Identify Your Reasons for Selling
One of the first questions asked by Potential Buyers to the Business Owner will be, “Why do you want to sell?” You’ll need a well-prepared answer to this ubiquitous question as a business seller. Some common responses are Retirement, Health Issues, Personal Issues like Divorce or Family Obligations, and Burnout.
One critical red flag to a successful business sale is an answer demonstrating a lack of commitment to a sale. Wavering on a promise to sell will scare away almost all qualified buyers as they don’t want to invest the time of bringing a deal to closing only to have the business seller decide to back out of the agreement.
Prepare Your Business for a Sale
The second step is preparing your business for sale. Preparing your business for sale is part of a comprehensive Exit Plan.
A well-drafted exit plan will outline a way for an owner to reduce his daily time commitment to a business and realize a substantial profit upon the sale if the company is successful. If the business is unsuccessful, an exit plan will enable the owner to limit losses.
The time, expense, and effort required to create an exit plan vary based on the size and complexity of the business. Small, closely owned businesses can quickly write down critical areas in a few pages. Larger, more complex companies with partners and working family members may require a lengthy succession planning effort with various partnership agreements and legal documents to protect the interests of everyone involved.
It is best to have all of the required documents ready in advance. Your goal should be to anticipate the due diligence process in advance with the ability to provide relevant information to the prospective buyer before they start asking questions. An advisor familiar with the sale process can help focus your efforts.
Buyers frequently look at hundreds of businesses. Any delay in sharing requested information only gives them time to become distracted by other opportunities. As the saying goes, “Time kills all deals.”
Selling a Business Takes Time and Effort
It takes a considerable investment of time and effort to sell a business over an extended period. Since it will take many hours of effort spread over six to nine months, you need to be sure you are up for the process.
Preparing a Business for Sale
Plan to invest at least 40 hours preparing the marketing materials. This will include financial statements and tax returns for at least three years and an Information Memorandum that describes your company, your customers, employees, and all the business details.
Screening Inquiries
Once you go to market, you’ll start receiving inquiries. You’ll want to develop a strategy to filter out the tire kickers and looky-loos, as they’ll waste your time and can’t close a transaction. Speaking to each interested prospective buyer takes a considerable amount of time. A fifteen-minute initial telephone call with 200 potential buyers will consume at least 50 hours, not counting the time required to schedule and confirm the appointments.
Experience Helps
Experience can make a big difference. Working with a skilled business broker, transaction advisor, or investment banker should be seriously considered. They bring the expertise to filter out the unqualified buyers quickly and will have a well-rehearsed process for getting through this stage in a time-efficient manner.
Is Your Business Saleable?
Business profitability and the transferability of the relationships with key stakeholders are the key aspects that make a business saleable. The business can be sold if the company can earn a profit after paying all expenses, including reasonable salaries for the management team, and the relationships can be transferable to a new owner.
Profitability is Paramount
The business’s profitability is easy to determine via careful examination of the financial statements and past tax returns. The transferability of the relationship is both factual and subjective. Various suppliers will clearly state the transferability of the relationships in their written agreement. Almost all real estate leases include this section, as do other agreements for critical business assets.
Owner Dependency is a Deal Killer
The more subject relationships will require a judgment call on the buyer’s part. It is usually assumed that most employees will continue working with adequate compensation. Most customers will continue buying at fair prices, and most suppliers will continue supplying. The potential buyers will invest the effort to understand the nature of these relationships and uncover the ones unlikely to transfer to new ownership. I find it best to identify the relationships unlikely to transfer. It saves everyone time, and this information will be known.
Many people use the hit by the bus metaphor to determine if the business is capable of transferring to new ownership. If you, as the owner, got hit by a bus on the way to work, could your company keep operating and producing a yearly profit?
Can your staff develop the leadership necessary to keep the business growing, or would it quickly fall apart and need to be shut down without your business experience?
