Selling a business is both an exciting and daunting prospect for many entrepreneurs especially if they are doing it for the first time. It is a lengthy process involving intense scrutiny of financial documents, regulatory approval, negotiations and eventually executing the deal. Once it is all over, entrepreneurs often feel doubts about whether they made the best decision to sell the business and if they got the best deal. This guide will take you through the process of selling a business and all the considerations you have to make with the goal of leaving you happy with your decision.
When you want to sell your business, it is important to set your personal feelings aside to objectively evaluate your business, its vision, and what it stands for. This enables you to give an accurate valuation. Many entrepreneurs often overvalue their business while some fail to capture the real earning potential leading to problems in the valuation process. You will need to objectively analyze the business, study the current market, and consider employing the expertise of professional advisors.
Depending on the type of business, its industry and size, there may be several considerations which may impact the sale process. These include:
- Reasons to sell.
- Legal considerations and implications to consider before the sale can be made.
- Can you afford to lose the income and/or live on the proceeds from the sale?
- What are you going to do with yourself and your time?
- How to handle the proceeds of the sale.
Table of Contents
Why Sell your Business
Many business owners sell their businesses for various reasons. Give this question a quick browse to evaluate which of these reasons give cause for you to be reading this guide. Some of the common reasons are;
You may a point where you feel drained or suffer burnout from the management of the business. Once you get to this point, you can no longer give the business the attention it deserves. Selling is a good exit strategy.
- Personal reasons
These reasons may include health, family emergencies, retirement, or to concentrate on other obligations.
- Working capital
Selling a stake in the business is a good way to raise working capital to continue and even expand operations.
- To cover liabilities
Liabilities in a business can accrue to high levels. Selling the business or a part of it to cover them is a valid option.
Some business owners just want to cash out of the business. It doesn’t mean that there is anything wrong with your business. Still, this means you have a desire to get some money for personal use or to diversify your investments.
- Need for a change.
- If the company needs new skills, a new approach, or resources you can't provide.
- If your company’s value has grown significantly.
- If you have received an offer too good to refuse.
- If you have achieved your business goals.
- If you want a fresh start.
Check out this excellent video guide by Kochies Biz which covers reasons why you might want to sell a small business of yours and how to approach the sale for each of the reasons.
How Long is a Business Sale Transaction
While every process is unique, a business sale may take between six months and two years, according to SCORE, a non-profit association for entrepreneurs and partners of the U.S. Small Business Administration.
It is, therefore, crucial to begin sale preparations as early as possible. It also helps to involve a team of professionals to guide and support throughout the process. Not only will their knowledge help make the process quicker and smoother, but they can also make sure you get the maximum value from your business.
To even hasten the process, it is advisable to analyze and address any bottlenecks that may impede the process. You must be as 'buyer ready' as possible.
Some seller or buyers may require signing a Non-confidential agreement while the process is taking place.
Steps to take when Selling a Business
Define the owner’s exit strategy
Do you want to completely move away from the business or do you want to retain some shareholding? What is your exit strategy? What role will you play after a sale? All these should be clearly defined even before looking for a buyer. The goal of selling the business should be clearly defined from the onset. Employees, suppliers, creditors, are some important people who have to be involved at some point in the process for the continuity of the business.
Timing of the Sale
Getting the timing right is an art that few entrepreneurs get right. Those who do reap handsome rewards. When to sell your business, whether in part or its entirety is something to be actively prepared for well in advance of a potential sale. Adequate preparations help you optimize the operations and adequately put the financial affairs of the business in order to get the maximum value.
Next, you'll want to determine the worth of your business to make sure you don't price it too high or too low. This is a critical step in the sale process. Business owners should have a proper and realistic valuation to minimize considerable disparities in the expectations about the business value between them and buyers. M&A advisors, as well as valuation experts, can help come up with the business' value. Hiring professionals to do the valuation not only eliminates the owners' sentiment from the sales process, but it also aligns the business value with current market conditions as well as provides objectivity that may lack when it comes to making an own fair assessment of the business. The valuation should be done prior to listing the business for sale.
If you are not one to spend for professional help, there is an online business valuation tool offered by Bizex. You can use it by clicking here.
Prepare the financial statements and determine the SDE.
The first step in business valuation is preparing the company's financial statements. You should gather business financial records for the past three years. These include your:
- Income statement
- Cash flow statement
- Balance sheet
If the business hasn't been operating for three years, consider using a projection model. As a startup, you probably don't have that much staff working for you and you may be more willing to go through the grit and grind of doing things for the business yourself. As such, look into making your own projections on Google Sheets by checking out this very detailed guide from QualityBusinessPlan.com's Paul Borosky.
