HOW TO SELL YOUR BUSINESS IN 2022
This definitive guide provides all the steps needed to sell your business for maximum value.
A DEFINITIVE GUIDE TO SELLING YOUR BUSINESS
Selling a business is no walk in the park – it’s a complex and time-consuming undertaking. While the sale of every business is unique, the fundamentals are the same, and there are well-established steps you can take to find the right deal. The more prepared you are, the more likely you are to maximize profits.
It’s ideal to get your business ready for sale a year or two in advance before the actual sale takes place. This will allow you to get things in order and command the highest price possible. Selling your business for maximum value will depend on a number of factors, including the quality of the broker you hired, the timing of the sale, and the reason you’re selling.
6 STEPS TO SELLING YOUR BUSINESS
Here are a few steps to help you navigate the sale process and make the most of your time:
STEP 1: GET A PROFESSIONAL VALUATION
Valuing a business is not always a straightforward process; you may need the service of a valuation firm to determine the true value of your company. Also, using a third-party firm for valuation will bring credibility to the asking price.
The appraiser will take into account everything from inventories to sales, debts and other business assets to identify opportunities and set a realistic price.
BUSINESS VALUE REALITY
Statistics show that the typical business owner has 80% of their net worth tied to their business, so preparing their business for sale to showcase maximum value is critical to their livelihood post-sale.According to experts, small businesses are worth two to five times their annual cash flow, plus any discretionary add-backs, depending on their location, market demand, financial health, eight core value drivers, etc.For many small businesses the focus is on cash flow, it’s very likely that physical assets will form only a small portion of the value of their businesses and is limited to what they generate towards the profit of the business.According to BizBuySell, small businesses with an annual cash flow of $100,000 and under received sales price of about 1.90 times their cash flow. And those with cash of flow $300,000 and above received a multiple of 2.81.
It’s important to note that cash flow alone will not satisfy savvy business buyers; you may need to present prospective buyers with a plan on how the business can grow and thrive without you at the helm.
STEP 2: ORGANIZE YOUR FINANCIALS
In today’s economic climate, buyers are looking to buy businesses that will not only be profitable but also have long-term viability. So many contemplate longer and perform their due diligence before making an offer. Savvy buyers will consider everything from equipment to real estate and business accrual-based financials; it’s your job to get these in order before taking your company to market.
Work with an accountant or business consultant to review your financial statements and tax returns dating back to 3 to 5 years.Create a list of inventories and equipment that you want to sell with the business, including any intellectual property and intangible assets.You should also provide information about how the company is run or present potential buyers with an operating manual to help them understand how you conduct business, buyers are looking for turn key operations.Make sure that all documents are organized and presented in a way that is useful to the buyers. You shouldn’t leave out any important information; you need to be as transparent as possible so that buyers know what they are getting. These will save you lots of time and future headaches, and they’ll present a consistent and unified story of the historical and future business.
STEP 3: INCREASE YOUR SALES
Companies with healthy income streams and multiple revenue sources are attractive; so you need to improve the overall performance of your company in order to maximize profits and ultimately your business value. Keep in mind that selling your business when sales are declining can hurt your profits.
Most buyers will look at sales and gross profit records to determine the viability of a business. They desire companies with sales growth year-over-year of 30 percent or more, which indicates buyers are looking to acquire businesses that are thriving, not surviving.Savvy buyers will also inquire about the contracts you have in place and whether those contracts are transferable.They’ll evaluate the future potential of your revenue streams as well, identifying recurring revenue opportunities that indicate ongoing sales sometimes years in the future.One thing that can put off a potential buyer is a business that has only a few customers. A significant revenue source will be lost if any of those customers left, so many buyers take the number of customers that a business has into account when negotiating.To make your company more attractive to buyers, you need to boost your sales and diversify your customer base if necessary. A diverse customer base, multiple income sources, and a robust management team will all help increase the value of your business.
STEP 4: TIME YOUR EXIT
Experts advise that business owners should plan their exit a year or two in advance. Being prepared will also help you get things in order including improving your sales, financial records, and customer base, which will make your business more attractive to potential buyers.
