By: Patrick Ungashick

You believe your business would grow faster, if you had more cash.

Or, perhaps you’d buy out that partner who’s not in sync with the company’s direction, if you had more cash.

Or, perhaps you’d take some cash home to diversify your wealth and sleep better at night—if only you had more cash.

Whatever your specific need, perhaps you’d do it—if you had more cash. That’s just the thing though. How do you get more cash to accomplish your business needs, without giving up too much in return, or taking on more risk than you should? Most business owners, at some point, will struggle with this question.

If a need for additional capital is identified, often owners automatically turn to debt to meet the need. Debt avoids dilution. In many cases securing outside debt is easier—one phone call to your commercial banker, and shortly thereafter you have a term sheet in your hand. Finally, owners know that with debt they are not sharing leadership and decision-making control with outsiders.

Yet, there are situations where investigating bringing in outside equity, either as an alternative to debt or as part of combined debt and equity approach, may make sense. We see seven common situations where raising outside equity may be a good fit to meet the needs of the business and its owners:

1.You can bring in outside equity without giving up control. It’s more myth than fact that if you bring in outside investors, you must give up control over your business. While some investors want control, many will consider minority investment situations, and some even prefer it. Most investors will require certain protections, often called “super-majority rights,” that require unanimous consent for the most critical decisions, such as selling the entire company, raising additional debt, or bringing in other investors. But the day-to-day operations and decisions can remain yours entirely in many situations.

2.You have a proven business model with no serious limitations to scalability. If this is accurate, then the more fuel into your company engine, the faster and farther it may go.

3.You have one or more co-owners who are not on the same page with regards to your company’s plans and direction, and buying them out will remove this obstacle and source of friction. With outside capital, you may be able to put cash on the table and buy them out quickly and at an attractive price.

4.You are racing against the competition, and speed to market and/or rapid gain of market share will define success or failure. If this is the case, then you may need to secure sufficient cash to win the race.

5.Your equity partners bring more than just cash to the table. If your investors can bring you market experience, leadership skills, transaction knowledge, industry contacts, or growth opportunities, then you may be getting a bargain. For example, many investors will require a certain number of seats on the Board of Directors. You cannot underestimate the value of having a formal board to help with financing, recruiting, financial and market analysis, project feasibility analysis, legal issues, and exit timing.

6.You desire to “take some chips off the table,” and outside money will allow you to diversify your personal net worth and gain liquidity outside the company. Many owners spend years and sometimes decades highly illiquid. Eventually, this causes most owners personal stress and anxiety—for a good reason. Bringing in outside investors may create personal liquidity, which not only reduces risk but for some owners infuses them with new excitement about taking the company to the next level, given their improved financial security. Bringing in outside investors often eliminates the need for personal guarantees, further reducing the owners’ risk.

7.You have a strong leadership or management team, some of whom want an equity stake in the company. Usually, these leaders and managers lack personal capital to buy into the business. Outside investors can help the management team to buy in, again without requiring taking control. Often we see this done with the current owner maintaining some ownership in the business, allowing him or her to gain liquidity while remaining involved in the company going forward.

There can be additional benefits to bringing in outside equity. One is the potential of increased credibility at your exit. If, after raising outside equity, you later decide to sell the entire company, many buyers have a perception that the business is more “buttoned-up” because outside equity investors have been involved.

While there are other reasons to consider bringing in outside equity, these seven are perhaps the most common situations where outside equity could be a game-changer for you and your company. If you face any of these situations, take an objective, comprehensive review of your company’s capital needs, and then determine the most effective capital strategy—including outside equity when advantageous.

To learn more, watch this webinar on how to “Cash Out Without Walking Out” or contact us with your questions.

If you have a quick question coming out of this article or, if you want to discuss your situation in more detail, we can set up a confidential and complimentary phone consultation at your convenience contact Tim 772-221-4499.

Have you ever heard the phrase “clean up the balance sheet” as part of preparing your company for sale when you exit? Well, has anybody ever adequately explained to you what a “clean” balance is, and why it matters?

And what if you don’t intend to sell your company to an outside buyer? If you are giving it to your kids, or selling it to one or more employees, should you still “clean up” anything?

This short article explains what you need to know about your balance sheet to avoid making the mistakes that many owners make in their exit planning.

What Is a Clean Balance Sheet? Why Does It Matter at Sale?

