner can do within a year. Three years can be enough time to solve much of the issue, if the owner wants to do it. Not everybody does.

Be careful about making big changes too late

Owners sometimes make changes that may be right for the business in the long term but are terrible to make immediately before a sale. The problem is that the change may take years to prove out. In the short term, profits may fall, which can reduce the valuation.

Buyers don’t pay for improvements simply because they’ve been started. They need to see proven results. If a new initiative hasn’t had time to generate visible benefits, the buyer may assign little value to it or offer a future contingent payment such as an earnout.

For example, suppose a project is expected to add $500,000 in annual profit. At a six-times multiple, proven earnings could theoretically add $3 million of value. If the project has only just begun and the profits won’t appear for another six months or a year, the buyer may say that it will be doing the work and taking the risk required to produce those profits. Since the buyer will be doing the work to generate those profits, it may offer the seller 10%, 25%, or perhaps 50% of them through an earnout. The buyer isn’t going to pay the full value of profits that haven’t been proven.

Every situation is different, but the general point is the same: an improvement needs enough time to show results if the seller expects a buyer to pay for it.

Fix it, mitigate it, or be ready to explain it

Not every weakness can be completely fixed before a sale. The owner’s timing determines a lot. If there’s time, even a few months of waiting and working on an issue can make a meaningful difference. If waiting isn’t an option, we look at what can be mitigated and how the issue could be addressed by a buyer.

Sometimes an issue for the seller is an opportunity for the right buyer. The owner may be able to tee up a solution even if there isn’t enough time to carry it through. Customer concentration may be less serious to a much larger buyer. A thin management team may not be a concern to a buyer that already has the right people. The goal is to understand how the issue affects value, terms, and buyer interest, then decide what is realistic.

There are generally two types of owners at this point. One is tired and ready to go. That owner may say, “It is what it is. I’m tired. I’m not going to change this. I’m not going to hire somebody. I’m not going to train anybody.” Assuming it’s still a good business, we work with what we have and find buyers that match what the business offers.

The other owner still has energy and a number in mind. That owner may decide to work on the issues for six months, a year, or two years, then come back to the market. We have seen that happen on a number of occasions.

If you may want to sell in three years, start by looking at the financial trends and profit levels, the customer base, and the management team. Then look for anything else that could affect a sale, such as lawsuits, environmental concerns, or product liability issues. The priorities will be different for every business, but buyers will respond to what has been proven, not simply what the owner intends to improve.