Statistics show that only 20-30% of businesses put on the market will actually sell, so timing is everything.You want to sell your business when things are good. Buyers want to buyer a growing and profitable business.You can’t expect to make a decent profit by selling your business overnight, experts warned.Markets change all the time; it is your responsibility to stay up/to-date with the current trends so that you can market your company as a leader in your industry.Don’t wait until disaster strikes before selling your business. If you let that happen, it will deplete the value of your company or lead to a potentially significant loss. The best time to sell a business is when it’s in good financial shape, experts said.
The worst mistake you can make is to not have an exit strategy. If you want to get the maximum value for your business, put in place an exit strategy now before an unforeseen situation forces you to sell.
STEP 5: FIND A THIRD PARTY BUSINESS BROKER
Business brokers are the best guide to get you the maximum value for your business and find you the ideal buyer. A business broker can help you with the following:
- Business valuation, negotiation and due diligence.
- Helping you to conduct sell-side due diligence to ensure a successful close.
- Marketing and locating potential buyers, including listing your company with various marketplaces to increase the buyer pool and get you the best possible price.
- Help buyers secure funding by tapping into the large network of financial institutions and private lenders they work with.
- Help to negotiate favorable deal terms on the sale.
- Another major duty of a broker is to vet potential buyers and ensure the confidentiality of the process.
- One of the hardest parts of the selling process is conducting due diligence. That’s where most deals fall through. Over 50% of deals fall apart during the due diligence process. A good broker will keep you on track and guide through the entire process so you can focus on running your business.
STEP 6: QUALIFY POTENTIAL BUYERS
Most new business acquisitions are funded partly by third-party lenders. And one of the reasons why many transactions fall apart is because buyers fail to secure loans after entering into an agreement with the sellers. Thus, it’s important to pre-qualify potential buyers before engaging with them.
There are many things you need to consider before entering into a transaction with a potential buyer, including asking the following questions:
- Has the buyer secured funding or does he/she have the necessary capital? Ask potential buyers to submit financial statements showing they have enough resources and means to fund the down payment including the first six months of working capital to fund operations.
- Is the buyer able to run the business and does he/she have business experience? Though lack of experience shouldn’t be a disqualifier, however, most qualified buyers are experts in the industry the business is in.
- Does the buyer have a reasonable timeframe? Ask prospective buyers whether they are ready to purchase immediately or are they still months away from making an offer.
These steps are not necessarily complex but if left unaddressed, you will spend valuable time and resources negotiating with unqualified buyers, increasing the chances of information leaking out before the sale.
Your business may be your most valuable asset, and building a successful company can take years of time and effort. If you’re considering selling your business down the road, this comprehensive guide can help you make an informed decision – and maximize the price you receive for the sale.
ACCOUNTING RULES OF THE ROAD
It’s important that you use a well-defined accounting process to post transactions and to generate your financial statements, and there are several reasons why:
- Consistency: If you use the same process each month, you’ll consistently produce accurate accounting data. You’re less likely to leave out a group of transactions, if you use the same system each month. You’ll also minimize the potential for errors or inconsistencies. A potential buyer will be more likely to rely on your financial statements if he or she feels that your process is nailed down.
- Comparability: Using a consistent process means that your results are comparable from one month and year to the next. Assume, for example, that you use a written procedure to post depreciation expense on fixed assets each year. Any trends you see in depreciation expense are more reliable, because you apply the same process each month.
- Supporting for an audit: Finally, a reliable accounting process makes it easier for an independent CPA firm to audit your financial statements. Say, for example, that an auditor is performing test work on your inventory balance. Your system ensures that each inventory transaction is correctly posted, and that your supporting documentation is easy to access. As a result, you can answer the auditor’s questions quickly and spend less time on audit issues.
Make the time investment to follow these accounting rules of the road, because you’ll spend less time on a buyer’s due diligence process.
It’s important to move away from Excel and Word documents and use accounting software. Using software speeds up the accounting process and helps you generate more accurate financial statements. Software, for example, includes check figures so you don’t post an accounting entry that doesn’t balance.
Integrate your accounting software with a payroll processing service. Payroll companies, such as ADP, can calculate each worker’s net pay, process employee payments, and handle your tax reporting. Payroll can tie up a lot of your time, so make the effort to automate the process.
