When running a business, hindsight is definitely 20/20, and it's often possible to use hindsight to change the outcome if given a second opportunity. When selling a business, however, hindsight may still be 20/20, but it is nearly impossible to change the outcome. However, business owners considering the sale of their business can gain from the hindsight of others. Gleaned from business sellers and business sale experts, these are the Ten Things You Need to Know well before you consider selling your business.
Among the ten things you need to know before selling your business, this one may be the most important, yet many business owners don’t fully contemplate their reasons for selling. They just know they want to sell. The problem is that a lack of clarity in the reasons for selling will likely lead to unrealistic expectations and/or the use of the wrong strategy for selling the business. Either way, it invariably results in an unsuccessful outcome, if not outright failure.
Do you WANT to sell your business, or do you NEED to sell your business?
The reasons for wanting to sell the business can be vastly different than the reasons for needing to sell the business. Generally, business owners who decide they want to sell are in a position to plan their exit and develop the strategy around its timing. Business owners who need to sell their business may be forced to let circumstances dictate the strategy, which can reduce the amount of control they have over the process.
Reasons for Wanting to Sell
Reasons for Needing to Sell
• Loss of enthusiasm, boredom, looking for new opportunity
• Health reasons
• Lack the capacity to take it to the next level
• Cash flow crisis
• Part of a long-range plan
• Deteriorating business environment
• Unwilling or unable to invest in the company's growth
• Loss of key employee or competitive advantage
Motivations are the key to determining the selling process
This is not to say that business owners who need to sell can’t have a successful outcome, nor does it mean that business owners who want to sell always achieve one. There are still more questions that have to be answered in either case. The critical point is whether or not business owners fully understand their true motivation for selling. Done right, business sales are strategic transactions that are shaped and influenced by the underlying motivation for selling the business.
In selling a business, your motivations are the key to determining the sales process. However, the way the sale is to be structured is dictated by your objectives, or your expected outcomes of the sale. The deal’s structure would be very different, for example, if your sole objective is to get the highest price for the business without regard for your employees, or if one of your primary objectives was to do the most to protect your employees. The former would require a completely different buyer and deal than the latter. So, having clearly defined objectives at the outset is critical to achieving a successful outcome.
Defining and Prioritizing your Objectives
You will also need to determine which of your goals are non-negotiable and which are in play for negotiation or compromise. The more specific your objectives are, the more precise your plans can be for achieving them. Also, it's important to prioritize your objectives because it's not always possible to achieve all of them, and some may even create their own conflicts. For example, if your primary objectives are to have your business remain in the family and maximize your price, you may not be able to realize both, because you're more likely to get top dollar from a third party buyer. In this case, you may have to sacrifice price or agree to an extended payment term in order to ensure an internal transfer.
You Need an Exit Strategy
Your sales objectives provide the framework of a formal exit strategy. This becomes the blueprint for making all exit planning decisions. The exit strategy should include a concise statement of your personal, financial and business goals, prioritized by importance. No two exit strategies are alike; however, they all should contain the following components:
- A target date for the exit
- A plan for maximizing the value of the business
- A determination of how to exchange the value of the business for cash in the most tax-efficient manner
- A determination of whether the business is to be transferred internally or externally
- A plan for ensuring the continuity of the business during the transition to new owners
- A determination of the role, if any, the owner will have with the business during the transition and after the transfer
- A plan for ensuring the financial security of the business owner and his family
It's critically important to view your business from the perspective of a buyer, especially if you think your business should garner a premium price. Then your focus should turn to eliminating the negatives while accentuating or enhancing the positives.
Evaluating the Salability of your Business
Potential buyers may have a number of criteria they include in considering the purchase of a business, but the core elements can be categorized as follows:
- Market position
It almost always comes down to the bottom-line. Is your business profitable? Equally important, however, is the multi-year trend going backward and forward. One or two years of profits may not be enough unless the recent trend shows steadily increasing revenue and there is a realistic forecast of continued growth going forward.