Timing of the Sale
You may have heard that timing is everything when selling a business. The saying goes that the best time to sell is when things are going well. Buyers do straight-line projects based on the past three years of financial statements and tax returns. If the business has been growing, they will estimate it will continue growing. If the company has been contracting, they will assume the business is struggling and likely to continue declining into the future.
Profitable growing businesses attract many potential buyers. It is challenging, if not impossible, to find a qualified buyer for a company in decline.
Business Valuation
You Compete with Other Opportunities in the Market
A market exists for buying and selling companies. To attract the interest of qualified business buyers, you need to advertise a listing price consistent with the other opportunities available. The final sale price will be determined by the relative merits of your specific company. These merits will be confirmed in the due diligence process.
Valuation is one area where an experienced advisor, acting as your trusted business consultant, can significantly improve the sale process.
Methods to Value a Business
Several methods are used in the business valuation process, depending on the type of business. The procedures involve looking at your financial statements and adjusting the net income to determine how much annual cash flow the firm has produced in the past three years. These adjustments are usually called add-backs, and the resulting figure will be SDE or EBITDA.
SDE or Seller’s Discretionary Earnings is the figure used in smaller companies without a management team in place. EBITDA is a similar concept used for larger companies with a management team running the company.
The most popular business valuation method is based on comparable transactions: The current market value is determined by looking at past sales of similar businesses and applying similar multiples.
The Comps model works well for most small to medium-sized companies with reasonable growth rates. Companies capable of very rapid revenue growth (like a SaaS company) without a significant increase in expenses frequently use a payback period model. Companies that require significant business assets will also use multiples based on the balance sheet (book value).
Creating Competition is Key
To effectively receive the highest offer, it is critical to create competition between the potential business buyers. While it is implausible to have a ‘bidding war’ like in the movies, it is reasonable to expect 3-5 different buyers to come forward with competing offers. The competition helps to push up the final sales price and generally creates an incentive to increase the cash portion of the offer.
Deal Terms are also Important
In addition to the sales price, typical business sales will include a non-compete agreement, a confidentiality agreement for deal terms such as the final selling price, and non-disclosure agreements for key employees to sign as a basis for future employment.
Alternative to Selling – Hire a Manager to Run the Business
One option to selling your business could be to sell your company to your business partner or hire a manager. Suppose the business is financially viable and able to support an absentee owner and a manager. This can be a better financial strategy than a business sale, especially if you own a high-profit business within an out-of-favor industry. Rather than settle for 1-2 years of earnings as a purchase price, you could cut your earnings by the price of a manager and continue owning the business well into the future. Your financial advisor can model this option to help you see the after-tax benefits of both options.
If you don’t have an employee who can run the business while you are away, you should consider hiring a manager to take over operations.
Alternative to Selling – Close the Business
Most small businesses never actually get sold upon the retirement of the owner. The reality is that due to lack of a yearly profit, unexpected life events, or poor planning, most small businesses just close when the owner is no longer willing or able to continue running the business. Shutting down is sometimes the best option with sole proprietors with barely profitable companies. Almost all potential business buyers will need to earn a salary and pay down the debt incurred to purchase the company. If the business isn’t profitable enough to cover both, it will be tough to identify a potential business buyer.
Selling via Business Broker or on Your Own
There are many options available to sellers of businesses. Some people prefer to do it themselves, and others would instead work with a business broker. Whichever route you choose, make sure you have a plan B as a backup. Finding a buyer and negotiating terms is a speculative endeavor. A backup plan will be necessary if a deal doesn’t close.
If you have the time, nobody can describe your business as well as an owner who has been working in the industry for many years. Answering questions is easy, and since you have so much knowledge, you’ll be able to provide details well beyond the ability of an outside broker.
Of course, selling a business is time-consuming. If you don’t have the time to meet many potential buyers and walk through the qualification process with each one, it makes sense to find a broker to work with. In addition to calculating the sale price and preparing all necessary documents, an experienced broker will also follow a well-defined marketing process to identify qualified buyers. This allows the entire process to remain confidential so that your customer base, employees, competitors, and suppliers don’t learn that the business is for sale until a deal closes and an official announcement is made.
