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Session 14: Selling your business

OBJECTIVE: Selling your business is not a process you can turn over to your broker, lawyer or CPA, although you will need all their services. This session covers what you should know before selling your business.

      Selling your business

Deciding when to sell your business

Deciding on when to sell your business will include consideration of both external and internal factors: for example, the condition of the economy (external) and the status of your health (internal). All of your reasons may not line up perfectly to make for an easy decision and most likely there will be certain issues that will emerge as more important than others. So making the right decision will be help greatly by preparing a "for" and "against" list, giving various weights to each of the considerations based on your circumstances.

Some of the considerations may become to-do projects in your overall exiting plan. For example, if you are facing a potentially damaging lawsuit, you would have reason to clear up this obstacle. Or if you have important leases about to expire, you may want to negotiate longer terms now so as not to be facing this roadblock later on when you decide to sell.

Good times to sellBad times to sell
Times are good and everyone is buying.Your business or the economy is in slump
Your exit plan is in place, well thought out and vetted by your exit committeeA new competitor poses a serious threat
You not enjoying your businessYou or your family have serious health problems
Your retirement would be well fundedThere serious litigation or disputes Pending.
You have received a timely and adequate unsolicited offerYour business is facing obsolescense
You have a productive lifestyle in mind after leavingYou are in gridlock with your managing partners
Your industry is growingThere are business problems that would impede a sale
Your sons and daughters are ready to succeed youYou love what you're doing and can't wait to get to work every day.
 Your industry is shrinking
 Your key leases are about to expire

Selling your business is a process

You may have made mistakes along the way, but when it's time to sell the business, you only have one chance to do it right. Two major points to keep in mind are:

  1. Selling your business is not a process you can turn over to your broker, lawyer or CPA. You will be the main player throughout the process.
  2. According to the SBA, as much as 90% of the sales of small businesses involve at least some seller financing, so it may not be realistic to expect a lump sum payment.

Careful planning is necessary

Most common mistake is lack of preparation
It will be important that your business be in top operating order and appearance. You should be prepared to answer probing questions and furnish specific documentation such as:

  • Copies of your leases. If any important conditions are not favorable, correct them if possible: the term, options, rent and assignment provisions.
  • Will your improvements and fixtures need to be replaced?
  • What is the quality of your inventory: overstocked or obsolete?
  • The condition and amount of your receivables. Collectable?
  • What is amount and status of your payables?
  • Is there an order backlog?
  • Do your good customer relationships justify goodwill pricing?
  • Is your primary marketplace stable or changing?
  • Are all your licenses and government approvals in place?
  • Copies of last three year's tax returns.
  • If your buyer intends to make payments over time, be sure that all your insurance policies are kept in force.

Have accounting for past five years in place
Provide your buyer with audited financial statements, the highest level of accounting scrutiny. This will be expensive but worth the cost. It's a good idea to begin getting audited statements two to three years in advance. Your audited statements will also be an important tool for the buyer to use in helping finance the purchase.

Include or exclude real estate?
Your lawyer and CPA will help analyze if you should include the business's real estate in the sale. In some cases sellers will retain the real estate and lease it to the buyer. There are large tax implications to be considered.

Recruit and pay for professional help

Dr. Dan Nathanson Anderson Graduate School of Business UCLA Dr. Dan Nathanson
Anderson Graduate School of Business UCLA
Play Video
What planning should I do before selling my business?
Business broker
Both buying and selling businesses involve complexities that in most cases justify the services of a business broker. A broker's commission is normally 10 percent and is paid after closing of the sale (much like a real estate broker.) Your business broker can assist in building your selling package, speed up the time it takes to sell the business, be responsible for marketing activities and screening of potential buyers.

Some qualifying pointers for selecting a broker include:

  • Does the broker have specialized experience in your industry?
  • Will the broker cooperate with and solicit other brokers to cooperate?
  • Will the broker prepare a business profile?
  • Will all marketing avenues be utilized including listing exchanges, newspapers, direct mail, trade journals, networking and telemarketing?

Professional appraiser
A professional appraisal can add credibility in the valuation of your business. It can provide a comprehensive and detailed document that will withstand tough scrutiny and provide a specific opinion of value. If you have a profitable business with prudent debt, reasonable risks and a good management, it will normally qualify as a going concern and be valued on the basis of the economic benefits it has provided to you. While an appraisal is not the only way you will be measuring value, it can stand out as a respected tool.

