Divestiture Preparation: Preparing to Sell Your GovCon Business 2 to 5 Years Out

At a glance:

• The main takeaway: Business owners can take a few proactive steps to help prepare for a potential transaction or divestiture, even years in advance.
• The impact on your business: Following these tips can help make your business more appealing to buyers while improving its function.
• Next Steps: Digest the insights in this piece about divestiture preparation and consider what you need to do to prepare for a transaction or divestiture.  

Schedule a consultation with Aprio’s Transaction Advisory Services specialists today. 

The full story: 

Whether you’re planning to sell your business in the next few years or simply considering your long-term value and strategy, divestiture preparation is an important aspect of business planning. By taking proactive steps now, you can optimize the probability of a successful closing, enhance your company’s value, and ensure a smooth transition when the time is right. This proactive approach to preparing for sale puts you in the driver’s seat, giving you control over the future value creation of your business.

Preparing to sell your business Q&A

Below are key questions and short answers to consider as you embark on the process of preparing your business for potential future transactions – sale and/or recapitalization.

Accounting and Financial Considerations

1. How will my business be valued by potential buyers?
Earnings before interest, taxes, depreciation, and amortization (EBITDA) is used with valuation multiples to estimate a company’s enterprise value. This is done by multiplying the company’s EBITDA by an industry-specific multiple. Factors impacting valuation multiples include the company’s growth prospects, profitability, industry conditions, market sentiment, and company-specific risks. By using EBITDA in this way, investors can compare companies within the same industry on a consistent basis, making it easier to assess relative value.

2. What is adjusted EBITDA and how is it different than reported EBITDA? 
Reported EBITDA reflects a company’s earnings before interest, taxes, depreciation, and amortization based on standard accounting practices which can vary from small founder owned businesses to large public companies. The Adjusted EBITDA metric is intended to provide a consistent financial metric that allows for comparability from one company to the next. Adjusted EBITDA excludes non-operating and non-recurring income and expenses, providing a clearer picture of the company’s core profitability.   Adjustments to EBITDA may include items such as transaction costs, discontinued operations, the impact of changes in accounting methodology, personal expenses run through the business, legal settlements, and severance expenses.

3. How can I optimize working capital to improve my company’s valuation?
A typical component of the transaction process is that a seller must leave a level of working capital in the business at closing.  Management of accounts receivable, inventory, payables, and accrued expenses are the primary areas for optimization. You can demonstrate operational efficiency, which is highly attractive to potential buyers, by accelerating receivables collections, extending payables where possible, and minimizing inventory levels.

4. How can aligning my financial reporting with GAAP standards benefit the sale process?
Aligning with GAAP provides transparency and consistency, facilitating easier evaluation of your financial health and reducing discrepancies, thereby enhancing buyer confidence and potentially increasing valuation. Buyers can benchmark your GAAP financial metrics to industry standards, which may lead to greater understanding and confidence in using a higher multiple for valuation.

5. Should I move from a financial statement review to an audit of my financial statements? 
A financial statement audit provides higher assurance about the accuracy of your financial statements. There is value in uncovering and addressing accounting issues early, and reducing due diligence risks thereby enhancing buyer understanding and confidence.

6. What is the importance of benchmarking my financial performance against industry standards?
Benchmarking helps identify improvement areas relative to competitors, enhance performance, demonstrate industry leadership and make your business more appealing to buyers.

7. How can moving from an entry-level accounting system like QuickBooks to a more sophisticated system increase my business’s value?
Transitioning to a more sophisticated accounting system enhances financial reporting accuracy, scalability, and integration with other business systems. This upgrade demonstrates to buyers that your business has robust financial controls and is prepared for growth. Advanced systems also provide better insights into business performance, aiding in strategic decision-making and operational efficiency, which potential buyers highly value.

8. What is the importance of maintaining a detailed and accurate contract backlog and preparing financial projections and budgets?
A detailed and accurate contract backlog provides visibility into future revenue streams and operational workload, indicating business stability and future earning potential. Financial projections reveal the company’s growth potential and strategic direction; and budgets are used for monitoring company’s financial performance and guiding operating decisions. It is essential to maintain both financial projections and budgets to demonstrate the company’s strong internal processes.

Government Contracting Considerations

9. How can I ensure compliance with government contracting regulations to enhance the value of my business?
Regularly review and update compliance practices to adhere to FAR Part 31 and other relevant regulations. Strict compliance reduces risks of penalties and contract terminations, making your business more attractive to buyers and enhancing its value.

