Ep 170: Data room first: exit readiness starts 24 months early

0:00Welcome to the Holistic Accountant Podcast. This is where we cut through conventional accounting and show you how a genuinely holistic approach drives better after-tax outcomes. It's not about ticking boxes or churning out tax returns, it's about strategic advice that builds lasting wealth. If you find this episode valuable, leave a rating and share it with someone who will benefit. Okay, today men and I would like to talk about getting ready for a sale and not necessarily into the extent that you might be thinking in terms of looking for a buyer and building the business ready to sell all those sorts of things, which we have discussed in this podcast before and those things are important. But it's really about getting ready for the sales process and more specifically the due diligence process that a potential buyer is going to conduct. Now, there used to be these things called data rooms. This was invented really before the internet. You know, when someone went to sell their business, normally the potential buyers would want to do some due diligence on their books and look at their legal agreements, all those sorts of things. So what they used to do is

1:04actually physically lock people in a room where this information existed and that's what they call a data room. Of course, now all of that stuff can happen online and all I'm doing by mentioning it is showing my age. But that's what we want to talk about today is how to get this data room right, how to get your data all organized because if it looks messy or you don't have the information at your fingertips, you know, it could put a buyer off. And also, it's not something that you necessarily need to start pulling together in sort of 90 days out of receiving potential first round offers. It's something that you might need to start really thinking about perhaps one or even two years in advance of starting that sales process. And so that's what we want to talk about today. And let's kick it off, Mena, because let's start by sort of exploring that point that a lot of sellers leave it too late. That's right. And the thing that I want to sort of emphasize here is that the deal itself doesn't create the value, whereas the preparation does. So if you have a clean

2:04structure, a clean set of books, you've got sort of low key person risk, you're going to attract a much higher multiple for your business because if you're thinking about it from push yourself in the buy issues, that is, you want to walk into a business where the systems and processes are all documented this statement. There's a standard operating procedures for every sort of process in the business. You're not worried about one particular individual being in or out of the business. It's more so that you're walking in the business as well structured. It's clean. You know exactly what the business is doing and where you can improve. Now, there's a lot of people out there that would, for example, that's called for tax purposes, would not present a clean set of accounts as an example or not have a clean set of accounts for a number of years. Now, that diminishes the value of your business, of course. Or they might, for example, incorporate personal expenses that would otherwise be deductible in their personal names within the business. Where in your buyer, it's hard to distinguish those expenses at times. So you need to make sure that what you're presenting is nice, clean, presentable, ensuring that whatever is in the sales and expenses of

3:09your P&L is truly representative of the business and its operation. So Stuart, what are buyers actually buying when they look at a business? I mean, this is a question we always ask our clients to focus on because we can get really bogged down in the detail and as nerdy accountants, that's really easier for us to do in terms of pulling a part of P&L or a balance sheet or looking at debt as listings, these sorts of things. But at the end of the day, we've got to remind ourselves what do purchases pay for? And really, the value of a business is really only influenced by two things, risk and growth. So we know what the cash flows are this year. How will they change over time? That's growth or they could decline. That's a risk too. And then risk is really how likely is that that those cash flows will persist into the future? And how predictable will they be? And if you can attack those two characteristics, risk and growth and prove to a buyer, this is a high growth business with very low risk, that's the best way to increase your sales values. So you know,

4:14things like predictable cash flows. So what we want to do is give them all the information that demonstrates that cash flow is predictable. So for example, if you had a whole bunch of clients and you didn't have too much client concentration, so for example, your top 10 clients made up say less than 10% of total revenues, that would be good or top 20 clients less 10%. Then you want to point that out. You want to give, make it obvious, give them up to date client listing so that you can present to that potential purchaser, hey, this is low risk. Or if you do have a high value customer, get them into a some sort of legal arrangement where you can hopefully provide a little bit more certainty to a purchaser. So that is, you know, looking, relooking at your customer agreements and the length of those agreements. Also, they're buying systems, hopefully transferable systems, you know, because at the end of the day, they don't want to have to go and reinvent the wheel, they don't want to have to go and build a business. That's a whole point of going out and buying something that already exists. But you want those systems really transferable, which means that

