"The seeds of a successful sale - for that matter, a private financing or IPO - are sewn years in advance. The following 12 steps don't cost a lot, but can make a huge difference."

The basic error made by most private companies is not beginning early enough to prepare for an eventual sale. The result is untold millions left on the table, or worse, transactions never consummated.

The steps described herein won't preclude the pitfalls that plague the process of actually finding buyers or negotiating a deal - that's another list. Rather, the steps described here are ones that can and should be taken long before that process begins. The following 12 steps don't cost a lot, but can make a huge difference.

1. CLEAN UP THE BALANCE SHEET
2. KNOW THE TAX CONSEQUENCES
3. HAVE AUDITABLE FINANCIALS
4. MANAGE THE INCOME STATEMENT
5. FILL GAPS IN MANAGEMENT
6. ADD OUTSIDE DIRECTORS
7. RAISE THE COMPANY’S PUBLIC PROFILE
8. POSITION THE COMPANY FOR THE RIGHT COMPARISONS
9. DOCUMENT THE COMPETITION
10. EXAMINE YOUR COMPANY AS BUYERS WOULD
11. UNDERSTAND BUYER NEEDS
12. BE PREPARED FOR THE UNSOLICITED APPROACH

1. CLEAN UP THE BALANCE SHEET
The first financial statements given to potential buyers set the stage. Subsequent revisions are at best viewed with skepticism. If owners want to pull out excess cash or retain personal ownership of real estate, equipment, copyrights or patents, get them off the balance sheet now.

Buyers view loans to the company from shareholders as equity. They should be replaced by bank debt, even if the shareholder has to pledge the company's payoff as additional collateral for the new bank loan. Receivables due from officers or shareholders should also be cleared up.

2. KNOW THE TAX CONSEQUENCES
Taxes can total over 50 percent of the proceeds of a sale, and inheritance taxes can take over half of what's left. Devastating tax bills down the road can be significantly reduced. Electing to be taxed as a subchapter S corporation if qualified, can make a big difference if done early enough as can transferring stock or assets to trusts partnerships or family members early, while values are defensively lower. Six months before selling at ten dollars per share is no time to try to move stock out at two dollars.

Estate planning may require some restructuring, but it's a shame to see the after-tax proceeds of a sale eventually halved by gift or inheritance taxes.

3. HAVE AUDITABLE FINANCIALS - if possible.
Audited financials add value and may make the difference between doing the deal or not. If your financials aren't audited, at a minimum have a credible CPA observe year-end inventory and file it away. The cost is nominal.

A "Big Five" auditor adds perceived quality and value, but counts more in an IPO than a sale. Some will give emerging companies reasonable "starter" rates. It doesn't cost to ask. Established regional auditors can do the same job, usually with less bureaucracy and lower fees. The trade-off is prestige and image. Also remember that auditors don't necessarily replace your accountants.

4. MANAGE THE INCOME STATEMENT
All buyers look for consistent earnings and growth. Peaks and valleys make them nervous. Earnings and growth can be managed to a degree within the bounds of generally accepted accounting principles (GAAP). Tax deferral is no longer the main objective.

Spikes and dips in year-to-year profits reduce credibility and value, but in a smaller company can often be legitimately smoothed out by increasing or decreasing reserves, giving or postponing bonuses or capitalizing or expensing, where the option exists.

Also, within the bounds of accounting rules, it is perfectly legitimate for financial reports to be different for tax returns.
Income statements can be "recast" after the fact to add back discretionary expenses such as excess owner's compensation and perks. Every dollar spent in a year can reduce the value of the company by five, ten, fifteen dollars or more. If you sell to a private buyer, discretionary owner expenses are usually taken into account; if you sell to a public company, it can only use what your audit says when reporting the acquisition.

If a sale to a private buyer is a more likely goal, keep discretionary expenses readily identifiable so recast statements are easy to track and reconcile. Try recasting past years now to see how they look. If sale to a public entity is a possibility, eliminate perks now and show earnings.

5. FILL GAPS IN MANAGEMENT
Most buyers consider management their top priority. Fill gaps in management, either internally or from the outside, sooner rather than later, and give people already on board the right titles. Companies with no vice presidents make management look thin, and managers with 60- days tenure aren't particularly inspiring. Credentials are important, too. Blue chip business pedigrees add value, all things being equal. Also, there should be at least the blueprint of a succession plan in place, and senior management should have meaningful and well thought-out answers as to their future intentions and expectations.