Business lawyer
Your lawyer will advise if your sale should be structured as an acquisition or a merger. He or she will also advise whether you should sell your assets or your stock. In most cases a buyer will want to buy the assets rather than the stock of a company to eliminate unknown liabilities. Your lawyer will also collaborate with your CPA to minimize tax burdens. Tax implications can be huge, either good or bad, so your lawyer/CPA team will be your key players.

CPA
Your CPA and lawyer should be brought into the very preliminary planning stage of your selling process. This could begin taking place years before the event.

Your CPA, with your lawyer, will help structure your sale so as to minimize your taxes. If not properly structured the sale could leave you with less than half your sale price after all taxes have been taken out. By structuring as an installment sale and spreading the sale over several years, a higher tax rate could be avoided. Also when providing seller financing to a buyer, you might ask the buyer to use non-business assets as security for your loan.

How to set the price for your business

Gwyn Myers, Ph. D. Management Consultant Gwyn Myers, Ph. D.
Management Consultant
Play Video
Do you have any recommendations for those selling a business?
Be realistic on pricing and financing
Too often sellers set a high price on their business before really analyzing its value. The problem created is that how long a business remains on the market is determined by its pricing. It is much better to complete a valuation process which can then be used to justify the price. Ultimate pricing could be determined by one or a combination of methods.

Methods of evaluation:

  1. Sales volume. In retail businesses the buyer may want to stand at the cash register for a week to verify the sales. Your industry may have pricing guidelines based on recent sales. Since the valuation and sales of your publicly owned competitors are known, they can provide a rough valuation guideline of valuation as measured by sales.
  2. Earning power is a common evaluation method. Pricing can be based on what return on investment the business will produce. Here's an example:
  3. Your business shows an annual net after taxes of $50,000 and your buyer has determined she wants a 25% return of her investment. She will offer $200,000 for the business. Here is the mathematics:

    math formula

  4. If your business owns the real estate it occupies (or other real estate) the market value of the real estate could become a principle factor in pricing.
  5. Dr. Dan Nathanson Anderson Graduate School of Business UCLA Dr. Dan Nathanson
    Anderson Graduate School of Business UCLA
    Play Video
    How can I exit gracefully from my business to insure it's ongoing sucess?
  6. Intrinsic value. When you sell a business, what you are really selling is the sum of all of its future earnings. Intrinsic value is a mathematical calculation which converts all future earnings into their present value. One method is to create a ten year spreadsheet of the estimated future year-by-year earnings and covert each of these, along with a residual long-term value, to an overall present value. This becomes the "intrinsic value" of the business. Search engines offer many solutions in determining intrinsic value and we strongly recommended you become familiar with this important tool. Here's a free resource that makes the calculations for you: http://www.moneychimp.com/articles/valuation/buffett_calc.htm
  7. Market comparables. Your selling price should also reflect what similar businesses are selling for at the time you plan to sell yours.

Goodwill
Goodwill is the value of a company's reputation which gives it a competitive edge and earning power. Accounting wise it is the amount paid above the book value of the company's assets. This can come about by the company having pricing power or a potential future that is not reflected on the financial statement. For example many Internet technology firms are valued at amounts that far exceed the financial statement value. If a selling company has built up an excellent reputation, or a valuable trade name, or has important customer contacts, it most likely will enjoy a selling price above its accounting book value.

Finding buyers for your business

John Powers Attorney-at-Law John Powers
Attorney-at-Law
Play Video
What are some of the mistakes made when selling a business?
Your broker's role
Finding buyers is the job of your business broker. As when you sell your house through a real estate broker, you depend on the broker to deploy his or her skills in marketing including preparing the selling package, exploring resources, advertising, qualifying and closing prospects. The same should hold true when you sell your business.

Advantages of selling to your competitors
As a rule, potential buyers that are already in your business or industry are better candidates than people unfamiliar with your business. A buyer already in your business has unique motivations:

  • Geographical expansion
  • Expansion of market share
  • Elimination of competition
  • Gaining efficiencies of sale in buying, shipping and advertising.
  • Are in a better position to appreciate the valuation of your business.
  • Potential for rapid expansion for future public ownership.
  • Already positioned to avoid beginner mistakes.