By following the steps in the video above, you will learn how to create a spreadsheet that will enable you to present prospective earnings to your buyers and paint a clearer picture of growth for your business.
Next, your income statement should be transformed into a seller's discretionary earnings (SDE) statement, which takes into account non-recurring purchases and discretionary expenses to more accurately reflect the value of the business.
Establish the asset value of the business.
The asset value of a business is determined by estimating the value of tangible assets and intangible assets. Physical assets are pretty straightforward to value. Intangible assets such as Goodwill, intellectual property, contracts, etc. are much more difficult to value. Moreover, asset valuation will only help determine the value of a business in a vague sense. Earning potential of the business is a more conventional approach taken by potential investors.
Using price multiples to value a business
Multiples are ratios that estimate the value of a business by multiplying a specific item on the financial statement by a certain number. It is based on the assumption that businesses in similar industries should be valued using specific ratios.
Use comparable to 'For Sale' and sold businesses.
This is a common valuation technique where businesses that are comparable priced the same way. That's why you'll commonly hear people reference that a particular business was sold for a specific value while finding value for another almost comparable business. Companies in the tech space often are prone to this type of valuation.
Improve the value of the business
Buyers are interested in businesses that offer the highest potential for future profit. So, the sooner you begin working on increasing the business's selling price, the better. Some of the ways to enhance the value of a business prior to a sale are:
- Streamlining processes
- Reducing expenses
- Focusing on core competencies
- Reducing customer concentration
Working with a knowledgeable mergers & acquisition advisor that has relevant transaction experience and understands the business can be very valuable in the sale process.
It helps a great deal to have proper documentation on the strategic plan, growth opportunities, and the financial status of a business.
Gather Financial Information
A business's financial and business history, as well as future projections, require to be adequately evaluated and presented as part of the sale process. Typically, businesses prepare their financial statements for tax purposes, and not for business sale purposes, they, therefore, need to be recast (with the help of professional advisors), so that prospective buyers have a good view of the company's earning capabilities.
Compile Due Diligence Information
All potential buyers will thoroughly scrutinize a business through the due diligence process. This is to be expected and should be facilitated adequately. A well-organized company with all documents readily available and organized reflects well on the owner and may even give them an upper hand in the negotiations. To enable quick access, you should designate a room as a data room where all available documents and data needed by potential buyers will be found.
One important document to prepare is Business Summary. It contains all necessary company information at a glance. It may also be referred to as a Confidential Information Memorandum.
A business, especially medium-sized firms often have quite a number of potential suitors. Engaging each of these can be draining and even impossible. It is vital to filter potential buyers to target those that are better suited to buy the business. This can be done by the management or through M&A advisors.
Qualify Potential Buyers
The next step is qualifying the potential buyers to screen their suitability. This is especially in view of the continuity of the business. Not everybody who has money and is ready to buy the business is qualified. Their long term vision, values, and what they stand for are essential, especially when they are buying a stake in the business.
A common mistake of sellers is to treat buyers the same way. Not all buyers are created equal and one must know how to effectively sell to each type of buyer. Here's a video to provide some insights on the different types of buyers by Dan Lok and see how you can make the most effective sales pitch to them.:
Negotiate the Deal
At some point, negotiations have to take place. They involve a lot of details regarding the potential sale. Often times, negotiations are called off when both parties can't seem to move forward past a contentious point. Other than the valuation of the business, they are some of the items that need to be ironed out. Some of these are
- Liabilities assumed by the acquirer
- Current assets retained by the seller
- Equity ownership
- Stock sale versus an asset sale
- Seller financing and security to support that financing
- Employment contracts
- Non-compete agreements
Check out this brief video guide by Neil Isaacs on the negotiation process and how you can best position yourself to get an approximation of your desired price and terms.
Indications of Interest, Letter of Intent and Transaction Documents
The three stages buyers express interest in buying a company are:
- Indication of Interest (IOI)
This is non-binding and has the proposed terms, valuation and the structure of the transaction.
This is more serious than the Indication of Interest. It includes the terms of the deal and an exclusive period where the buyer deeply evaluates the company.
- Purchase Agreement
This is the binding document that outlines the terms of the sale. It goes along with any other document that was signed, such as NDA, Non-compete agreements, etc.
The transition period
After a sale, a transition period where the seller assists the buyer to settle in the business is common. This is one of the items negotiated on. In the case of mergers and part acquisitions, there will still be a transition period where the processes are optimized to reflect the new entity.