There are also many additional cloud and web-based applications that can work with many of the available accounting packages. Software that automates time and attendance, expense reporting and administration, billing software, inventory and warehouse management, and more.
If you come to an agreement and sell your business, it will be much easier for the buyer to take over and operate the company using the same software.
PROCEDURES MANUAL: HOW YOU DO WHAT YOU DO
One factor that may attract a buyer to your firm is your ability to operate efficiently and to leverage industry knowledge. If you formalize your business processes in a procedures manual, your company will be more attractive to a buyer.
Document the steps you use to complete routine tasks in your business, and who completes each step. Everyone on your staff should have access to the manual, because it eliminates confusion about how a certain task should be performed.
Assume that your accounting software allows you to automatically email an invoice to each client. If you document how the software is set up, and who can make changes to the invoicing system, your staff will know how to accurately process invoices.
To order to comply with Generally Accepted Accounting Principles (GAAP), your business must post accounting activity using the accrual basis of accounting. A buyer will expect you to produce your financial statements using the accrual method, so that your results can be easily compared with similar companies.
The accrual basis requires a company to match revenue earned with the expenses incurred to generate the revenue. This concept is also referred to as the matching principle, and it presents a more accurate picture of a company’s profitability.
Some small companies use the cash basis of accounting, which posts revenue when cash is received and records expense when they are paid in cash. The cash basis presents a distorted picture of your financials and should not be used.
ADJUSTED TRIAL BALANCE
A trial balance is a report listing each account used to post transactions, and the current account balance. Accountants frequently review the trial balance to verify if a particular transaction was posted, and to quickly assess the current financial condition of the business.
To comply with the accrual basis method of accounting, business owners post adjusting entries. For example, assume that you owe workers $3,000 for payroll earned during the last week of December. On 12/31, you post a $3,000 entry to wage expense and to wages payable.
This adjusting entry records the wage expense in the month that it was incurred to generate revenue, and you need to post adjusting entries before you generate the financial statements.
NORMALIZING ADJUSTMENTS TO FINANCIALS
Some expenses may not comply with accounting standards, and those expenses will be removed when a potential buyer analyzes your financial statements. These changes are referred to as normalizing adjustments.
This is the most sensitive issue you’ll face as a business seller, but you have to consider the buyer’s point of view.
Assume, for example, that the business pays for 100% of the vehicle cost for a family member who only works part-time in the business. Let’s also assume that a CPA audits the financial statements and determines that 100% of the vehicle cost is not consistent with Generally Accepted Accounting Principles (GAAP).
The buyer would compute an offer price for the business based on the audited financial statements, which would remove some of the expenses.
Have a CPA review your financial statements and point out accounting transactions that do not conform to GAAP. You’re better off making changes to your financial statements before presenting your records to a potential buyer.
Finally, here are some final accounting rules of the road to consider:
- Financial statements: A potential buyer will want to review financial statements for at least the past three years, so the accounting tips listed here should be applied to past years as well.
- Goodwill: Goodwill is defined as the price paid for an asset above the asset’s fair market value. If a company buys a business, a product line, or intellectual property (patent, copyright), the dollar amount paid over fair market value is posted to goodwill in the financial statements. Note, however, the goodwill does not apply to internally generated intellectual property. Those costs are expensed as incurred.
- Tax returns: Your business tax returns will also be provided for past years, and your returns must comply with applicable tax laws.
- Getting help: Every business owner should work with a CPA, and you should work with an accountant from the day you start your business. A CPA can keep your accounting on track and confirm that your records comply with accounting standards and tax laws.
Make the effort to comply with these accounting rules of the road, even if you’re not planning on a business sale right away. Making improvements now will make the process much easier down the road when you sell your business.
FINANCIAL STATEMENT AUDITS
Your financial statements drive the business valuation process when you sell your business, and it’s important to understand why financial statements are audited. It’s very likely that a potential buyer will want to see audited financial statements, and you should consider paying for an audit each year, even if you’re not ready to sell just yet.
When financial statements are audited, an independent CPA firm provides an opinion as to whether the statements are free of material misstatement. The term “material” refers to an error in the financial statements that is large enough to change the opinion of the financial statement reader.
