A smart seller will position his business for sale several years in advance. The process should begin with an objective assessment of how potential buyers will likely value the business. What are the key drivers? Are they cash flow, product, technology, distribution channels or human capital? Know the elements that are likely to attract an acquirer.

Recently, a client company underpriced its interest in a $25 million sale to a larger enterprise. The seller thought the buyer wanted its superior technology, but the buyer really coveted the relationships our client had with key customers. As a result, the seller was in a weak negotiating position because it was promoting a value in which the buyer had no interest and it missed an opportunity to leverage the buyer’s true objective. Often, we as business owners are too close to the business to correctly identify what the buyers perceive as most valuable. Understanding how a business is valued is important but, for the business owner, understanding what drives value is paramount.

Know Thyself
Separately, a thorough review and development of intangible assets can be critical to increasing the value of a business before taking it to market. Trademarks present a perfect example. In another recent transaction, a buyer performed a trademark search on our client, the target company, which operated in the Southwestern United States. The buyer concluded that the trademark was not viable in the Northeast—an oversight that effectively cost the seller, since the buyer would have paid more for a nationally viable trademark. Identifying these factors before selling your business can help build on strengths that are valuable to others.

Business owners rarely underestimate the value of the companies they build. To avoid disappointment, determine a realistic target price by analyzing the key elements of your business.

Identify your key assets. These may include customer relationships, market position and/or employees. Recognize and nurture them.

Focus on cash flow. Give up the pet projects that are still trying to reach breakeven. Today, the market will pay a premium for stable, reliable cash flow.

Develop realistic growth targets. If your projections appear too optimistic, the market may discredit them entirely.

Cut expenses. But do not cut to the extent that growth is sacrificed.

Renegotiate or restructure your debt. You can decrease your risk by restructuring your debt to improve its terms or, in some cases, by increasing the amount of debt in your capital structure, which can reduce your overall cost of capital.

Develop contingency plans.

It is imperative to carefully consider the structure of the deal to suit your tax, cash flow and risk preferences. During one business sale in the advertising industry, for example, the seller inadvertently increased her risk by agreeing to hold restricted stock of the acquiring company. As a result, she was at the mercy of wildly gyrating markets. In another all-stock transaction, a post-sale employment agreement prohibited the seller from hedging the buyer’s stock. This agreement made risk management much more difficult.

Perils to Proceeds
Investing the sales proceeds is also rife with potential pitfalls. A good place to start is with an honest assessment of your lifestyle preferences, and your new portfolio’s ability to produce income and to grow, as well as your willingness to dip into principal. We’ve had a handful of clients who, for the first few years after they sold their business, simply overspent, made reckless investments, and gave too much away. A few years later, they had to rein themselves in and sell the airplanes, boats and third or fourth homes. A rule of thumb might be to limit your portfolio consumption to no more than about 3 percent or 4 percent of the balance annually, in order to retain enough to pay taxes and still have enough so growth of the portfolio will keep pace with inflation.

Many of the entrepreneurs we work with relay harrowing stories of financial duress endured during certain development phases of their businesses. Nearly all sellers tell us that they do not want to have to make their money over again. This is true for both 30-year-old Internet entrepreneurs and 70-year-old industrialists. Their desire to reduce their risk is often the reason for the sale in the first place. So investment objectives are usually capital preservation and income generation, with a dose of inflation protection.

To set up a portfolio, you need to decide whether to hire an advisor. The seller should make an honest assessment of his own investment skills. Warren Buffett advises that the size of your circle of competence is not so important, but that recognizing and remaining within its boundaries is critical. Successful business people tend to be bold, persuasive and tough negotiators. Talented investors are skeptical and meticulous. The seller should accept the fact that quality investment advice will be needed if the requisite skills are lacking.

Understandably, paying unnecessary taxes touches a raw nerve, but we try to shift their focus from tax minimization to after-tax, net-worth maximization. In one unfortunate case, we saw a seller take back $300 million in stock, which he refused to sell or hedge in order to avoid taxes, and the company ended up in bankruptcy. Our most successful clients care most about valuation and risks and pay taxes when appropriate.

A healthy skepticism toward the advice industry is also crucial. After a sale, the seller is deluged with advice-peddlers ready to "assist." Picking advisors with integrity, common sense, knowledge and ability is key, as is making sure that the compensation system is one that eliminates or reduces conflicts of interest.

If you have spent the better part of your life as a business owner, it is only natural to want to get through the sales process quickly, reinvest the proceeds right away, and get on with enjoying life. However, objectivity, careful planning, and some rigorous, post-sale work will provide you and your family with the financial security and lifestyle that you worked so hard to achieve.

Wally Obermeyer is president of Obermeyer Asset Management Company, located in Aspen, Colorado. Brett Suchor, CFA, ASA, is president of Quist Valuation Incorporated, located in Broomfield, Colorado.

Photograph by William Whitehurst/Courtesy of Corbis