Key executives should have professionally prepared employment, option and incentive agreements in place before discussions start. Seek outside help to determine what's customarily given in your circumstances and considered acceptable to investors, buyers or underwriters.

Also, consider using "phantom stock" instead of conventional options or issuing actual shares. In either case, have a clear understanding as to how vesting will be affected by a sale.

6. ADD OUTSIDE DIRECTORS
Outside directors are an economical way to obtain valuable advice, contacts and insight from the objective perspective of people not involved in the day-to-day crunch.

"Name" outside directors with attention-getting credentials, affiliations or accomplishments enhance perceived value and marketability. They count more in an IPO or sale to a public company than in a private sale, but they can't hurt. They should not, however, have just joined the board and should own some stock or at least options.

Finding and recruiting the right outside directors requires focused time and effort. Also, easing friends and family lacking ownership or bona fide business credentials off the board should be done, but is delicate and can require more time than you think.

A "name" law firm can also add credibility and value, and a "name" firm attorney on board is a plus, if they will do it. The trade-off is that they can be overly conservative as well as expensive.
If your present attorney isn't seasoned in acquisitions, meet with one or more others respected in the financial circles in which you anticipate dealing. Then try one for some nominal corporate work before you really need them.

7. RAISE THE COMPANY'S PUBLIC PROFILE
Good, credible business publicity, beyond just trade press, adds visibility and perceived value. A smaller but interesting private company can orchestrate more coverage in the business press than it would ordinarily expect. Local newspapers and business publications are good, but many relatively small companies also show up in national publications such as Inc., Forbes and Business Week - and not by accident.

Enlist the services of a financial or business PR firm or consultant, who knows the ropes, or make it a priority and do it yourself. Also, household name customers - the more the better - add perceived credibility, even if they only account for a small percentage of sales. Have as many as you can.

8. POSITION THE COMPANY FOR THE RIGHT COMPARISONS
Buyers judge by comparison. Maintain a running, comparison of your operating and financial statistics versus those of your peers and competitors. Prospectuses, IOKs and annual reports are excellent sources, as are trade associations and bankers' industry profile books.

Such comparisons may show that you need to change your accounting categorizations. If so, do it before giving out financials showing unfairly, for example, that your gross margins don't measure up to others in your industry.

Study security analysts' reports on companies in your industry and determine:

a) which similarities you want to reinforce;
b) which you should distance yourself from; and
c) how to accomplish that.

Also, try to determine a range of values for your business in the context of a sale based on what you can glean from public and trade sources. Do not, however, fall into the trap of believing your company will be valued at the same multiple as public companies many times its size and/or with other significantly different characteristics.

9. DOCUMENT THE COMPETITION
Many company descriptions or business plans lack a truly realistic assessment of the competition. Buyers can sense when a company is in denial. A product or service with no meaningful competition is extremely rare. Even if it is unique, there usually are or will be alternatives to fill the need.

Document the facts accordingly on actual and potential competitors and an objective comparison of similarities and differences, strengths and vulnerabilities, in a form understandable by someone outside your industry and believable by someone in it.

10. EXAMINE YOUR COMPANY AS BUYERS WOULD
Be the first to do "due diligence" on your own company. Buyers all have comprehensive evaluation screens that go well beyond financial records. Put your company through such a process before a buyer does. Make it one that covers operations, marketing, personnel and technology as well as legal, regulatory, environmental, insurance, contractual, credit and accounting issues.

Have a professional outsider do it to make it objective, and develop a program to fix what the exercise indicates needs attention before the buyer comes on the scene.

11. UNDERSTAND BUYER NEEDS
Each buyer has certain criteria which they are not going to negotiate away. A buyer has requirements for returns on investments, their lenders have requirements for debt service, and the shareholders of a public buyer want a positive effect on the stock.

Specific criteria will vary by industry, the economy and the type of buyer, but they are always there. Under-standing such criteria well before negotiations begin will give you time to arrange things to maximize the probability of a transactions meeting both your objectives and the buyer's needs.

12. BE PREPARED FOR THE UNSOLICITED APPROACH
Unsolicited approaches by bona fide buyers do occur, and range from bargain hunters to the opportunity of a lifetime. Since the latter are usually motivated by a buyer's immediate needs or circumstances, they tend not to wait around.

In addition to the eleven steps described above, you can prepare yourself by having established relationships with financial advisors who know your business, who you trust and to whom you can turn for counsel on a quick reaction basis.