10. What role does a strong past performance record play in the valuation of a government contracting business?
A strong past performance record demonstrates reliability and capability, enhancing your business’s reputation and increasing the likelihood of winning future contracts, thereby boosting its value.

11. How can diversifying a contract portfolio impact the value of a government contracting business?
Diversifying your government contracts portfolio reduces dependency on a single revenue source, showcasing stability and lowering business risk, making your company more attractive to buyers and potentially increasing its value.

12. Why is it important to review and optimize indirect cost rates before selling a business?
Reviewing and optimizing indirect cost rates ensures they align with industry benchmarks and regulatory standards, accurately reflecting the true cost structure of operations. It is also important to reconcile provisional to actual indirect cost submissions, as any resulting receivables or payables can impact a business’s financial position. This process enhances profitability and competitiveness in government contract bidding, demonstrating to potential buyers that financial management practices are rigorous and reliable. Showcasing optimized and well-documented indirect cost rates provides greater transparency and reduces perceived financial risks.

13. How can maintaining a robust contract management system make a business more attractive to buyers?
A robust contract management system ensures efficient tracking, compliance, and performance monitoring, reducing administrative burdens and enhancing operational efficiency, making a business potentially more appealing to buyers.

14. How can focusing on full and open contracts compared to set-aside contracts impact business value?
Full and open contracts increase the pool of potential buyers who can maintain the contract backlog post-sale, potentially enhancing the attractiveness and value of a business. These contracts indicate broader market competitiveness and stability.

15. Why is it important to review the accounting system a business uses for compliance with DCAA requirements?
Ensuring DCAA compliance enhances credibility and reduces audit risks, demonstrating financial integrity and making your business potentially more appealing to buyers.

Estate Planning Considerations

16. Will the sale of my business impact my estate plan and will I be subject to estate tax upon my passing?
Estate plans are often tailored to accommodate specific assets. Once you have sold the business, you should revisit your estate plan to ensure your wishes will be carried out as you intend.  Also, when you have sold the business, it will likely be in exchange for cash, which is not subject to the same valuation discounts of a business. This could lead to a significant increase in the value of your gross estate for estate tax purposes, a financial implication that you need to be aware of. At time of publication, each individual enjoys a federal gift and estate tax exemption of $13.61 million of value subject to change January 1, 2026.

17. What can I do to eliminate or mitigate estate taxes and maximize the value of my estate for my heirs?
Creating a gifting plan to utilize your remaining gift/estate tax exemption before 2026 can preserve that exemption in the future and potentially reduce the overall value of your estate for estate tax purposes. Moreover, for certain assets, you can apply valuation discounts to your gifts, allowing you to move more value while using less of your exemption. Develop a plan and consider gifting interests in your business as early as possible before it appreciates. Consider life insurance and charitable giving to further reduce estate tax burdens for your heirs.

18. Can I utilize trusts to make my estate plan more effective? Also, I am going to realize tremendous capital gain upon the sale of my business; is there anything I can do to mitigate the impact?
Trusts are incredibly versatile vehicles that can be used to gift and sell assets to remove items from a taxable estate. Grantor trusts often allow you to remove an appreciating asset from your taxable estate while maintaining favorable income tax rates. If you live in a state that will tax your gains on the sale of your business, you may be able to use an out-of-state trust to reduce the impact of income taxes following the sale.  

Tax Considerations

19. What corporate structure should I choose to optimize tax liability when planning to sell my business?
Choosing the right corporate structure can significantly impact your tax liability and the net proceeds from the sale of your business. Structures like S corporations and LLCs offer pass-through taxation, where profits are taxed only at the individual level, may result in lower overall tax burdens if assets are sold. Owners of a C corporation would likely benefit from selling stock rather than assets of the C corporation. By selecting a tax-efficient structure, you can maximize the amount of money you retain from the transaction, making your business more appealing to potential buyers.

20. Why is it important to take an inventory of sales and use tax filing requirements?
Ensuring compliance with all sales and use tax obligations minimizes the risk of unexpected liabilities. By demonstrating thorough regulatory adherence, your business will be more appealing to buyers and potentially increase its value. This could also decrease the amount of escrow a buyer requires at closing to cover this risk.

21. How do I ensure that my S corporation status is maintained?
Regularly review shareholder agreements, distributions, and operative corporate documents to ensure compliance with IRS requirements for S corporations. Maintaining S status avoids significant tax consequences, preserving transaction structuring flexibility at closing.