To maximize the price you receive at sale from an outside buyer and facilitate a smooth transaction, you must have a clean balance sheet. A clean balance sheet shows low-to-no debt, is accurate, and is uncluttered by underperforming, out-of-date, or non-productive assets.

A clean balance sheet presents a clear picture of the company’s assets and liabilities, with no surprises or required adjustments. The more accurate and clear the balance sheet, the more credible your company’s financials, which in turn gives buyers more confidence in the company and its leaders and supports a strong price and favorable terms at sale.

Think about it from the opposite point of view — a “dirty” balance sheet is a warning sign. If your company’s balance sheet is riddled with inexplicable, inaccurate, or non-productive items, potential buyers are likely to suspect the rest of the company’s financials.

The result can be a reduced offer price followed by a more rigorous due diligence process because the buyer has reasons to ask themselves, “What else might be wrong here?” For any offer you do receive, expect something less than all cash and rather burdensome contingencies in the buyer’s favor.

Many companies have balance sheets that are not as clean as they should be, not because of any intentional oversight or effort, but because owners and leadership teams often do not know how to maintain a clean balance sheet.

How to Clean Up Your Balance Sheet Before Sale

To prepare your company’s balance sheet for sale, consider the following issues and steps:

• Receivables – Collect what you can and write off what is uncollectable. Buyers discount overdue receivables and won’t pay anything for uncollectible debts. Slow collections may leave the buyer less confident in your team and/or cause the buyer to lower its price to adjust for the reduced cash available.
• Debt – Pay it down or off where possible.
• Verify the Assets – Review and document the company’s assets. Companies, like people, tend to accumulate stuff with time: vehicles, equipment, furniture, computers, etc. Review the assets and accurately account for them and their value. Keep in mind this requires identifying which assets are in the business, since the depreciation schedule does not always include everything, and titles can be incorrect.
• Non-Business Assets – Remove non-business assets or assets that might not be included in a sale, such as personal assets, non-operating real estate, or assets of sentimental value to the owner. They clutter the balance sheet and may distort your financial ratios. Removing them presents a cleaner, truer picture of the asset base.
• Inventory – Make sure all inventory is sellable. If you have obsolete or slow-moving inventory, talk to your tax advisor about writing it off. Writing off inventory decreases earnings, so get this step out of the way before you go through a sale process. Be prepared to explain to potential buyers your actions and what steps you have taken to prevent building up excess or obsolete inventory in the future.
• Excess Cash – Distribute it. Many business owners accumulate more cash than the company needs for operations and investments. If you wait, you’ll find yourself negotiating with your potential buyers how much is excess and how much needs to be left in the company for working capital.
• Owner/Officer Receivables and Payables – Pay them off. For any that you cannot pay off, make sure they are fully and properly documented and have market-rate terms. If an owner/officer’s loan to the company cannot be paid off, consider converting it to equity.
• Intra-Company Loans – Pay them off. If not possible, consider establishing third-party financing. At a minimum, ensure the loans are fully documented and terms are consistent with market standards.
• Off-Balance Sheet Items – Payables and accruals that are not documented need to be addressed and properly documented.
• Company-Owned Life Insurance – Review with your insurance and tax advisors to determine if any company-owned life insurance policies should remain in the company or be distributed out and/or cashed-in prior to sale.
• Inexplicable Items – Many companies accumulate items or accounts on the balance sheet that are not well documented or understood. Investigate and clarify anything on the balance sheet that you cannot readily and accurately explain.

What if You Are Passing the Business to Family or Selling to an Inside Buyer?

If your exit strategy does not involve selling to an outside buyer, but rather, you intend to pass the business down to family members or sell the company to an inside buyer, the balance sheet still plays an important role.

But do not rush to clean up the balance sheet as described above. In many situations, a lower valuation for the company is favorable in order to reduce potential taxation when passing to family or selling to an inside buyer. Therefore, a weaker balance sheet may paradoxically be desirable to the extent that it helps support a lower company valuation.

Don’t Wait to Evaluate Your Balance Sheet

Long before you pursue selling the company, take a hard look at your balance sheet just as a potential buyer would. Ideally, start this process no less than five years prior to selling the company, because potential buyers will want to see at least three and sometimes five years’ historical reports.

Clean up where possible. Remember, what you uncover and deal with prior to sale does not have to be negotiated with the potential buyer. A more organized balance sheet is a sign of a better-managed and more valuable business.

To learn more about the steps necessary for a successful exit, contact Tim for a complimentary consultation: 772-221-4499 or email.