Assume, for example, that your firm has a $1 million balance in inventory. A $500 error in the financial statements would probably not change the opinion of a potential buyer reading your financial statements. However, a $50,000 error is material, and the financial statements should be adjusted for the error.
Note that an audit opinion does not say that the financial statements are free of any error, only that there are no material errors. Also, note that an audit is not designed to identify small frauds, because employees can work together to bypass accounting controls and commit fraud. However, audits are designed to identify potential material frauds in the business, like embezzlement of funds or theft above a threshold that could impact the opinion of a potential buyer.
Here are some other important points related to a financial statement audit:
- Qualified vs. Unqualified audit opinions: An unqualified opinion states that the financial statements are free of material misstatement, while a qualified opinion lists some issues related to the audit. Assume, for example, that the auditor could not perform a physical count of inventory at year-end, and does not have sufficient audit evidence on inventory. That issue would be disclosed in a qualified audit opinion.
- Related party transactions: These are transactions with businesses that have a relationship with the company under audit. For example, assume that your firm buys raw materials from a company controlled by a board member. An audit report will disclose this fact, because the purchase was not at “arm’s length,” meaning not a transaction with a third-party entity.
- Contingencies: Contingencies may be disclosed in the audit report, either as an adjustment to the financial statements or by adding a footnote. A legal case that has not been resolved, for example, is contingent on an event that has not yet happened, and legal issues are common business contingencies.
Business owners should have an annual audit performed on their financial statements. You need to understand what an audit opinion states, the types of opinions that may be issued, and other issues that may be disclosed in footnotes.
A potential buyer will consider all of these factors before making an offer for your business.
Why do you want to sell your business?
Maybe the better question is: do you really want to sell your business now?
Before you start to look for potential buyers, think carefully about your answer to these questions. After all, building your business took years of time and effort, and selling your company may be the biggest financial decision you ever make.
Selling your business is also an emotional decision, so consider how you’ll feel when the company is no longer in your control. Especially if your identity is tied with the business, which is the case for many owners. Many business owners treat their business like another family member, and selling the business can feel like a death in the family, regardless of the sale amount.
Here are some common motivations for selling a business:
- Need more capital: Businesses need capital to grow, and you may need a new owner who has the funds needed to expand.
- Retirement: You’ve made the decision to retire, based on your age, a health issue – or simply because you feel overworked.
- Net worth tied up in the business: It’s common for the business to be the largest asset owned by a founder. To diversify your holdings and reduce the risk of tying up your net worth in one asset, you may want to sell your business.
- Mature industry: A mature industry is a market in which overall sales are declining. A good example was the market for cameras and film as mobile phones became popular. An owner may decide to sell the business before the company declines further in value.
- No clear successor: Many founders run their businesses without considering the need to identify and mentor a successor. Rather than invest the time and effort to find a successor, you may decide to sell the business.
- Partnership disputes: Growing a business is challenging and disputes can occur between owners. Rather than continue to operate the business under difficult circumstances, business partners may decide to sell the company and part ways.
- Boredom: Finally, you may simply be bored with operating your business, and you want to move on to a new challenge or interest.
Talk with family, friends, business peers, and other people that you trust. Ideally, you should be able to verbalize why you want to sell the business. You may not tell a seller your reasons in detail, but you need to know for yourself.
There are several tools you can put in place to prepare for a successor, and the future structure of your business can take several forms:
- Promote from within: You may identify and mentor someone on your current management team to take over the business when you leave. The manager may not necessarily be an owner, but instead a CEO who will report to the ownership group. Promoting from within helps you maintain relationships with customers, vendors and employees.
- Buy/sell agreements: Owners can put an agreement in place with existing business partners, or with an outside potential buyer, and the agreement dictates how the future selling price will be calculated. For example, a partnership buy/sell agreement may state that a partner must pay three times annual sales as the price to buy out the other partner. These agreements speed up the sale process.
- Employee Stock Ownership Plans (ESOP): An ESOP allows company managers and other employees to set aside funds in a trust to eventually buy the business from an owner, and the ESOP agreement typically provides a metric to compute the sale price (multiple of sales, earnings, etc.). A common problem with ESOPs is that the employees need a number of years to accumulate the funds, and an owner may want to sell before the ESOP is fully funded.