Buyers will next want to know how solvent the business is - essentially determining its net worth. Buyers want to know that the business liabilities are exceeded by its assets; and if there are liabilities, they want assurance that the current revenue is sufficient to cover the debt payments while maintaining profitability. The bottom-line is the less debt on the books, the better for attracting good buyers.
Businesses that have successfully differentiated themselves in the market are especially attractive. A business can establish a strong market position through successful branding, distinct products and services, or innovative operational processes. Buyers consider all of these when determining the market position of the business and its ability to retain or build on it.
Business owners know that employees are the backbone of a successful business, and so do prospective buyers. They will typically evaluate the experience and abilities of your employees and management staff. If buyers determine that certain employees will be a drag on the business during or after the transition, they will view it as a cost to the business, which will translate to a lower offering price. For certain key employees, the buyers deem as essential, they may want to know that they are “locked in” with a contractual agreement.
Unquestionably, the business's customers are its most valuable asset. Your customer base - its size, its diversity, its loyalty to the brand (and not you), and its growth potential - is a key determinant in how buyers value your business. Is your customer base diversified among several industries and types of companies, or is it too concentrated, increasing the risk that the loss of one company could severely impact revenue forecasts?
Are You Expendable?
One last, but very important factor buyers consider is how expendable you are. Much to the chagrin of some business owners, a business is much more attractive to a buyer when the owner is not an important part of the day-to-day operations. While it might be hard to admit that your business doesn’t need you, the fact is that by making yourself expendable, your business is more valuable.
Most business owners have no idea how much their business is worth, and those who are keeping score are often too optimistic in their estimates. Valuing a business for sale is both an art and a science, so using general rules of thumb, as many owners do when they begin the process, has very little basis in reality. it's a mistake, anyway, to try to put a price on the business as if it is a real estate sale. In the business selling world, the business owner doesn’t set the price; the market does.
It's not surprising then that most business owners are disappointed when they finally have their business valued by a professional. However, if a valuation is done well before engaging in the sales process, a business owner may have ample time to take measures to increase the value of the business.
In most cases, the sale price and the deal structure will be determined on the basis of who is buying the business. For instance, if the buyer is one of your executives, you may structure a deal in which you receive installment payments and the ultimate price will be based on the actual cash flow generated over the installment period. Or, if a buyer simply wants to buy and liquidate the company’s assets, then the value of assets will determine the sale price. You are more likely to receive a premium price when you sell to a third-party buyer than to a family member.
The Science of Valuing a Business
It usually requires the expertise of a valuation professional, preferably a certified valuation analyst, to obtain an official value that can be used as a starting point in setting a sales price. Depending on the appraisal method, the valuation can differ widely. The valuation approach used in any particular case depends on the valuation specialist’s preferences, as well as your business’ situation, but it is usually one or a combination of the following:
- Income approach: A multiplier approach that takes into account past current and projected revenues and cash flow in the same market
- Asset approach: Only considers the fair market value of the assets owned by the business
The Art of Valuing a Business
The science, or math, of business valuation is fairly straightforward. It's the art - the valuation of the variables and intangibles - that is somewhat more subjective and makes pricing a business for sale difficult. It's about many of the factors discussed earlier (Is my business saleable?) -- the employees, the customers, the market position, contractual arrangements, industry trends, environmental or regulatory issues - that, at any given moment, can be perceived by a buyer differently than another buyer at a different moment in time. The key is to understand how each of these elements can impact the value of the business and then take steps to optimize them for a business sale.
Don't Wait to Value Your Business
Even if your planned exit date is far off in the future, you shouldn't wait to have your business valued. If nothing else, it will provide you with an important benchmark that allows you to keep score. But there are plenty of other reasons to value a business. You can’t properly fund an estate plan or a business continuation plan without knowing the value of your business. If you are considering the sale of your business, by valuing your business today, you will know more precisely what aspects of your business you need to work on to increase its value and its ultimate sale price.
