All businesses must change hands at some point. It could be from the founder to children, from the owner to employees, the results of divorce or death or the most common scenario; sold to a total stranger.
Is it time to sell my business? Selling a business is one of the most misunderstood and poorly managed processes in small business today. This is unfortunate too, because a lot of high-energy, risk-taking entrepreneurs have spent years bare-knuckle brawling with lenders, suppliers, employees, competitors and governments to provide for families, create wealth and provide jobs and service to their communities and one might think exiting for other opportunities or the golden years would be rewarding.
It’s a major decision and to have the advantage, or at least an opportunity to get to the closing table, you must see the business through the eyes of a buyer and lender so you’re prepared for the incoming fire that will inevitably come your way. Buyers and sellers are at cross-purposes when it comes to terms and conditions of a sale so knowing how to proceed once the swords are crossed is critical. You have devoted your time, money, and energy into building, running, and operating your business and it may well represent your life’s work and retirement.
The best time to sell your business is 1) when you’re ready and 2) when the recent history and near future are positive within your business, your industry and your region. Ideally, you should have 3-5 years of steady, manageable growth in both revenues and earnings. There should also be a strong likelihood that this trend will continue. The old saying, trends are a friend is true for one party or the other in a deal. When a seller says the business is likely to grow, just look at my history, it’s very credible. If you have just one down year in your recent history, you’ll spend forever trying to explain that one period to buyers and lenders and it’s exponentially harder to sell. Btw, what the business did 5-10 years ago, in a completely different economy, has little bearing today.
Following are some of the most common topics for sellers with regard to selling a business. If you have any questions that we have not covered, please don’t hesitate to contact us.
Establish a defensible value;
Show it to the right buyers;
Demonstrate transparency and close the deal.
Where to start?
If you’ve read this far, then you’re on the right track. You don’t have to make a commitment at this point; just get informed about what is necessary to successfully sell a business. This section should answer some basic questions.
Item 1, What’s it worth, is it ready to sell?
The first question almost every seller asks is: “What is my business worth?” It’s the obvious question.
An appraisal is not about what it’s worth in the current owner’s hands; it’s about the company’s transferrable value.
It doesn’t make any difference what your accountant, attorney, partner, friend or lover thinks the business is worth, or even what you want for it, it boils down to an equitable deal between a willing buyer and willing seller.
Start with a defensible estimate of value (which is the same thing as an appraisal). You don’t have to spend thousands of dollars on an appraisal, but you must be able to defend your asking price. Otherwise, buyers and lenders won’t take you seriously. Even if you start with a simple rule of thumb, it has to make sense. Use caution though, if you value your business with math a 10-year old can do in their head, you may be in for a rough ride.
Make sure your records are in order. You simply can’t sell (or even appraise) with poor records. Make sure your business tax returns are not extended, that any professionally prepared records (such as tax returns) are reconciled with your in-house system and your accounting system is up to date. Good financial records reduce the chances for a buyer to work the price down during due diligence.
A few advantages of pre-sell valuation work:
- Is the value high enough? Let’s face it, we all believe in sweat equity, but it doesn’t exist in a sale. An appraisal provides an informed opinion about the business value, so a seller can decide if the asking price will be enough to move on from the business.
- You can see the business from a neutral, 3rd party perspective, which is how a buyer and lender will see it.
- It acts as a financial health check-up identifying strengths and weaknesses that can aid in long-term planning.
- Saves time and money. Wouldn’t you rather know now? There is cost and time required to get an appraisal, but the advantages far outweigh not getting this done.
If you go the appraisal route, choose an appraiser who has transaction experience. If they learned to appraise from a book, it’s likely pretty, but it should also be realistic. Also, choose someone who is independent…would you buy a business based on an appraisal done by the company accountant who is also the owners 20-year drinking buddy.
Common valuation docs you’ll need:
- Four Years Profit & Loss Statements and Balance Sheets
- Interim year-over-year (aka “comparative”) Financial Statements
- Four Years Business Federal Tax Returns
- List of Furniture, Fixtures & Equipment (might be in the tax return)
- Facility Lease and lease-related documents.
- Copy of any Franchise Agreement, if applicable.
Btw, it likely goes without saying but everything should be electronic. No one has file boxes, fax machines or windows XP anymore…if you do, you might want to assess your tech a bit, just saying…
Item 2, create a compelling story!