Succession planning is time consuming, but putting a plan in place can help you avoid a forced sale. A forced sale occurs when the owner is under pressure to sell the business, or the owner’s heirs are trying to sell the company.
In a forced sale, the seller does not have any bargaining power, and will likely receive far less for the business when the sale is finalized.
Make the effort to put a succession plan in place, even if you’re not planning on selling the business for years.
INCREASING COMPANY VALUE – BEFORE A SALE
Your goal is to maximize the price you receive for your business, and you can take proactive steps to increase the value of your company. Increasing the value of a business generates more profits while you remain the owner, and helps to justify a higher sale price.
To start this process, perform a SWOT analysis on your business. The term SWOT stands for strengths, weaknesses, opportunities and threats, and you can write down issues in each of those four areas. Get input from other people on your staff, share your SWOT analysis with your team and ask for feedback.
Here are some steps you can take to increase company value:
- Brand awareness: Many of us buy products from a particular brand, such as Apple iPhones or Tide laundry soap. Work with a marketing firm to increase your brand awareness in the eyes of consumers. This also helps differentiate you from your competition, creating a defensible moat to ward off competitive threats.
- Stable customer base: Make improvements to increase the dollar amount of sales generated from repeat business. A stable customer base that continues to buy your products over time can increase company value.
- Disruption: Perhaps the most difficult – and the most financially rewarding – change you can make is to create a disruptive product or service. Uber, for example, disrupted the taxi business, and the owner’s disruptive idea was hugely successful.
- Close unprofitable division: Make the hard choice to close a company division or product line that isn’t profitable. In the short term, your decision may require you to reduce your workforce, but you’ll eliminate a portion of your business that is dragging down your overall profit results.
- Improve pricing and cost allocation: Every business should create a budget each year, and your budget should include budgeted sales prices and costs. Each month, compare your actual sales prices and costs to your budget, and investigate any differences (also called variances). You may find ways to increase your prices and to reduce costs.
- Investments:Investing in technology and in worker training can have a positive long-term impact on your business. Both types of investments can help you to operate more productively, which can increase profits.
- Segregation of duties: Finally, use the accounting concept called segregation of duties to protect assets from employee theft. To illustrate this concept, think about handling cash. One person, maybe an administrative assistant, should have physical custody of the checkbook, and the owner has authority to sign checks. A third person, the accountant, reconciles the bank statement. Work with an accountant to put systems in place to prevent theft.
Consider implementing all of these ideas to lower costs, work more productively, and increase your profits. You’ll benefit financially, and your business will be more attractive to a potential buyer.
METRICS TO REVIEW
Successful companies develop repeat business, and this strategy allows a business to increase sales without dramatically increasing sales and marketing costs. Satisfied customers may buy products every month or year, and the business doesn’t need to spend all of its marketing efforts on finding new customers.
Here are three metrics that measure the financial impact of doing repeat business, and these concepts may be important to a potential buyer:
CUSTOMER ACQUISITION COST (CAC)
Customer acquisition cost (CAC) is the amount of money spent to acquire a new customer, and the formula for CAC is (marketing costs) / (number of new customers acquired).
Business owners strive to lower CAC, and developing a pipeline of customer referrals can sharply lower CAC over time. If Bob, an existing client, refers Julie to Acme Plumbing, for example, Acme can take on Julie as a new customer with very little spending on marketing costs.
Word of mouth referrals can make a huge financial difference.
MONTHLY RECURRING REVENUE (MRR)
Monthly recurring revenue (MRR) is the amount of revenue a business can consistently produce each month, and MRR is valuable, because the revenue is somewhat predictable. If, for example Acme Plumbing generates $30,000 a month in MRR, a buyer may be able to generate that same level of consistent revenue, and that has value to a purchaser.
Finally, churn rate is most useful for businesses that drive revenue through subscriptions. This rate is the percentage of subscribers to a product or service who stop subscribing within a month or year. Companies strive to minimize churn rate.