Your broker will also function to pre-qualify buyers including determining if prospective buyers are financially capable of closing the sale and having a confidentiality agreement signed.

Negotiating your sale

Dr. Dan Nathanson Anderson Graduate School of Business UCLA Dr. Dan Nathanson
Anderson Graduate School of Business UCLA
Play Video
How should I establish a price for my business?
See Session 5 Negotiating Tools

Selling your business will probably be the single most important time to exercise good negotiating skills. The earlier session, "Negotiating Tools" covers the basic do's and don'ts. We'll emphasize two points here:

  • Keep your buyer's point-of-view in mind in balancing what works best from both points of view.
  • As stated at the outset of this session, as much as 90% of the sales of small businesses involve at least some seller financing...that's you! Financing is an opportunity to be creative. For example you could bring multiple sources of financing into play to close the gap between cash and the sale price. The buyer might combine financing from a SBA guaranteed loan plus your own subordinate financing guaranteed by some of the buyer's other resources.
  • If your sale includes the leasing of real estate, here is the kind of leasing checklist that a good buyer will be using to negotiate the lease. It is taken from session 10, Location and leasing" of the Starting My Own Business course.

Selling the business to your employees

Stan Henslee CPA Stan Henslee
CPA
Play Video
What mistakes are made when owners sell their business?
Employees are highly motivated
Nobody knows your business and its prospects better than your employees. They could be highly motivated and should not be overlooked as prospective buyers of the business. Studies have shown a direct connection between high levels of employee ownership participation and increased performance. Assuming a key employee also has the necessary business qualifications and integrity, he or she would be powerfully incentivized by ownership.

Employee workouts
If you have key employees who are capable of filling your shoes and have an entrepreneurial zeal to carry the company forward, your lawyer can structure protective provisions where the acquiring employee "works out" their ownership by making payments over time to purchase the firm. In such cases the acquiring employee should be required to put up a significant cash down payment. The selling owner then provides financing to be repaid in installments out of earnings. In some cases the employee-buyer may be required to secure outside financing in place of the owner or along with the owner.

Employee Stock Ownership Plans (ESOPs)
An Employee Stock Ownership Plan (ESOP) is an employee benefit plan which makes the employees of a company owners of stock in the company. They are a variation of a traditional profit-sharing plan. Companies create ESOPs as an employee retirement plan for purposes of business continuity, financing, enhanced employee motivation or as a combination. In the U.S. there are now over 11,000 Employee Stock Ownership Plans (ESOPs) covering 11 million employees.

An ESOP is required by law to invest primarily in the security of the sponsoring employer. In addition to the substantial tax advantages, selling to the ESOP preserves the company's independent identity. A sale to an ESOP also provides a significant financial benefit to employees. Selling to an ESOP also permits the seller to sell all or just a part interest in the company, and to do this gradually or all at once.

Your lawyer and accountant can give you opinions as to whether use of an ESOP plan would be appropriate in the disposition of your business. Since its inception in 1978, the ESOP Association has represented the interests of companies that sponsor ESOP plans.

Top Ten Do's and Don'ts

THE TOP TEN DO'S
  • Spend sufficient time to polish up all aspects of the business.
  • Build your team of experts including accounting and legal counsel.
  • Establish value based on appraisal and industry standards.
  • Establish value based on intrinsic value and professional appraisal.
  • Select an industry-specialized business broker with care.
  • Have audited records for the last 2 years.
  • Develop your negotiating skills.
  • Let your broker find and qualify potential buyers.
  • Qualify the buyer's ability to service your seller financing.
  • Get tax advice on all aspects of the sale.
THE TOP TEN DON'TS
  1. Overprice the business.
  2. Expect to be paid in cash.
  3. Fail to consider some seller financing.
  4. Fail to consider a key employee workout.
  5. Overlook possibilities of selling to a competitor.
  6. Be unprepared to furnish all important documentation.
  7. Forget to consider your buyer's point of view.
  8. Disregard investigation of an employee owned ESOP.
  9. Fail to get tax council on all issues of the sale.
  10. Be unprepared to continue running the business.

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