Successful small and medium businesses are generally forged over a lifetime of trying and perseverance by their owners.

The eventual sale or realisation of a business should therefore be met with careful consideration and diligent planning to ensure that the owners are adequately compensated for their efforts by maximising value achieved on exit.

First and foremost, you should ask yourself the following questions:

1. Why do you want to sell your business?

Contemplate your reason for sale. Whilst retirement or a change of scenery may be compelling, consider your decision with your broader financial and lifestyle goals in mind, and whether a business sale is the most appropriate course of action.

2. Are there operational changes that might alleviate the desire to sell your business?

The desire to sell-up and head for the doors may be alleviated by changes to the operational efficiency and management of the business which permit time away from the ‘coal face’ to focus on other pursuits. This may include the introduction of outside management, select 3rd party investors (as opposed to selling the entire business) or succession of the business within the family as some examples.

3. From what you know about your business and the industry, is now the right time to sell your business?

Timing is another important consideration as to whether industry-specific and broader economic conditions are prime for sale.

Business sale structure, timing, and valuation

Those who are committed to the outright sale of their business should consider the following:

What is being sold and how is it structured?

Selling the whole business or income streams: Business owners need to consider whether the business is to be sold in its entirety, as opposed to ‘breaking off’ specific income streams, IP and/or other assets of the business for sale. This may provide you the option to retain certain aspects of the business, either through the existing structure or in a new special purpose vehicle.

Review licenses and agreements: Next, review to ensure that the licences and agreements necessary for the operation of the business are transferrable to a new owner. Where applicable, the terms of key customer, supplier, lease and other agreements should also be reviewed and (ideally) extended beyond the intended sale period, to provide prospective buyers with additional comfort around the continued operation of the business. This may require the consent of certain customers, suppliers, landlords and other stakeholders to the transfer of existing contracts and agreements which may be in place to a new owner.

Ownership structure: The ownership structure of the business itself is crucial in determining whether the business can be transferred by way of an entity sale (e.g. shares in a company) as opposed to an asset sale. We recommend that a detailed review is carried out to assess the potential for a sale under either method and to understand the CGT, GST and other tax implications, as outcomes can differ significantly from one circumstance to the next.

Findex can assist with this key piece of analysis to ensure that business owners are well informed of your options and potential tax implications before proceeding with the sale of your business. In certain circumstances, owners may require restructuring their affairs to achieve the desired outcome which is a process best managed by an experienced business advisor and taxation specialists.

Timeframe

Whilst the timeframe for a business sale is generally dictated by personal and financial reasons set out above, we generally recommend a minimum period of 12-months preparation in the lead-up to the sale process. This 12-month period is potentially your final window of opportunity to maximise the value of the business before the sales process gets underway.

We recommend this time is used to address the following:

• Document the various systems, processes and other IP of the business into an ‘operating manual’. Often key ‘know-how’ regarding the operation of the business resides with the owner which can be invaluable to an incoming business owner;

• Secure the commitment of key operational staff. People are the lifeblood of an organisation and the retention of experienced staff throughout the sale process can have a significant bearing on the likelihood of the business’ success in the hands of the new owner. This can have a material impact on the overall value realised where the sale is subject to an earnout clause, for example;

• Resolve outstanding legal and/or other compliance issues. Buyers will often undertake their own legal, financial, taxation and other due diligence and will favour prospects with a clean record of compliance.

• Optimise the profitability and valuation of the business. More on this below.

Profitability and business valuation

The key objective (with limited exceptions) of a business sale process is to maximise value for its owners. Valuations are subjective by nature and the preferred valuation ‘methodology’ will differ from one industry to the next. Unsurprisingly however, each methodology will generally involve a metric of revenue, profitability and/or asset value which owners should seek to maximise prior to initiating the sale process.

A common valuation methodology used across various industries is the ‘earnings approach’ which looks to assess the future maintainable earnings (‘FME’) of the business, to which an ‘earnings multiple’ is applied to arrive at an estimated business valuation, as follows:

FME x Earnings Multiple = Business Valuation

It is therefore in the interest of the owners to consider how each factor in the equation can be optimised, let’s discuss.

