When selling your business, timing is an important aspect. Not only the timing of your adventure as an entrepreneur or the maturity of your business, but also on a financial level you are faced with the choice of what is the right time.
In practice, being able to precisely time a business sale will not always be obvious or simply not possible. After all, you can't time the market. With any sale, a buyer will usually look at the last financial years (say 3 years). They will scrutinize this period to get comfort with profitability in order to make an estimate of what they can earn from the business in the future.
Structural earning capacity
A normal year does not actually exist and thus profitability can be distorted in both positive and negative ways. For example, you can think of one-time costs in the recent past such as an IT investment that was not capitalized, an anniversary or a one-time staff allowance.
By not correcting such costs, a potential buyer might draw the wrong conclusion when estimating the profitability and thus the value of your company. Normalizing the figures can solve this. This means that the figures are corrected with the aim of showing a "normal" picture of what the company has realized in recent years and thus can possibly earn structurally in the future.
For example, these one-time costs can be spread out, if they actually relate to several years, or eliminated altogether if it can be argued that these have not made an operational contribution or can in no way recur in the future.
Other side of the coin
Incidentally, it is also good to look at non-recurring gains and determine whether and how they will be handled. Experience shows that it may be wiser to address these benefits at an early stage (a stage when, for example, several parties are still looking at the company) than at a due diligence stage (when only a single party is still being discussed). In the latter case, the one-time gain can more easily be used to (re)negotiate the purchase price.
Role of DGA within company
Also look carefully at the impact you yourself have on the business. For example, where in the past it seemed beneficial to take certain costs at once when the costs(investments) could also have been capitalized on the balance sheet (and depreciated). If costs are taken as a lump sum, then this has an impact on profitability and therefore possibly also on the valuation.
Also look critically at the level of compensation for your work; often a management fee billed from a personal holding company. If this fee is (far) above a market level, this reduces profitability and so you can consider adjusting the management fee to a market level.
Be careful, however: a buyer will often see this level as leading for the future. So if you remain active as a director yourself, for example after a partial sale to an investment company, this may become the actual level of your management fee.
Pitfall
Although certainly common, normalizing figures in the context of a sale is often accompanied by some suspicion. After all, a potential buyer, especially in the pre-bid phase, will have less information than the seller. It is therefore questionable whether a potential buyer will fully go along with the corrected figures in advance.
If he does take these as the basis for his valuation, you can bet that the normalizations will be scrutinized during the audit. Therefore, always make sure that the normalizations are well substantiated. The moment the normalizations do not hold, the company value offered, or possibly even the entire deal, will be at risk.
Advice
Try to be as transparent as possible when normalizing figures. For example, show also the non-normalized figures and share in advance a clear justification. If you are working with an information memorandum in a sales process, this is a good place to include potential buyers in this.
However, remain critical and realistic, but don't sell yourself short either. Say a party offers 5 times the average profit of 2021-2022, you don't want that profit to be negatively affected by one-time or non-structural costs. The right balance lies somewhere in the middle and is supported by a good rationale.