5:18somewhere all those systems are documented and that it's really about training. Once someone, you can hire someone, you can train them on their systems and then they can run those systems. That is truly a transferable system, whereas a lot of us operate businesses where a lot of that knowledge sits inside someone's head within that business. And it's not just one person, it could be, there might be five or six key people that really understand the systems and processes. Well, that's not transferable. Next thing is to think about risks. So how can you, what information can you provide to demonstrate to that potential purchaser? It's, it's low risk. Do you have supplier agreements that give people comfort over, you know, what the input cost will be and that they're manageable? Customer agreements, how tight are they? Employee agreements and arrangements, how tight are they? So it just depends on the type of business and the income and expense elements and the key levers within a given business, but it's really about thinking through what information

6:19can you provide to a purchaser that demonstrates it is a low risk. And what we're talking about risk is how predictable is that future surplus cash flow? So really it's future profitability of the business. And if those things don't exist, so if you don't have really robust up-to-date customer agreements, get all customers to sign new agreements. And this is why we say that it's a process that should start probably around two years out at least not shorter than one year out because if you if you want to go ahead and do something like that, it's going to take time. And lastly, think about key person risks. So again, if if you as the owner complete certain tasks or key tasks or the information sits inside your head, then you're going to be the biggest impediment in maximizing your sale. When you want to make sure is all you're doing is selling a customer list, some good wheels, some intellectual property, some documented processes, they're the assets of the business that you can sell and transfer to a new owner and that aren't attached to any particular team member in your business. That's how you're going to maximize the value. So it's all well and

7:23good to maximize the value, but we want to keep as much of that value as possible, which obviously comes to something you love, which is paying tax. Not sure loves the word for it, but I want to talk about an actual real life example that we use for one of our clients. Now this client, we knew that was going to sort of retire in the next sort of three to five years. So what we did was restructuring his affairs. He had a lot of personal expenses going through the business. Now these personal expenses are otherwise deductible, but just could be deductible to him personally. So what we did is we extracted these expenses and made sure that they're actually representative in his personal return rather than business returns. Now these were totally discretionary expenses. So it's not like all manipulating the accounts. It was also the fact that for example, it was a travel expense for a conference that the gentleman went to overseas. Now that's not something typical that would be recurring in nature for a business, but at least that way we've claimed the expense personally, but not represented in the business account. So we can easily

8:24establish what the maintainable earnings of that business was. So then that in that way, then the multiple is improved a whole lot more. Now what we also did is the fact that he wasn't going to be able to access the small business CGT concessions in three to five years span. He was receiving an inheritance. The property values were on the uplift. So if we had waited for when the sale had actually occurred, he wouldn't he would have breached a six million dollar net asset cap and not been able to access the small business CGT concessions. So what we did was because he was so poorly structured now, we actually sold his business now to himself. We sold it he had individually owned the shares. We sold it to to a trust. Now everything's above board because you can always sell shares. You're selling it to a different legal owner. We actually represented it and accounted for all the CGT. However, we used the small business CGT concessions. So as a result, we not only got an uplift in the cost base, but we used a small business CGT concessions right after total gain. And when he did actually subsequently sell his business, the tax savings were

9:27amounted to almost about half a million dollars. Now that was a significant, significant win for that gentleman. And he was actually able to maximize these after tax proceeds. So the thought process started about three years before he actually decided to sell. And this is why it's really important to get your affairs ready well and truly before you actually looking to sell your own business. So to do it, what's some of the information that we need to start collecting? Well, I don't want to bore everyone to death by giving listeners a huge checklist at the moment. I might just touch on some of the financial information and then I'll get you to talk about some of the operational stuff. Okay, so of course we want to start with the profit and loss statement. Normally, we want three years. If they're going to do due diligence, go back further than that's possible. But normally the last three years, remember, a purchase is more concerned about what future expected profitability is rather than what happened, you know, beyond three years ago. We certainly want to produce a normalized bidder calculation. EBITDA is an acronym that stands for