By viewing your business through the eyes of a buyer and understanding what factors buyers consider in determining a price they will pay, you can concentrate your efforts on improving those aspects of your business that will have the most immediate and visible impact on its value.
Increase Cash Flow
There is just no escaping the cliché - in selling a business, Cash is King. Buyers place the most weight on the amount of cash flow the business is currently generating; first and foremost because they are most interested in making money; and, secondly, most buyers will probably require some financing in order to purchase your business, so they will need assurances that the cash flow is more than adequate to cover the debt payments. There are several ways to increase cash flow over time, including:
- Hire a part-time CFO or CPA to review your books and operations for inefficiencies
- Work with your bank’s cash management department to automate your receivables and payables, which can increase your on-hand cash flow and keep more of your cash earning interest
- Consider outsourcing non-essential functions to reduce man hours
- Pay down debt faster
You may be thinking, “If increasing revenues is so easy, why have I waited until now to do it? No one said it is easy, but the fact is that buyers are willing to pay a higher price when revenues are growing; so, it is worth any extra effort and resources to boost revenues. It may be time to increase incentives, update some sales campaigns, or take on a business development specialist. You need to ensure that your revenue increases are not concentrated among a few customers. In fact, if you can increase your revenue while increasing and diversifying your customer base, you’ll add even more value.
Make Yourself Expendable
The best indication of how well-oiled your machine is how expendable you are. A business in which the managers and employees don’t even know if the owner is around is much more valuable than one that requires the owner to be in on every decision.
Get Your House in Order
The devil is always in the details. In addition to ensuring that your books are in order, it's important to review all of your contractual arrangements - leases, employee contracts, and vendor contracts - to ensure they are not a hindrance to the sales process. Here are a few more of the details that many business owners miss:
- Update your financial reporting system if it's outdated.
- If you have been dealing with environmental or regulatory issues, make it a priority to put them to bed.
- If you have been considering relocating your business to a more prime location, or adding locations, do it sooner rather than later.
- If you haven’t already done so, file patents on products or processes.
- Consider adding suppliers to hedge supply line risks.
In most privately held businesses, the stakeholders are easily identified - a business partner, spouse or family member with an ownership interest, a board of directors, a key employee. And, from a legal or a practical standpoint, their approval is required in order to proceed with the sale of a business. The timing and approach taken for involving the stakeholders may vary, but business owners need to consider the needs, opinions and possible objections of all stakeholders before wading into the process too far.
Before you can say “yes” to a deal, you need to consider who can say “no”
Sellers are often surprised by the number of consents and approvals necessary to close the sale of their business. In many cases, it goes well beyond the approval of key stakeholders and family members. It's not unusual for sales to be cancelled or postponed due to the objections of lenders, landlords, local authorities, or others with whom either party has a material agreement in place.
The actual sale process will vary depending on the motivation of the business owner. A seller, who needs to sell the business quickly and is, therefore, willing to accept a lower price, may be more interested in taking certain shortcuts. While a seller who wants to obtain the highest possible price while achieving his most important sale objectives, would have to be willing to endure a longer, more intensive sale process. If the objective is to transfer the business internally, to family members or management, the deal structure will be completely different than if the objective is to have the business transfer to a third party or strategic buyer.
Assuming that the seller is looking to optimize both sale price and the opportunity for achieving specific objectives, the process should actually begin with identifying and engaging a qualified, independent business intermediary who will only represent the seller’s interests.
