Most founders start exit planning a little late (in my humble opinion). Buyers start sniffing, and all of a sudden we’re getting calls for help with accounting prep for valuation reporting. Next, bankers get involved, then diligence starts, and now the add-backs get calculated.
Let’s be clear, add-backs = discounting your value.
If you want to exit in three to five years, the work starts now, beginning with how your business is run.
Why Buyers Don’t Trust Your Add-Backs (And How to Fix That Now)
Add-backs are a friction point in any deal. Speaking from experience as a buyer, there is a difference between theoretically removable costs and provable separate ones. A clean NOI structure reduces negotiation risk.
Buyers are looking for systems with numbers that back them up.
Every seller believes they can explain their numbers. (And I’m all for a good financial narrative). Personal expenses and one-time costs can be backed out. And while, in theory that’s true, in practice, the more explaining a seller has to do, the less confidence the buyer has, and the story begins to fall apart. Add-backs become negotiation points. Negotiation points reduce multiples.
Clean financial history beats clever math every time. So what steps can you take starting today?
6 Steps to Prepare for Exit in 3-5 Years:
Step 1: Normalize EBITDA like it’s a habit.
Strong exits are built on consistent, repeatable financial reporting. Start with separating owner expenses from operating expenses now, not later. It means treating one-time events as one-time when they happen, instead of retroactively during diligence. The formula for normalized EBITDA is:
Normalized EBITDA = EBIT + D&A + Non-Cash Expenses + Adjustments
Examples of adjustments that might be made:
- owner salaries higher than market rate
- owner expenses (vehicles, entertainment or networking expenses)
- above-market salaries (family wages, management wages)
- one-time fees like legal fees
- asset write-down (inventory write-downs are normally included for full transparency)
When buyers see years of clean net operating income with owner and non-recurring items clearly below the line, credibility goes up. Risk comes down. And multiples are more likely to go up.
- Identify what is truly non-recurring
- Treat one-time events as one-time when they happen
- Stop burying cleanup costs in COGS or operating expenses
Goal: Build a multi-year history buyers can trust.
Step 2: Reduce founder dependency
Buyers look at more than profits. The more operationally involved the owner is, the harder it is to sell the business at a premium. Tactics that make sense personally often weaken the business. Things like manual approvals and owner-driven workarounds may feel efficient, but they signal lack of scalability.
If replacing the founder requires rewriting processes, changing workflows, or rethinking how bills get paid, the business feels fragile. That fragility gets priced in.
If you’re a hands-on owner who wants to exit in 3-5 years, begin writing yourself out of the equation now. Start with the easiest repeatable tasks, then move on to putting the right people in the right places. (If you’ve been following expandCFO for awhile you know I love the EOS Worldwide framework).
Pulling yourself out of day-to-day decisions is simply good valuation strategy.
This takes time. Start early.
- Document decision-making processes
- Remove founder approval from routine workflows
- Build a leadership layer that owns outcomes
Test: If the founder disappears for 90 days, does the business stall?
Step 3: Fix reporting so it matches how your business runs
Buyers notice structure fast: margin by product line, customer type, and channel, consistent definitions, reports that need no further explanation MoM. Most companies report for accounting, not for management or buyers. That gap creates confusion during diligence. Get in front of your reporting early so 3-years down the road you’re confident in the numbers and can really sell your true margins.
Two things happen when a buyer sees. a messy P&L: it lowers valuation, and they start asking for a QoE report.
What makes a company feel “seller-ready” in diligence
What to start now:
- Clean up the chart of accounts
- Align reporting to product lines, customers, or channels
- Use classes, departments, or segments to show how revenue is really generated.
- Ensure margins, performance and cash flow can be explained without spreadsheet workarounds.
Litmus test: If a buyer asks “Why did margin drop in March?” and the answer requires a spreadsheet and a meeting, reporting is not ready.
Step 4: Clean up working capital and cash flow visibility
Running a predictable working capital and cash flow forecast is especially critical for manufacturing and distribution. Common issues buyers might look for: inventory that absorbs cash faster than profit is generation; AR drift with no urgency to collect; AP that hides true cash requirement.