10:29earnings before interest and tax depreciation amortization. So what it's trying to do is eliminate how the entity is taxed because that's an ownership structure decision and how the entity's finance, particularly how the assets are financed as well. And that's an interest and depreciation decision. They're both decisions sort of rests with the owner of course. What we want to do, the EBITDA is is really giving us a picture of the underlying profitability and more correctly the cash flow before interest and tax that we should expect. As I touched on before, we'd look at revenue concentration by customer. So again, what we want to do is if there is concentration, we want to mitigate as much as possible through, you know, relationships, agreements, these sorts of things. But if it's not, if it's very diversified, we want to highlight that. Margin trends and explanations. So if we've had tighter margins in particular periods, we want to highlight that and explain it away and demonstrate why that is once off event or impacted by

11:29a particular scenario situation rather than expected to be experienced ongoing. And working capital, now this is obviously important for a business that requires working capital. Of course, if you've got a positive cash flow business, that might not be necessary. And also businesses that might be seasonal, for example, you know, where all your cash flow comes in a small part of the year or where there's a lot of assets within a business as well. They're going to want to see all bass payroll, lodgements, super contributions, all those sorts of things. They want to make sure that your tax compliance is up to date, everything lodged on time. They're going to look at all contracts, whether it's leases, higher purchases, employee contracts, customer contracts, anything related to intellectual property, shareholders agreements, a constitution if they actually buying the shares of the particular entity, all those sorts of things. So that's just a broad list of all the financial information. Remember, we're trying to sell the business and as I said previously, what we're trying to do is demonstrate or hit on those factors risk and

12:34growth. So don't look at it as an exercise, a laborious exercise to collate all this information. There's just a painful process. Look, it is a painful process. But ultimately, how you put that information together and what information you put together will certainly help maximize the result. So there's a sort of financial information, but there's a lot of operational stuff that we can add into this data room that's going to help us with the risk and growth situation, which I might invite men to talk about. So the first thing to do is start with the key person risks that your business presents. So if you as the owner or even an employee are the top salesperson or an operations bottleneck or their relationship holder with your key clientele, then the buyer's going to severely discount the business and the process, then the price they give you. Sorry. So it's really important to implement some practical fixes to this. So it could be things such as documenting standard operating processes or SOPs, install or invite or empower employees to be

13:35sort of a second tier level of leadership so that empower them to make those decisions, transfer those relationships and help build a recurring revenue in the business. So it's not all-reline on one particularly individual. Now this is particularly the case for service-based businesses where you don't have really a product to sell, but it's all about the relationship. Now it's these types of businesses that tend to suffer the most when it comes to EBITDA multiples because people or buyers are weary of the fact that the value is in the relationship itself rather than the rather than the product being being sold. So systemization is what makes your business transferable. It's what gives your business value. So it's really important to document your processes, have KPI dashboards that can be easily sort of transferred to the new owner that they can understand and still implement and run with. You need to have an a delegated authority framework that would allow sort of employees to empower or empower the employees to be able to sort of make decisions at their levels or in their respective departments.

14:37Have a CRM that sort of documents and has all your customer contacts and details because if all lies with you as the owner or a handful of employees, then the buyer is going to be a bit weary about that and have a signed client contract. So the more that you've actually got documented and the more that the clients are sort of invested in your business or entwined in your business, then the buyer is going to have some certainty around the degree of revenue in your business. And then finally focus on your supplier agreements. Now a lot of people or a lot of businesses might just have personal relationships because they've been working together for 20, 30 odd years. They might have preferential sort of supplier pricing. So it's really important to put these agreements in place to give the buyer some assurance around what they're buying. So as you can see, there's quite a complex and thorough process and again, what we don't want to do is try and cut corners because ultimately that could come at the cost of, you know, taking a haircut on the sales price. But hopefully what you've learnt from today's episode is that it is a process that should

15:42be started many years out as said, I reckon two is probably perfect. But the best thing to do is bring up the conversation with your holistic account as soon as you think about it. Now that might say, look, we're five years out, there's nothing we need to do now. And so I'm not suggesting you invent work to do, but have that conversation sooner because at least then your holistic account and can keep that in the back of their mind. And if there is something that arises that is going to have an impact, a longer term impact, particularly around the sale process, then it's something they can refactor or reflect in their advice. Okay, until next week, bye for now.