Documents Required to Complete a Sale Process
You need to prepare certain documents and review them for accuracy before listing your business for sale. The documents help you value your business correctly and negotiate for a good value. Potential buyers will also be particular about some documents that show the strength and weaknesses of the business. Financial advisors and professional business brokers can help you prepare these documents in the best way possible. In the process of preparing these documents and reviewing them, you can find some pitfalls that you can then fix before selling your business to get the highest value.
These are the most common documents that we see potential buyers being interested in:
- Confidential Information Memorandum
- Three years of historical financials inclusive of tax returns
- Five years of projected financials
- SWOT analysis
- Projected growth of your industry
- Key end markets and their projected growth
- Critical employees
- Any contracts with suppliers and customers
- All loans and their payment schedule
- Tangible and intangible assets
- Copies of leases
- Confidentiality agreement
- Letter of Intent
- Purchase agreement
Some of these documents may be confidential and business owners may not be comfortable sharing them with every potential buyer. However, potential buyers need these documents for their due diligence. The solution is to have a Non- Disclosure Agreement document that is signed by both parties.
If you are buying a business, check out our Letter of Intent Template so you can get a head start towards coming up with the essential documents you need to be able to buy a business. If you're looking to sell, read on and learn more.
What Happens to Debt
One may wonder what happens to debt when selling a business. Does it disappear, or is it absorbed in the transaction?
This largely depends on how the transaction is structured. Sale transactions are typically structured either as a stock sale or an asset sale.
A stock sale involves buying the entire company, including all disclosed and undisclosed assets, as well as all liabilities, including those that may not be known at the time of the purchase. A stock sale is normally done by bigger companies that want to merge with other big companies or want to completely acquire the entire operations of a medium-sized business.
An asset sale involves the transfer of stated assets and liabilities. The buyer normally chooses which assets to buy and which liabilities to assume. The seller may also transfer some assets to a different company if they don't wish to sell them. Many small businesses are acquired through an asset sale to mitigate the risk of any unknown liabilities. Normally referred to as contingent liabilities, these are unknown liabilities that can pose a significant risk to any purchaser.
An asset sale is more complex to finalize due to the negotiations and the agreements that have to be executed. A stock sale is more straightforward since only the stock certificate is executed, and all assets and all liabilities automatically transfer.
The prospect of dealing with debt of a business being sold can turn away many buyers. This can often be mitigated by how you transparently present the debts of the business while proactively showing that the business is worth more than what it owes. Check out this commentary on how to deal with debt in a business sale or acquisition to know how you can put your business in the best light possible.
1. Leased Equipment
If the equipment is leased by an individual, that lease or asset would have to be transferred over, regardless if it's an asset sale or a stock sale.
2. Successor Liability
There is some successor liability in the sale of a business, which means that the buyer could potentially be liable for certain things, even though that wasn't agreed to contractually. Examples could be unpaid utilities, sales tax, property tax, payroll taxes, income, and social security taxes, and so forth. Successor liability occurs by operation of law, not by contract.
Involving a Broker in the Deal
The team to involve in a business sale largely depends on the size and nature of business. An attorney and an accountant are the bare minima. The attorney will handle all legal issues regarding the transaction and advice all necessary federal and state laws. An accountant will hand the tax and accounting side of things. More complex transactions will often involve a bigger team. You should never view these professionals as an expense. In most cases, they often optimize the process such that you get the maximum value from the deal.
Even a small business will need an attorney to review the transaction and ensure all documents are in place. If some contracts and agreements are not drafted correctly, you may be shortchanged or be exposed to huge claims and liabilities.
All sale transactions will be subject to federal and state taxes. An attorney and an accountant will advise you on the best way to structure the deal in relation to tax liability.
The following are some of the necessary people to involve when selling a business:
· Attorney to look over your sales contract as well as advise on everything legal
· Accountant to prepare all your financial documents
· Tax expert to compute, advise and minimize tax liabilities
· Valuation expert to accurately value assets and provide a realistic business valuation
· Business broker/ M&A advisors to help groom the business, identify buyers, widen the list of possible buyers and write the sales memorandum/purchase agreement, boost your business credibility, negotiate on your behalf.
· An investment banker or another financier, if third-party funding is needed.
This team will allow you as the business owner continue running the business while they concentrate on selling it.
Pitfalls to Avoid when Selling a Business
The temptation to overvalue the business is very high among many entrepreneurs. It is only natural to expect top dollar for what you have worked on for a long time. However, potential buyers will thoroughly scrutinize the business before committing their money. The prospect of undervaluation is also true, with some business owners shortchanging themselves.
Selling too quickly
Some business owners are too quick to sell their business. You should always analyze all options available to you. A financial advisor will help you decide which is the best option for your business.