Future Maintainable Earnings (‘FME’)

As a concept, FME is an estimate of the sustainable profits that a business is able to generate in the future.

The starting point for the calculation of FME is generally the historical financial performance of the business (i.e. profit and loss statement). To arrive at FME, the historical earnings of the business is ‘normalised’ and updated with financial projections and estimates of other events which may affect the financial performance of business in the future.

The process of normalising a profit and loss statement requires the adjustment for:

• Once-off or non-recurring events which may be reflected in the historical earnings. This might include adjusting for the sale of a major capital asset or material and unseasonable interruptions in the normal course of trade (think COVID-19 lockdowns);

• Non-arms length transactions, whereby the market value of certain transactions are substituted in the profit and loss when calculating the normalised profit. Common examples of this arise where:

  • The business owner does not draw a salary from the business, or to the contrary, pays themselves and/or other family members excessive salaries for their roles relative to market;

  • The profit and loss includes private expenses of the owner, such as motor vehicle expenses, travel costs and phone and internet expenses to name a few;

  • The owner also owns the business premises and does not command a market rate of rent from the business;

• Interest, taxation, depreciation and amortisation. These charges are often eliminated so that the operating profit of the business can be analysed irrespective of the capital and finance structure of the owner.

Earnings Multiple

The earnings multiple is a financial metric used to assess the risk of return associated with a particular business. Multiples are generally determined by reference to comparable transactions and will vary in accordance with the size of the business and particular industry and location(s) that the business operates in, among a myriad of other factors.

Owners can look to maximise the earnings multiple by ‘de-risking’ the future returns of the business in the eyes of a prospective buyer. This can be achieved by working with an experienced business advisor to:

• Diversify the revenue streams of the business;

• Retain and empower key staff and reduce reliance on you for the successful operation of the business;

• Reduce the concentration of major customers and reliance on few or single key suppliers;

• Increase brand awareness and customer loyalty;

• Demonstrate an increased future earnings potential for the business such as through the adoption of new technology and entrance to emerging markets.

Business Valuation

The business valuation calculated under the earnings approach will generally encapsulate all of the core elements required to operate the business, including stock, plant and equipment, employees, IP and other assets.

Contemplate the extraction of surplus assets from the business such as excess cash, personal use assets (e.g. motor vehicles) and related-party loans in certain circumstances. We suggest working with an experienced business advisor to ensure that the business is structured appropriately for sale and unintended tax consequences are not triggered on exit.

Findex can assist with determining the most appropriate valuation method for a business and provide valuation services to ensure that owners are taking their business to market with an informed view of the estimated proceeds to be realised upon sale.

Post-business sale

Following the successful completion of a business sale, owners should turn their attention to the potential application of the small business capital gains tax (‘CGT’) concessions which, if successfully utilised, may exempt or otherwise reduce the tax payable on the sale of the business to Nil.

The small business CGT concessions are a complex area of law which require review by an experienced taxation specialist to ensure that the necessary criteria and steps are satisfied for the successful application of relief. Serious tax consequences may arise where the concessions are not correctly applied and administered.

Get support through business and tax specialists

Selling your business represents the culmination of years of hard work, dedication, and strategic planning. With its experienced team of business advisors and taxation specialists, Findex can assist you with comprehensive advice and support throughout the business sale process, including an intensive review period in preparation for the sale. This may include a suite of services such as:

• Detailed analysis of normalised EBITDA and future maintainable earnings;

• Rolling 3-way forecast including 12 – 36 month projected profit and loss, balance sheet and cashflow statement to demonstrate the future earnings potential of the business;

• Management reporting and benchmarking analysis to closely monitor the financial performance of the business against industry peers;

• Business strategy and planning review including analysis and recommendations for improvement;

• Valuation services;

• Taxation advice, including the application of the small business CGT concessions available to SME business owners.

Enquire today for a complimentary and fully confidential discussion regarding the health of your business and maximising value upon sale with an expert local Business Advisor.

The views and opinions expressed in this article are those of the author/s and do not necessarily reflect the thought or position of Findex.

This document contains general information and is not intended to constitute legal or taxation advice. If you need legal or taxation advice, we recommend you speak to a qualified adviser.