The Business Sale Process
An experienced business intermediary will begin the process with a comprehensive fact-finding session consisting of many of the questions asked in this guide. The more prepared you are with your answers ahead of time, the more quickly and effectively your advisor can initiate the process. The total time frame for this sale process is approximately nine months, or six months under ideal circumstances. Once fully engaged, your advisor will conduct the following steps (approximate time frame in parenthesis):
- Conduct thorough due diligence: Learn everything there is to know about the business. (Up to 1 month)
- Write a memorandum: A selling document that briefly describes the business in the best possible light. This is, essentially, packaging the business for sale. (2 weeks)
- Research the market: Determine who the ideal buyers are, including financial buyers (private equity firms) and strategic buyers. Develop a targeted list of potential buyers. (2 to 3 weeks)
- Go to market: With a memorandum in hand, reach out to potential buyers via phone calls and emails. Present a one-page summary to elicit any indication of interest. Have the prospective buyer sign an NDA and present your memorandum. In the right setting, this could generate as many as fifty interested parties. (2 to 3 months)
- Qualify the buyers: Following additional Q & A, if they want to move forward, request a letter of interest, along with the price range they are considering, a summary of their intentions for the business (how they align with the seller’s objectives), and how they would finance the purchase. A typical engagement might attract three to ten qualified buyers. (1 month)
- Examine the business: Invite interested and qualified buyers to visit your facility, meet management and learn more about the business. This may narrow the list of prospective buyers down to three or four.
- Negotiate: Negotiations with the buyers typically begin as soon as they sign a letter of intent in which they have indicated a price range. As the list of prospective buyers is narrowed through the process, negotiations will intensify until the list is narrowed to one or two. (1 month)
- Seller letter of intent: When the most qualified and interest buyer is identified, the seller signs a letter of intent to grant exclusivity from that point forward.
- Additional due diligence and financing: The prospective buyer will conduct additional due diligence while he or she is arranging for financing. Legal considerations are addressed, paving the way for the final transaction. (2 to 3 months)
Needless to say, business owners should not try to sell their business on their own. There are too many moving parts of the process that must be managed while doing the job of running a business; and business owners can be their own worst enemy when trying to engage in complex negotiations on their own account. The process can be too lengthy, complex, and emotional for anyone who cannot focus one hundred percent of his or her time and attention on the strategy and minutiae.
Because it is vital to have a solid plan in place, the search for experienced professional advisors should begin well in advance of a sale. The advisory team needs to have the necessary expertise to handle a business sale transaction, and they must have the capacity to work in a collaborative fashion to ensure the coordination of strategies, tactics and outcomes.
The Business Seller Intermediary
The importance of engaging an experienced business seller intermediary, as discussed earlier (How do I go about selling my business), cannot be underscored enough. When it is done right, the process of selling a business is a full-time endeavor. The business seller intermediary will take on the arduous tasks of due diligence, writing the memorandum, finding qualified buyers, narrowing the field, negotiating terms, and finalizing the deal - all on behalf of the seller so he or she can continue to run the business.
A business owner’s legal counsel is often his or her most trusted advisor; however, they may not have the specific background or expertise to evaluate, much less create the contracts and agreements involved in a business sale transaction. The attorney must be fully engaged throughout the process, evaluating letters of intent, advising on employee agreements, and writing and enforcing NDAs. And, when it comes down to the final negotiations and structuring of a deal, it is important to have a battle-hardened “deal” attorney with a solid reputation in business transactions.
The accountant plays a vital role in many facets of a business sale, from preparing the seller for the sale, assisting in the valuation of the business, overseeing the due diligence process, structuring the deal for tax advantages, and acting as a sounding board in the final negotiations. The tax implications of selling a business alone can be extremely complex, requiring a specific expertise and level of experience limited to CPA firms that specialize in business transactions.
The Financial Advisor
The sale of a business will impact every aspect of a business owner’s financial life. Chief among the immediate decisions that you will have to make are the disposition of the sale proceeds and their tax ramifications. As a business seller, you not only need a comprehensive investment strategy in place prior to the sale, you will need a well-coordinated plan for enhancing your wealth through tax planning, protecting your assets, and preserving your wealth well into the future.