You’ll need a marketing package. For Small Business transactions, its normally called a Confidential Business Review (CBR) which, after the buyer signs the NDA, acquaints the buyer with the business. Sometimes, they’re called a teaser, offering memo or confidential information memorandum but regardless of the name, it should be detailed enough to answer most questions about the business including detailed discussion of the following topics:
- History of the business.
- Owners involvement.
- Products and services.
- Marketing programs.
- Financial recasting and records.
- Discussion of Owner Perks.
Since you only get one chance to make a first impression, the document should be impressive. A few tips include:
- It should be typed and emailed as a pdf. Use a professional font and try to avoid scanned or faxed documents. Check the file size too, everyone hates getting a huge file to download.
- Do not capitalize words i.e. GLASS COMPANY WITH AMAZING POTENTIAL.
- Avoid the fluff; “once in a lifetime opportunity” etc. Buyers want cold hard facts and superlatives are not credible.
- State the good, bad and ugly being brutally honest. Buyers and their lenders will perform substantial due diligence and if they discover dishonesty or an omission, your credibility will not recover. Every business has challenges and you’re not diminishing value by pointing out areas that could be improved.
- Keep it concise. Buyers look at many opportunities and they need the facts clearly stated. They will refer back to this document until closing.
Finally, it’s important to update the document on a regular basis, at least quarterly. Buyers get frustrated receiving a document that has old financial information which reflects poorly on the business moving forward.
Market the Business for Sale
Think Internet…obviously. Print is obsolete, expensive and just doesn’t work. Social media is right there with print…ineffective! I know, young people will argue social media is totally lit but remember dude, social media crazies don’t buy. You have to appear where the buyers look which is not on Facebook or some real estate MLS, but legitimate business for sale websites. There are dozens of sites to choose from.
Who are the Buyers?
The Individual Buyer: This type of buyer is solely a small business or “Main-Street” buyer (because of lack of resources). This buyer usually seeks a business with a value range of $100,000 to $1,000,000. Additionally, this type of buyer is usually buying or replacing a job and wants to: a) control their own destiny, b) not work for someone else, and c) leverage their talents, skills and abilities to make more money. Because the buyer will be working in the business, pride of ownership and other psychological and emotional factors are usually involved in the buying decision. Most importantly, this type of buyer is a down payment driven buyer.
The Financial Buyer: This type of buyer is usually an individual as well, but of substantial means, i.e. this buyer is not just buying a job. (S)he is influenced not only by the return on investment and salary the business offers, but also its scalability and potential to accumulate wealth by taking it to the next level which is likely the private equity market. This buyer often buys Small Businesses but also larger businesses on occasion. This type of buyer is also a down payment driven buyer.
The Strategic or Synergistic Buyer: This buyer is usually a company or private equity group buying a business that fits in its portfolio of similar businesses. They may also buy if the target acquisition can increase market share, provide new technology, add distribution channels, or eliminate competition. Typically, their definition of value is investment value which is usually higher than fair market value. However, in order for you to value your business using this definition of value, the specific buyer would have to be known because a target’s investment value is likely different for each potential buyer because of the synergies that are created through the acquisition. Therefore, unless the specific buyer is known at the time of the appraisal, the individual buyer and financial buyer will be the most likely candidates. For the Strategic Buyer, the target business will usually have, at a minimum, more than $1,000,000 in Owner Benefit. This type of buyer is a return on investment driven buyer.
In summary, the most likely buyer of a Small Business is the individual buyer for the reasons stated above. They typically search for a business with an asking price of 4 to 5 times their down payment ability knowing they will leverage the cash they have on hand.
Buyers Buy Cash Flow (worth remembering this saying!)
Appearances Do Count
It’s best to show during business hours so the buyer can see the operation. If it’s a confidential sale, then there’s nothing wrong with showing after hours or on a weekend. At some point however, the buyer will want to see the operations and meet the staff, but it doesn’t have to be at the first meeting.
Be organized and clean…unfiled/unscanned documents, obsolete or overstock inventory, equipment in disrepair and clutter in general reflects poorly on management. It’s much better to start the meeting talking about an award or plaque on your wall than with an apology about being too busy lately to tidy up.
