When it comes time to sell a business bad practices become costly.

The general rule of thumb is that a business is valued at three times income or one time sales then adjusted according to circumstances.  While this appears to be a clean and simple method of valuing and selling a business it is unrealistic based on my experience and, I suspect, those who have successfully sold or assisted in the sale of a business. 

At the most basic level, why should the potential buyer of a business actually believe that the seller is providing realistic and reliable information?

How does one get around this tendency to mistrust the other party in such a transaction?

Selling a business involves a high degree of trust between buyer and seller.  A seller must provide information (particularly financials) that are real, indicative of the business and presented in a manner that exudes confidence.  A potential buyer of the business must be trusted not to use confidential information provided to them to damage the business. 

Mutual trust requires a level of compromise and openness that is not easily given.  It is necessary to the successful sale of a small business.  Overcoming this hurdle is the responsibility of the seller of a business.  It typically involves preparing for the sale of the business at least three years in advance to ensure that financials (a key component of achieving this trust) are ready for disclosure at the time of sale.

I was recently involved with two businesses where this trust was compromised.  Failure to obtain this trust resulted in early termination of negotiations for the sale of each business.

In one instance, the business lacked even the most rudimentary Profit & Loss Statement.  They provided two years of revenue by month and "estimated" the cost of goods sold as a standard percent of sales.  There was no reference to operating costs - a complete lack of even the most rudimentary accounting systems. 

A prospective purchaser of the business had no understanding of the profitability or operations of this business.  While the business was may have been profitable, lack of reasonable disclosure made this difficult to determine.   

This sale failed to due to a lack of disclosure.

The situation of the second business was quite different.  It had extremely effective management control and accounting systems.  The owner provided a comprehensive set of financials that allowed a prospective buyer to fully understand the business.  Unfortunately, the business was unprofitable.  To compensate, the seller provided a "normalized" set of financials that showed what a new owner could earn. 

This seller was relying on a level of trust that enabled a prospective buyer to purchase based on potential rather than actual results.  Perhaps this was considered necessary in order to justify the desired selling price. 

Nevertheless, the necessary trust between both parties was never established.  Discussions on the sale of the business were terminated.

Many business owners consider management control systems are an unnecessary expenditure.  Perhaps this is because they do not understand how to use the information gleaned from these systems to improve their business. 

This approach may increase short term profitability but at what cost?  The success of any business is determined by its profitability and a lack of adequate management insight is a serious liability.  When this same business is for sale and exposed to a potential buyer, a lack of management insight is likely to result in a reduced valuation by an outside party.  Perhaps this is why many owner operated businesses fail to survive to a second generation of ownership.

Investing in good management control systems is the foundation upon which successful businesses are built and maintained.  Maximizing the valuation of a business is important to the owner selling the business. 

It is only through effective management control systems that this value can be determined and reliably documented when the business is put up for sale.

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