22. What is a phantom equity plan, and how does it help drive employees throughout the transaction process?
A phantom equity plan is a form of incentive compensation where employees receive a payout triggered by a change of control, based on the ultimate transaction value. It aligns employee interests with shareholders, motivating them to contribute to the company’s growth. Creating a phantom equity plan in the years prior to the transaction allows time to structure the plan in a tax-efficient manner.

23. How do I ensure that my net operating loss and/or tax credit carryforwards may be utilized by the buyer, thereby maximizing the sales price?
Regularly review the capitalization table and other applicable legal agreements to ensure that C corporations have not had an “ownership change” in the past. Ensuring that an ownership change has not occurred avoids significant tax consequences. It may permit sellers to request additional purchase prices from buyers who will be able to utilize the carryforwards (subject to certain limitations) following the acquisition.

24. Why is it important to consider whether any independent contractors have been misclassified?
The misclassification of one or more employees as independent contractors may lead to potential exposures, tax penalties and interest. A buyer may reduce the purchase price (or hold back a portion of the purchase price) to cover any potential exposures. Ensuring that all contractors have been properly classified will ensure a smoother transaction.

Strategy Considerations

25. How do strategic decisions related to pipeline pursuits and resource allocation impact the value of my business?
The impact of strategic decisions can have a residual impact for years to come and significantly impact the value of your business. By investing in high-growth and high margin pursuits, the management team can drive sustainable growth and profitability. This proactive approach not only enhances the attractiveness of your business to buyers but also increases the likelihood of applying higher valuation multiples to reflect its growth potential.

26. How can diversifying my customer base impact the value of my business?
A diversified customer base reduces dependency on a few key clients by lowering business risk and showcasing stability. Additionally, it makes your company more attractive to buyers and potentially increases its value.

27. How do succession planning and leadership continuity impact the sale process?
Clear succession planning ensures business continuity post-sale, reducing risks associated with leadership changes. Buyers are more likely to invest in a company with a strong, next-level management team.

Legal Considerations

28. How can addressing any outstanding legal issues or contract disputes impact the sale of my business?
Resolving legal issues and contract disputes before entering the sale process reduces uncertainties and potential liabilities, making your business more attractive to buyers and increasing the probability of closing the transaction.

29. What impact do intellectual property (IP) rights have on the value of my business?
Strong IP protection, including patents, trademarks, and copyrights, safeguards your innovations and provides competitive advantages, enhancing your business’s value by showing potential for future growth and market differentiation.

30. How important are well-defined contractual agreements for the sale of my business?
Well-defined contractual agreements that establish clear terms and obligations with customers, suppliers, and partners, reduces risks and uncertainties for potential buyers. 

31. How do employment agreements affect the sale of my business?
Employment agreements that include non-compete and confidentiality clauses help retain key employees and protect sensitive information. This stability and protection can enhance your business’s appeal to buyers.

32. Why should related party transactions be conducted at arm’s length before selling my business?
Conducting related party transactions at arm’s length ensures that the financial statements reflect a normalized level of activity. This transparency and fairness make your financial statements more reliable and credible to potential buyers, enhancing the credibility of the financial metrics that impact the company’s valuation.

IT and Digital Considerations

33. What are the benefits of enhancing my company’s cybersecurity measures before selling?
Strengthening cybersecurity measures protects your business from data breaches and cyber-attacks, addressing significant buyer concerns and potentially increasing its value by demonstrating robust data protection.

34. How do you know if you need to make IT investments before preparing a business for sale?
Conduct an IT assessment to arrive at a strategy and determine whether additional investment is necessary. Understanding your full scope of IT maturity will guide your IT management, workforce, and cost/budget investment decisions, including capital investments versus operational expenditures.

35. What role does digital transformation play in preparing my business for sale?
Embracing digital transformation improves operational efficiencies, enhances customer experiences, and streamlines processes. Investments in modern technologies make your business more scalable and attractive to buyers.

36. How can obtaining and maintaining relevant industry certifications (e.g., ISO 9001, CMMI) impact the value of a business?
Industry certifications demonstrate commitment to quality and process improvement, differentiating a business from competitors and enhancing its value by showcasing excellence and continuous improvement.

The bottom line

Addressing key strategic financial and accounting issues may enhance your business’s value and appeal to potential buyers, increasing the possibility of a successful and profitable sale.