The best example of churn rate is cable TV. With the rise of streaming services, such as Netflix, many subscribers are cancelling cable TV subscriptions. This creates two problems for cable firms: they must spend more to find new customers, and these firms lose the recurring subscription revenue when people cancel their service.
If you can make changes to improve these metrics, your business may be more valuable to a potential buyer.
YOUR COMPANY’S WORTH: THE VALUATION PROCESS
The valuation of your business involves a group of professionals, which may include a valuation expert, accountants, an attorney, and a business broker. There are a number of factors used to evaluate a business, and the buyer and seller may have different views on the importance of each metric.
PROFESSIONALS AND THEIR ROLES
Here are several experts who are involved in most business sales:
- Certified Valuation Appraiser (CVA): A person with CVA designation has completed a field of study on the valuation process, and the methods used to value a business. CVAs use a number of metrics to value a business, and they document their work in a formal report.
- Accountant and/or Tax Preparer: As discussed earlier, you may have an accountant work in your business or review your accounting activity and financial statements each month. Most businesses also use an accounting firm to prepare the business tax return.
- Attorney: A business may use one attorney for day-to-day business transactions and contracts, and a second attorney for the business sale documents.
Each of these professionals has a role to play in a business valuation and sale.
ROLE OF THE BUSINESS BROKER
The professional who may have the most involvement in your business valuation and sale is a business broker. An experienced broker can add tremendous value to a company sale, and they may perform these tasks for a seller:
- Pricing and Valuation: The broker can research and explain the metrics used to determine the price of businesses in your industry and the value of your company.
- Industry research: Your broker can analyze the sales of similar companies and identify sales trends in your industry.
- Buyers: Perhaps most important, a broker can use a network of contacts to find potential buyers and educate them about your business.
- Negotiate final price: The broker can also use industry experience and the knowledge gained on past transactions to negotiate the final selling price.
Ask industry peers and your network of professional contacts to help you find a business broker.
FACTORS THAT IMPACT VALUATION
A business valuation is based on both financial and non-financial data, and a buyer may value some forms of information more than other metrics. A seller, also, may consider some measurements to be more important than others.
The true value of a business involves opinions and judgment.
This section discusses many of the tools used to assess the value of a business, and why buyers and sellers consider this data to be relevant to a sale.
EARNINGS BEFORE INTEREST, TAX, DEPRECIATION AND AMORTIZATION (EBITDA)
Earnings before interest, tax, depreciation and amortization (EBITDA) may be the most common valuation metric, and you’ll hear about companies that are priced as a multiple EBITDA (“3 times EBITDA”, etc.).
The earnings total refers to net income, which is defined as (revenue less expenses), and the earnings balance includes all expenses. EBITDA takes earnings and adds back the expenses incurred for interest, tax, depreciation and amortization. Consider each of those line items individually:
- Interest expense: Interest incurred on all loan balances.
- Tax expense: Federal, state and possibly local taxes paid on company earnings.
- Depreciation expense: Assets are resources used in a business, and fixed assets depreciate as they are used up over time. A $30,000 truck, for example, might be depreciated at a rate of $5,000 year for six years.
- Amortization expense: Intangible assets, such as a patent or copyright, incur amortization expenses as they are used to produce revenue. Assume, for example, that a company buys a patent for $100,000 and accounting standards dictate that the patent must be amortized over 20 years. The firm may post amortization expense of $5,000 per year.
After adding back (removing) these expenses, the EBITDA balance is larger than net income.
CAPITAL EXPENDITURES: WEAKNESS OF THE EBITDA METHOD
While EBITDA is widely used and understood for valuations, it has an important flaw that business owners need to know. EBITDA does not account for the cost of replacing assets over time, and this cost may be substantial for some businesses.
Here’s an example: Julie owns Hillside Restaurants, a business that operates three restaurant locations. Each location’s balance sheet lists over $400,000 in assets, including furniture, fixtures, ovens and refrigerators. Over time, these assets will need to be replaced – and EBITDA does not account for asset replacement.
Assume, for example, that the Main Street location has a number of assets that are near the end for their useful lives, and the store posted a large amount of depreciation expense in the last 12 months.