It happens more often than you might imagine - a business buyer comes back to the table after a deal has been negotiated to ask for concessions due to the declining financial performance of your business in the final months prior to the closing transaction. It is not uncommon for a deal to completely fall through if the financial results fail to meet the expectations of the buyer. Often, the primary cause of negative turnarounds during the sale process is the performance of the management team, which has focused its attention on the deal rather than the business.
Business sellers should ensure their business is being run as if they are not going to sell it. As part of the sale strategy, they should establish clear assignments and objectives for the management staff. Some may be involved in the sale strategy, but others must be responsible for managing the business and held accountable as if it was not going to be sold - because it might not. Ensuring your business is running optimally and meeting forecasts during this critical period are all the more reasons to have an experienced advisory team and plan in place.
How do I maintain confidentiality throughout the process?
Of all of the things that can go wrong in the selling process, the inadvertent leak of information can be the most damaging. In this day and age, information travels at digital speed, and it wouldn’t take long for it to reach employees, customers, or the market, any of which could derail the plan and possibly impact the value of the business in any future sale. In most cases, information is leaked by the business owners themselves through a family member, an advisor, a colleague, or anyone to whom the business owner might drop even the slightest hint.
The most essential rule of thumb for business sellers is to never tell anybody who doesn’t need to know; and when the need to divulge any aspect of the idea or plan to anyone arises it shouldn’t be done unless a non-disclosure agreement has been signed.
How and when should I communicate my plan to my employees?
Perhaps the most challenging aspect of selling a business is determining the best time to communicate the plan to key employees, and, ultimately, to all employees. The timing is critical to the structuring of a favorable deal, and it can have a significant impact in the transition phase. Business owners who decide not to tell their employees until the last possible moment, risk information leaks that can cause anxiety among employees. This could result in decreased productivity, or even defections, which can derail negotiations.
The question of when to communicate the sale of the business to employees and management comes down to their absolute need to know and timing, both of which are entirely dependent on the circumstances. However, the question must be asked as early on in the process as possible.
At the risk of oversimplifying the very complex process of selling a business, by taking the time to thoroughly address each of the issues previously outlined, you will significantly enhance your chances of a successful outcome.
Steps to ensuring a successful business sale outcome:
- Know the real reason why you want to sell.
- Be clear about your motivations as this will dictate the sale process.
- Honestly assess whether you are really ready to sell - seller’s regret can dampen any outcome.
- Clearly define and prioritize your sale objectives.
- Develop an exit strategy with specific goals and milestones.
- Have a solid post sale personal financial plan.
- Evaluate the salability of your business through the eyes of a buyer (Would you buy your business?)
- Make yourself expendable.
- Determine how much your business is worth in the market.
- Understand the different approaches to valuing your business.
- Have your business valued by a certified valuation specialist
- Take steps now to increase the value of your business.
- Explore ways to increase cash flow, increase revenue, and increase operational efficiency.
- Get your house in order.
- Consider the interests of all stakeholders
- Will all family members get on board?
- Identify any stakeholder who can say “no” to a deal.
- Anticipate how your management and employees will react.
- Educate yourself about the sale process.
- Focus on maintaining confidentiality throughout the process.
- Have a plan for how and when you communicate the plan to your employees.
- Begin forming your business sale advisory team.
- Evaluate your existing advisors’ capacity to guide you through the business sale process.
- Have your advisory team in place before you begin the sale process:
- A business intermediary who works exclusively on your behalf
- An attorney experienced in business transactions
- An accountant experienced in business transactions
- A wealth manager who can work in collaboration with a team of advisors
- Have a clear plan in place to manage your business during the sale process
- Run your business as if you are not going to sell it - because you might not.
That brings us to this tenth step, which is to be very clear on the essential steps to ensure a successful outcome. Essentially, this checklist should form the blueprint for your business sale plan, which should be developed further by your team of advisors.