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ACTION LIST
The other corporate cleanup areas to focus on, and specific steps to take, are described below. While it is unlikely you will need to address every category, it's worth taking a fresh look at each one.
Business Plan.. Update your company's internal business plan to specify your forecast for at least the next three years. The forecast should be consistent with the company's past performance, not based on best-case scenarios (unless you can support your case).
Compensation. A company's workforce usually constitutes a substantial part of its overall value. Thus, it is important to establish compensation arrangements to retain key employees -- for example, employee stock option plans, bonuses, and employment agreements.
Value drivers. Determine what are the elements that give your company value and try to fortify, enhance, and protect these. If market penetration is your company's strongest suit, for example, you would want to apply a large percentage of your marketing resources in coming months to bolster your lead. Here are two more examples of value drivers:
- Customer base. Let's say your company has a loyal customer base in a niche part of the real estate industry where you have 80% of the market. This took 10 years to develop and would be prohibitively expensive for another company to capture. Since this is a key to your business, you would want to try to capture the rest of the market.
- Intellectual property. Though your high-tech company produces three different technologies, only one of them is truly cutting edge. With that one, you have at least a year lead on the competition. While you don't want to neglect your other lines, you should focus extra resources on that key product to enhance your lead.
Financial Statements. At minimum, you should have a qualified CPA maintaining your financial statements on a regular basis. And if you have the statements audited by a CPA firm, that would be a great way to enhance your credibility with potential buyers. In many cases, a buyer will demand an audit anyway. If you have one conducted on your own, that would allow you to solve any potential problems that are uncovered.
Board minutes. Make sure all board meetings are recorded. If they're not you could lose your limited liability protection and the IRS might disallow certain tax advantages.
Board of directors. A strong board of directors serves to bolster a company's long-term growth. This is a good time to rally its members and solicit strategic feedback.
Favoritism/nepotism. Look for any potential red flags. For example, is a family member being employed at the company for no good reason? Or did a family member get a loan with no interest payments? You need to have a standard policy for wages and perks. An independent compensation committee of the board can deal with these issues.
Compensation. A business can deduct "reasonable" salaries, but some business owners stretch this definition to the limit. If the IRS deems the compensation unreasonable, the excess amount could be taxed as a dividend. Bearing this in mind, wage-scale adjustments might be in order.
Independent contractors. There are many well-known advantages to using independent contractors, such as not having to pay for the person's benefits or to withhold taxes. But in recent years the IRS has pursued a more aggressive policy on how to classify independent contractors, with a 20-factor checklist used to discern the difference between employees and contractors. Quarrels between companies and the IRS over this issue are common, and when a company is found at fault, it could be hit with back taxes and penalties. So this is an area to examine closely, making sure you have applied strict definitions.
Professionalism. For starters, it is essential to ensure your company's premises are always clean. And if you own a family business, avoid such forms of address as "Dad" during work hours.
Environment. Make sure you comply thoroughly with current environmental and OSHA regulations. Any potential environmental liability exposure is likely to scare away a potential buyer.
Corporate Structure. Is your debt load and cash flows healthy? Or is your company's debt too high for existing cash flows? Remember that in many (if not most) cases, a buyout will require the buyer to borrow money. Therefore, it is a good idea to take steps to structure your company's current debt to make an acquisition easier on the buyer. It's a good exercise to look at how much more debt your company can take on if there was an acquisition. If the margin is slim, then it is probably smart to look at ways to reduce debt. (Your broker should be very helpful here.) Of course, every industry is different. The cable industry, for example, generates both massive debt loads and gushing cash flows.
GOOD HOUSEKEEPING
While the following three elements don't necessarily fall under corporate cleanup per se, they are all indicators of sound business practice. A potential buyer -- especially a savvy one -- will take you more seriously if you have these pieces in place. They demonstrate that you have done your homework, work with competent advisers, and are forward looking.