On the other hand, you may be guilty of waiting too long. Selling at the opportune time is a skill than an entrepreneur should work on.
Not making use of professionals
Many sellers are averse to hiring professional advisors to facilitate the sale of their business, yet in most cases, these professionals are capable of adding at least 10-12 percent to the sales price through their skills and experience.
Lack of preparation
This is a critical point in the life of your business. Ruining it by under preparation is disastrous to your future and that of the business. It is better to hire an advisor to help you streamline all the processes and prepare all documents before listing for sale. Adequate preparation will help with your confidence and give you an upper hand in the process.
There is nothing as bad as this in the process of selling your business. Serious cases of misrepresentation can even land you in legal problems even later after the transaction has gone through. In most of cases, potential buyers will notice the inconsistencies and pull out of the deal.
Always prequalify potential buyers
The pre-qualification of buyers saves time that could be wasted with buyers who may not be suitable. Small businesses may not have this luxury. Medium-sized businesses are in high demand and thus can attract quite a number of potential buyers. Going through the due diligence with all of them can waste time.
Failure to oversee the process
It is not enough to have some advisors working on the process. The owner must be involved to see it through. However, do not be all over the place, just maintain a good grasp of the process. If you find a very good accredited broker with extensive networks, your involvement will be minimal.
Fear of negotiations
You will be surprised by the number of people who fear negotiations. They do not want to be in a room where things may get heated. However, negotiations in business will always be there and it is a good skill for all entrepreneurs to have.
Confidentiality throughout the process is important. Anybody involved in the sale should sign a confidentiality agreement detailing what they can say and cannot say about the process. If words get out prematurely about the sale, the process can easily get scuttled.
The transition process is as important as the sale process. It determines the future of the business as it changes ownership. The transition period should be part and parcel of the negotiations as both the buyer and the seller reach an agreement on how the business proceeds and their involvement during the transition phase.
Tax considerations when selling your business
All sale transactions face significant tax liabilities that you should always keep in mind. Sometimes the federal and state taxes can add up to up to half the amount of the sale. However, there are many options available where you can structure the deal to minimize the tax exposure on the potential deal. M&A advisors will advise on what the Federal and State law requires. You always want to minimize the tax bill or defer it to a later time.
Income tax and capital gains tax are some of the taxes you should pay special attention to. The following considerations can help in structuring the sale for tax purposes.
Nature of business/entity
Sole proprietorships, partnerships, S Corporations, and Limited Liability Partnerships have tax flexibility as owners can sell their assets with just a final tax. C corporations do not enjoy that since once they sell their assets, the proceeds must be distributed over to the shareholders and incur double taxation.
While it is possible to convert from one type of entity to another, the tax rules have generally been structured to prevent you from improving your after-tax position by converting your entity to a different form of entity immediately prior to a potential sale transaction.
Stock sale vs asset sale
An asset sale is subjected to double tax at the corporate and shareholder level while a stock sale in most cases makes business owners obtain clear, long-term capital gain treatment on the sale.
A stock sale is applicable to incorporated businesses. It has some advantages over an asset sale, especially for big companies.
For an asset sale transaction, both the seller and the purchaser must allocate the purchase price to all the assets involved. The same allocation must be used and declared by both of them.
Stock exchanges are an example of a tax-free deal. This involves one corporation taking over the stock of another in exchange for its own stock.
According to section 388 of the IRS code, three types of corporate acquisitions qualify as tax-free deals.
Type A Reorganization -Stocks for assets acquisition
Type B Reorganization Stock for stock acquisition
Type C Reorganization -Stocks for assets acquisition
If you haven't read enough about how to sell your business, check out this quick TLDR on the process by Visualistan:
Every year, thousands of small and medium-sized businesses are sold. The buyers include private equity firms; bigger corporations or people flush with cash willing to enter a new market. There are many reasons you’d want to sell your business. The key thing is to get the timing right. Some entrepreneurs optimize their business over several years to make it ready for a sale. Even if you do not wish to sell your business in the near future, it is important to know how these types of transactions are structured and what leads to a successful sale.
However, selling is not just about going with the highest bidder. All buyers are not the same. You need to carry out some due diligence in the values and reputation of the potential buyer. Even if you are completely exiting the business, you’d still want it to succeed after you leave.
Do you think that you have the necessary knowledge to sell your business? Check out our free template of an agreement to sell a business and take the first step to applying what you learned from this guide. Alternatively, you may also explore taking steps to buy a business. The letter of intent to buy template may also be of use to you as you secure the business you are looking to acquire.