It’s possible for the Main Street location to produce the same level of revenue, even with older assets. Since EBITDA adds back the depreciation expense, the potential buyer does not consider the aging group of assets.
The balance sheet will report the declining book value (cost less accumulated depreciation) of fixed assets, but EBITDA does not reveal the issue to a buyer. Both net income and EBITDA should be considered for a valuation.
PROFIT VS. CASH FLOW
Generating a profit does not immediately translate into a higher cash balance.
A valuation should also consider the cash inflows and outflows of the business, because no company can operate without a sufficient level of cash.
A potential buyer will pay close attention to the growth in sales, compared to the increase in accounts receivable. If sales are growing at 15%, and the accounts receivable is increasing at a 30% rate, a business will eventually run short on cash. The company is selling more, but the average customer is paying more slowly.
Eventually, a cash-strapped business may have to borrow money to operate and incur interest expenses. Alternatively, a firm could sell equity and raise funds from an investor.
Profitable companies that can also generate cash inflows quickly are the most valuable to a buyer.
TRENDS IN PROFITS AND MARKET SHARE
A potential buyer analyzes several years of financials to assess trends in your business, including profit trends. If, for example, a particular product’s sales are increasing, how can the buyer grow sales even more?
Also, a buyer will consider the size of your market, and your company’s position in the market. If you operate in a growing market in which no company has more than a 5% market share, the buyer may see an opportunity to grow sales, which makes your business more valuable.
Potential buyers will also consider the diversity of your product offerings. If you sell hiking and camping equipment, along with mountain bikes, you can manage a slowdown in one particular product line. If, on the other hand, you only sell hiking boots and clothing, you’re more at risk if the hiking market declines.
Here are some other factors that impact a valuation:
- Return-on-investment (ROI) and relative risk: Many buyers make a formal estimate of the return earned on the investment and compare that to a formal calculation of relative risk.
- Only a few key customer:A number of small businesses start by serving the needs of a few key customers. Over time, however, you need to diversify your customer base to increase your firm’s value to a buyer. If any one client represents over fifteen (15) percent of your annual sales, you may have a customer concentration issue, and buyers will take that into account when they are considering an offer for your business.
- Credit history: A seller must demonstrate a strong credit history and the ability to pay vendors on time. Timely payment helps a business maintain strong relationships with vendors.
- Management team: An experienced management team can make smart decisions to increase profits and grow sales, and retaining talented managers has value to a buyer.
- Synergy with a potential buyer: Your business may be a missing piece for a potential buyer. As an example, many manufacturers purchase vendors that supply key materials for production.
All of these factors play a role in the valuation of a business.
FINDING A BUYER, DEAL STRUCTURE
Estimates vary, but it can take six-months or longer to complete a business sale. Your timeline can vary greatly, depending on the size of your firm, how well your records are organized, and the current state of the economy.
Once you start to identify buyers, you need to consider how much information you’ll provide to them, and in what form. The structure of the sale has a big impact on the sale price, and you should work with your business broker on negotiation strategies for the sale.
MARKETING YOUR FIRM TO PROSPECTS
A potential business buyer can come from a number of sources, but here are three that are fairly common:
- C-suite executive leaving corporation: An executive who has a large net worth leaves a company and decides to use his or her capital to purchase a business.
- Industry peers or competitors: Someone who works in your industry is most likely to recognize the value of your business – or see an opportunity to improve your company.
- Private equity firms: These firms pool money together from wealthy individuals, foundations and other sources and invest in privately held companies. They get heavily involved in management and work to generate high returns for investors over a five to 10 year period.
Your business may receive interest from one of all three of these groups.
OTHER FACTORS WHEN FINDING A BUYER
As you move through the process of finding a buyer, think carefully about these topics:
- Preparing a Prospectus: A prospectus is an extensive document that explains your business, your product and services, your industry, and includes your financials. The amount of information you provide to potential buyers, however, can vary greatly, so consult with your business broker on this issue.
- Pre-qualified financing for a buyer: Does a potential buyer have the financial means to buy your business? If a buyer is interested, find out if they have financing in place, either from a lender or through investors.