Due to the time-consuming nature of the selling process, the confidentiality necessary to not disrupt the operations of the business, and the extensive marketing plan, the vast majority of business owners would be well served by working with an advisor who can bring both industry experience and a track record of successful sales. This is a niche service best delivered by a specialist, not a generalist.
Preparing the Necessary Documents
You’ll need three sets of documents to tell your story. Business brokers and M&A advisors add considerable value to drafting these documents for smaller transactions. For more significant transactions, this will be a service provided by your investment bank.
Marketing Documents
These documents provide the necessary details of your business from a qualitative perspective. Like a business plan, they tell the story of why your company exists and who derives value from its ongoing success. Product details, customer targets, employees, and organization charts are all included in this document. If you’ve been strategic in the running of your business, then you’ll also want to include your marketing strategy, customer acquisition cost, copies of agreements with customers.
You should also include your basic accounting standards, the name of the accounting software you are using, and whether your business is on a cash or accrual accounting basis.
Depending on your process, you may also break this document into sub-documents to provide a little information in a teaser before requiring a non-disclosure agreement and supplying the entire Confidential Information Memorandum.
Financial Statements and Tax Returns
Your accountant should create these documents. They will reflect your annual sales, expenses, and net income. They will also show the various financing-oriented expenses like depreciation, amortization, interest expenses, and tax payments. Buyers will also want to see the tax returns and understand any differences between the returns and your provided financial statements.
Process Oriented Documents
These are the documents used to control the sales process. Documents like Non-Disclosure Agreements, Letters of Intent, and Offers. For smaller transactions, these are typically templates. For more significant transactions, they will be drafted by the attorneys involved.
Identifying the Buyer Types
There are a few types of buyers in the marketplace. Knowing who is most likely to buy your company will help as you begin to meet the buyers and qualify them both financially and according to their industry experience.
The broad categories of buyers include
Owner/Operators
Family Offices
This is either a single or small group of wealthy families who have pooled their resources to buy small businesses as an asset class. They are typically all-cash buyers and generally pursue buy-and-hold strategies for their acquisitions.
Private Equity Firms
These are financial buyers who intend to sell the company after a 3-7 year growth period. During the holding period, the fund will work to improve the financial aspects of the company by increasing revenues and decreasing expenses. This will allow the company to sell for a significantly higher price than its purchase price. Many of these firms can bring deep expertise to their portfolio companies and have experienced significant returns over many years of operating. These are the ‘expert business owners’ and bring extensive intangible assets to a transaction.
Corporations
Many large corporations try to grow through acquisitions. They look for businesses that are complementary to their existing operations and seek to generate returns by being able to scale up operations due to this synergy.
Attracting Prospective Buyers to the Business
Knowing the type of buyer you are trying to attract will be vital in driving your strategy in this phase. Owner/Operators are frequently focused on specific geographies, so knowing who is looking for new business opportunities in your area can happen through your personal and professional networks. Various online marketplaces also try to match buyers and sellers within specific regions. For larger companies, working with an advisor who already knows many of the private equity funds and family offices is usually the best way to attract interest from those types of buyers and will dramatically reduce the time frame required.
For Corporate Buyers, if you’ve operated your company for many years and have a solid professional relationship with senior executives in these companies, that would be the place to start attracting interest.
Working with Accountants and Attorneys to Close the Transaction
Once you know who the buyer is, you need to understand any proposed transaction’s specific legal and financial aspects. This will involve receiving legal advice about the contract terms on the Purchase Agreement. An accountant familiar with the tax implications of business sales should also be consulted before signing any contracts. Be sure to work with an attorney and an accounting firm familiar with M&A-type transactions. This is somewhat specialized knowledge and requires an accounting firm with business clients engaged in these transactions.
Summary
Selling a company is the liquidity event business owners look forward to through the late nights and long workdays of building their company over many years. While it is possible to sell a business yourself, working with a trusted business broker or M&A advisor makes the process have a considerably higher chance of producing the desired outcome of a high transaction price and reasonable deal terms.