Be honest, but not modest. If there’s something about the business that could be improved, it doesn’t hurt to talk about it, they will likely discover it anyway. You should not feel pressured to have a perfect small business, there’s no such thing.
The buyer will likely come with a list of questions and transparency should be the word of the day. Help the buyer learn. Some of the more common questions we hear at showings include:
- How/why did you start or buy the business?
- How long have you been trying to sell?
- Why are you selling?
- What will you do after the sale? Will you stay in the area?
- How was the price determined?
- How much will you carry?
- Experience and age of the staff? Will they stay?
- My background is XYZ, can I learn your business?
- How can I grow the business?
- How many hours do you work per week?
- Are you able to leave the business, is there someone who can step in while you’re gone?
- , etc., etc.
Remember two important things; 1) transparency and 2) this is Small Business, you’re not on Wall Street and this is not a corporate take-over rather it’s a small business transaction where Buyer and Seller work together to get deals done. All this tough talk from Attorneys and Brokers about hard negotiations and fist-slamming ultimatums only leads to wasted time. Effort, ethics and reasonable compromise gets you to the closing table.
Item 3, demonstrate transparency and close the deal
Long before you put your business on the market, eliminate the surprises! Review every facet of the business and remedy any problems that could appear during the sale process. No one likes surprises – most of all potential buyers. Whether legal, accounting, environmental, or anything else – solve it now.
Due Diligence is a review, investigation and confirmation process designed to corroborate the representations of a business owner about the true status of the business with the intent to uncover material variance.
Sounds hard-core, right? Well…it is. The buyer is always the most nervous party in a transaction and by far, has the most risk. There is a legitimate need for access to accurate, timely records to help manage the risk and provide some level of assurance that the seller’s representations are materially true and correct.
About half of all deals fall apart during the due diligence process and it’s usually because the buyer (or an advisor) finds the earnings were overstated. When this happens, most buyers walk away mad with the encouragement of their lender, but some will ask you to cut your price to account for the discovery. Avoiding this pitfall can be simple.
We suggest conducting an internal due-diligence examination as you prepare the business for sale. This is helpful in several ways…1) it will allow you see the business from a buyer and lender perspective, 2) will refresh your memory and identify problems and 3) confirm to a buyer and lender that the business is well managed.
Common Deal Killers…
In the Small Business arena, deals go south…a lot. Here are some of the more common reasons we see (outside of the obvious overpriced business):
- Poor financial records; they have to instill confidence.
- Lack of transparency; be open and honest.
- Lack of Seller financing.
- Your business requires too much working capital.
- Excluding assets that are used in the business.
- Business is too dependent on the owner, a customer, an employee or supplier.
- Landlords; make sure your lease is transferrable to a Buyer.
- Employees won’t stay after the sale.
- Non-compete issues.
- Revenue starts to decline during the sale process.
- No recurring revenue.
- You are in a commoditized business, nothing differentiates you.
- Professional advisors; most people think attorneys kill deals and while it does happen on occasion, it’s usually the accountant. Make sure you have a good deal team that specializes in Small Business transactions.
- Lenders; the Buyer will need to have experience in the field being bought which is rare. Most Buyers are looking to change careers, not expand in their current one.
All Main Street Businesses change hands at some point. It could be from parents to kids, owners to employees, taken over by a creditor or the most common transaction; sold to a complete stranger. Whichever transaction works best for you will require planning…. advance planning. You simply can’t wake up on your 65th birthday and decide to sell, there are too many outside forces (the economy, your recent trends, etc.) to consider. Realistically, the process should start 1-2 years in advance.
As stated earlier, you must take a close look at your business from a Buyer’s perspective which is quite simple to do. When you go to work tomorrow, look at your facility as your drive up; are you impressed? Go in and tell your assistant to print a YTD financial statement and last year’s federal tax return; did you get it within about 5 minutes? How does it look? Are sales trending up? Are you able to read it without being interrupted? Get the picture?
Selling a Main Street Business is hard to do because they’re risky investments. This is evidenced by lenders who want a guarantee from the government just to loan money on them or at least have tangible collateral like real estate to back it up. They will also want the earnings to be at least 125% of what it will take to pay the debt and draw a livable wage. They’re not being difficult, they’re managing risk.
Though risky, there are a lot of people who want to control their own destiny and build a better life through entrepreneurship which gives you a good chance you can sell if you are reasonable, transparent and patient.