- Equity vs. asset purchase: With an equity purchase, the buyer purchases the equity (assets less liabilities) of your entire business. Conversely, an asset purchase means that the buyer is only buying certain assets – not necessarily the entire business. Consult with your accountant and attorney on the legal and tax implications of each purchase method.
- Earnouts: As a seller, when will you be paid? Will you receive one large check when the sale is closed or will you be paid through earnouts over time? In many cases, a seller stays with the business for a period of time, and can receive additional compensation, depending on the firm’s financial performance.
- Negotiation strategies: You only get one chance to properly negotiate a sale with a particular buyer, so work with your broker and other experts to understand negotiation strategy. For example, become familiar with the term zone of possible agreement (ZOPA), which is the price range within which the two parties may come to an agreement. Another important term is best alternative to negotiated agreement (BATNA).
As you can see, the sales process can be time consuming and demanding for a seller, and you have to balance the demands of running your business with the process of finding a buyer. Get help and cover all of your bases.
If you find a potential buyer who is a serious candidate, you may allow the interested party to perform due diligence. Due diligence is a formal, confidential agreement between you and a potential buyer, and it allows the buyer to see far more information about your business.
This process is designed to give the buyer enough information to make a purchase offer for your business. Here are some of the documents provided in a typical due diligence process.
You’ll provide a company organization chart, and other general information, such as the number of employees on staff.
A buyer will need to review several types of agreements that your business may have in place:
- Employee agreements: You may have employment agreements in place with your management team and with other key employees. Reviewing these agreements will help a buyer decide how to structure an incentive plan to motivate key employees to stay at the firm.
- Customer agreements: Businesses often have written agreements with customers that document pricing and the number of units to be sold to the customer each year.
- Vendor contracts: Your company may have a contract with vendors who supply materials and services to you. In addition, and you may have an office lease, or lease agreements on equipment.
Organize your records so that, when you start to look for a buyer, you can easily produce these documents for due diligence.
Your marketing expertise helps you get attention and generate interest in the marketplace, and that information is valuable to a buyer who wants to grow your business after the purchase. Here are some other items that you can provide during due diligence:
- Market research: Research you’ve gathered about your industry, including competitor analysis, pricing, and customer trends.
- Marketing strategies: This information is how you market, and your strategies may include website, blogging, print, e-commerce, other media approaches.
- Website visits, social media statistics (views, conversions): These are the results of your marketing efforts.
Your marketing information helps a buyer to build on your success after the sale.
Organize your records, so that you can provide the needed documents for due diligence. If you can make the process easier and faster for a potential buyer, you may get closer to a purchase agreement.
OBSTACLES TO A BUSINESS SALE
There are several obstacles to a business sale, and these issues may come up during the due diligence process:
- Lack of Financing: The buyer cannot obtain financing. As mentioned earlier, find out if a buyer has the financial means to purchase the business before starting the due diligence process.
- Owner Divorce: If an owner is going through a divorce, a portion of the owner’s business interest may be designated as marital assets, and the ex-spouse may have an ownership interest in the business assets. The owner’s attorney must resolve this legal issue before the business can be sold.
- Management Leaves:If a number of key managers are not willing to stay with the purchased company – even with incentive compensation – the purchaser may not want to buy the business.
Consider each of these issues as you move toward selling your business.
CLOSING: THE BUSINESS SALE AGREEMENT
The payoff for all of your effort is closing on your business sale. It’s important to understand what the agreement includes, and what happens as the business is transferred to the new owner
At closing, you may sign documents related to the sale of specific assets, and your agreement may require you to sign a non-compete agreement, which will be in place for an agreed-upon period. Another document is the contract for the sale.
If you agree to stay on during a transition period, you may spend a great deal of time with key managers from the purchaser’s company. Your best practices for running the business can help them retain your customer base.
One difficult issue for sellers who stay on for a period of time is the change in company culture. As a seller, you have to accept the fact that you’re no longer in charge, and that the buyer will dictate much of the company culture.
Finally, work with your accountant to understand the tax impact of the sale, and meet with a financial advisor to invest the sales proceeds.
Selling your business may be the culmination of years of work and effort, and the sale may be the most important financial decision you’re ever make. Put a team of people together, do your homework, and maximize the sale price of your business.