10 Biggest Mistakes Business Owners Should Avoid

On Jan 8, 2016

Stephen N. Klein, CPA and partner with Klatzkin & Company LLP (Klatzkin), one of the leading accounting and consulting firms in New Jersey and Pennsylvania, advises business owners to be proactive to avoid the 10 biggest mistakes they commonly make. His insight is based on more than 40 years of experience working with owners of closely-held and family owned businesses.

“I have identified mistakes many business owners make in regards to the eventual sale or transition of their business,” states Klein. “Most business owners do not think of selling their business until they are close to retiring or about what to do with the business in the event something happens to them. Being proactive and taking the necessary steps now to avoid these mistakes will help to increase the value of their business while protecting their interests and securing their future.”

 

1. Mistake: Not running your business like you are going to sell it tomorrow.

Downside: Not going to get as much money for the business when you are ready to sell.

Potential Solution: Start taking steps to prepare your business for sale that will maximize the value of the business by working on your Value Drivers.

 

2. Mistake: Not having a written contingency plan.

Downside: If you pass away or become disabled, your family won’t get as much money for the business or they may have to liquidate it.

Potential Solution: You should prepare a short memo and give it to your spouse or family members that includes at a minimum whether the business should be sold to family members, key employee(s), an outsider, liquidated or continue to be operated. You should also indicate which of the employees are capable of running the business if you become disabled or pass away or if you want the company sold, liquidated or to continue operating.

 

3. Mistake: If a C corporation, staying a C corporation for tax purposes or not electing S corporation status earlier enough.

Downside: You will definitely pay more taxes and be left with less cash from the sale of your business.

Potential Solution: Consider making an S Corporation Election for Federal and State purposes.

 

4. Mistake: Not keeping accurate books and records, having CPA prepared financial statements and good internal controls.

Downside: It could kill a sale, especially if the buyer finds material errors when conducting due diligence.

Potential Solution: Businesses should establish strong internal controls to reduce the chances of theft and ensure that revenues and expenses are reported correctly. Companies should also have CPA reviewed or audited financial statements depending on their size, for a minimum of three years before they are ready to sell.

 

5. Mistake: Not reporting all income and paying personal expenses through the business.

Downside: It could substantially lower the price that a buyer will be willing to pay.

Potential Solution: Report all business income and only business expenses through the business. Buyers of most businesses pay a multiple of Earnings Before Interest Taxes Depreciation and Amortization (EBITDA). As an example, if a buyer is willing to pay six times EBITDA and the seller understates sales or overstates expenses by $20,000 a year, the seller will receive $120,000 (6x $20,000) less on the sale of the business than if they had reported the correct income and expenses.

 

6. Mistake: Not saving enough in other investments so that the business is not such a large part of your net worth.

Downside: If your business declines significantly, you may not have enough assets to retire as comfortably as you would like.

Potential Solution: A business is a non-liquid investment and not easily converted to cash. Business owners should put as much into their retirement plans instead of leaving all the earnings in the business. They should also take a salary and distributions if the business is profitable and invest the money outside the business.

 

7. Mistake: Not operating the business so that it can operate without you.

Downside: Buyers prefer businesses that can operate without the owner and pay accordingly.

Potential Solution: As your business grows, cross-train your key employees and develop a management team that can operate the business without you.

 

8. Mistake: If you have partners or co-owners, not having an ownership agreement with provisions for the sale of the owners’ interests or not reviewing and updating it periodically.

Downside: You or your loved ones could end up with a lot less cash when you sell, pass away or become disabled. Also, if the business value declines but the formula for selling price in the agreement has not been reduced and one of your co-owners leaves the company, you could end up paying more than the co-owner’s business interest is worth.

Potential Solution: You and your co-owners should review the agreement annually and agree on the current value of the company each year. Also review the buy-sell insurance policies to see that they are sufficient to cover all or a substantial portion of each owner’s interest in the business if their interest had to be purchased.

 

9. Mistake: Not having written policies and procedures covering the major aspects of the business operations.

Downside: Buyers like and want companies that have written operating policies and procedures. This may reduce the purchase price they pay if they are not in place.

Potential Solution: All businesses should take steps to create written documentation of their operating policies and procedures covering the major areas of the business operations (i.e., sales, credit and collections, purchases, payroll, personnel, etc.).

 

10. Mistake: Not having a written Succession/Transition and Exit Plan years before you want to leave the business.

Downside: You will not have peace of mind, maximize the after-tax proceeds from the sale of the business, minimize the taxes (income and estate), accomplish your non-financial goals or leave on your time table.

Potential Solution: Engage a professional advisor who specializes in succession and exit planning who will work with you and your advisory team (e.g., lawyer, CPA, investment advisor, etc.) to come up with a tailor made exit strategy for you, as well as a written road map, to help you achieve your goals and objectives.

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