The part of your sale nobody explains
A distributor we work with has $8.5 million of inventory on the books.
It’s a known issue. (We normally recommend most distributors run on 90 days or less. Really efficient ones get by with only a month or two). It’s something the distributor is working on.
But what they didn’t know was how it might all boil down if they were to sell. (Which they want to).
The cliff notes: every extra dollar tied up in working capital when you sell, is a dollar you hand the buyer for free.
How you get paid when you sell
Buyers value most businesses at a multiple of EBITDA. Say you make $2M in EBITDA and the market pays 5x. Your business is worth $10M.
That $10M buys the whole business, including the working capital it needs to keep running. That means the inventory on the shelves and the receivables your customers owe you, minus what you owe your suppliers. No buyer wants to walk in on day one with an empty warehouse and no collections coming in.
So the deal sets a target called the working capital peg, usually based on your average over the last 12 months. You leave that much working capital in the business at closing, and it’s included in the $10M. You don’t get that money back.
Likewise, if you have $500K in receivables, you don’t get $10.5M. You get $10M, and the $500K stays with the business.
The cash in your bank account, on the other hand, usually stays with you. (Most deals are cash-free, debt-free.)
You can see where this is going.
Now back to our distributor. Their numbers:
- Inventory: $8.5M
- Receivables: $1.5M
- Payables: ($3M)
- Net working capital: $7M
If they sold today for $10M, $7M of what the buyer gets is inventory and receivables. The price doesn’t change whether that number is $7M or $3M, because it’s based on EBITDA.
If they brought inventory down to a normal 90 days (roughly half of what’s on the books), that’s about $4M in the warehouse, that could be cold hard cash instead. And that cash is theirs to keep.
Same sale price, but with ~$4M more in their pocket.
The catch: you can’t do this the month before you sell. This is where all that exit planning really comes into play.
The peg is based on your history.
If you slash inventory right before closing, you deliver less working capital than the peg, and the price drops dollar for dollar. The cash you freed up goes straight back to the buyer.
The improvement has to be real and be backed by your numbers for a year or more before a sale. So if selling is anywhere on your five-year horizon, well, hint hint.
How to improve your working capital
- Know your number. Calculate net working capital every month and watch the trend.
- Measure it in days: how long inventory sits, how long customers take to pay, how long you take to pay suppliers. Compare those against your industry.
- Find your dead stock. Slow-moving SKUs are cash you already spent.
- Tighten collections. Every day you take off your receivables turns into cash.
- Negotiate supplier terms. Longer payables reduce your working capital too.
- Track cash conversion cycle monthly
- Build a rolling 13-week cash flow forecast
Side bonus: buyers like businesses that run lean. Tight working capital tells them someone is managing the business, which makes due diligence easier and leaves less to argue about in the peg.
Why it matters: Buyers care about cash conversion, not just profit. Two businesses with the same EBITDA can have very different valuations if one consumes cash and the other produces it.
Step 5: Understand Your Multiple Drivers
Not all revenue is valued equally. Ask yourself, which streams are recurring versus transactional, which products carry premium margins and strong demand, and alternatively which lines are drawing more resources?
Action items:
- Identify which products, customers, or revenue streams drive premium multiples
- Separate revenue streams that carry different risk profiles
- Isolate anything valued differently, such as residuals or contracts
- Decide intentionally what stays in the business at exit
Mistake to avoid: Letting a buyer define the structure for you. Set an exit valuation target from day one and build your structure around that.
Step 6: Pressure-Test the Story Internally
If you’re exit planning, you must know your numbers and test them before a buyer does. Look to uncover gaps ahead of time by having leadership run this exercise (without prep):
- Why did margin change last quarter?
- How does profit reconcile to cash?
- What breaks if volume increases 20 percent?
What you are looking for:
- Consistent answers
- Clear ownership
- Confidence without defensiveness
If the internal team struggles, buyers shopping your numbers will too. Want your exit-planning to be running for the best multiples? Your trends should span multiple years and any changes you make should be intentional rather than reactive.
The real takeaway
Exit readiness is operational discipline applied early. It’s about building a company that could be sold at any time.
Start your exit planning today with expandCFO’s outsourced CFO services.
