There are many business owners who are looking to sell their business but are unsure of the steps they should take and conversely there exist buyers looking for a business without knowing where to start. Often the two will need a point in the right direction in order to find the buyer or seller that is compatible with them.
The decision to buy or sell can be a stressful process involving personal emotions, the current state of the economy and well-planned timing. That is why knowing how to navigate your way from the initial decision, all the way to the closing transaction is essential. Often the best way to increase a business’s chance of a good outcome in either buying or selling is by arming oneself with the right information.
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- Making the decision
- Finding sellers and buyers
- Evaluating the company
- Financing the purchase
- Pricing the company
- Making and evaluating offers
- Closing the transaction
- Planning Your Business Exit
Making the decision
Business owners make the decision to sell based on a variety of reasons including:
- Partnership dispute
- Diminished interest
- Illness or death
- Company growth beyond the business’ capacity to fund
- Growth beyond the ability of the existing owner to manage
The decision to sell a business is often more difficult than selling an asset because a business is more than an income- it’s a lifestyle. Ideally plans to sell a company should be made years in advance. This permits time to adjust accounting practices and demonstrate at least a three year track record of maximum profitability.
It is important to remember that minimising tax liability during these years will also minimise the value of your business. Audited statements are the best kind of financial evidence to show to potential buyers because they are easily verified. The neatness and aesthetics of the company should not be disregarded either. Things like office cleanliness and well organised files can be improved over the years after the decision is made.
Buyers of businesses usually have one of three motives:
- Some are themselves owners of private companies looking to diversify their market, or perhaps access to new technologies
- Others evaluate the purchase solely for financial gain
- Lastly, there is a majority who wish to not only buy the business but operate it
These buyers must make several judgments about their position to buy a company beforehand including:
- If the size of the company is appropriate in terms of sales, profits and employees
- Whether the profitability and stability of the company is adequate
- How the company sits in relation to the have the amount of money they have available for investing
- If cash is not readily available then a buyer must also consider the possibilities of obtaining funds from another source
By assessing their own decision in terms of their financial situation, buyers can establish a list of criteria for the businesses they wish to buy and narrow down the field.
Finding sellers and buyers
After they have made preparations to sell the company a seller must then find a buyer. Similarly, after having considered the criteria a potential company must cover, a buyer must find a seller.
The best source of information for both the buyer and the seller on how to do this is a business opportunity intermediary.
- Business brokers (who mainly handle small businesses)
- Investment bankers (who handle larger corporations)
- Merger/ acquisition specialists (who help obtain outside financing for ‘in-between’ companies).
The work of the intermediary can include things like preparing a presentation package or a valuation report for prospective buyers. This can involve pricing the company, setting the financial terms and other conditions, professionally marketing the company, screening potential buyers and helping to evaluate or negotiate offers. Networking with solicitors and accountants can be a good way for a buyer to be the first to approach the seller when a business goes on the market.
There are also other forms marketing sellers might consider on their own. For example, print advertising is a great way of a putting your business out there. The Sunday edition of a larger local paper is usually the best option. Larger companies are often not advertised at all but are marketed by intermediaries. Trade sources can also be a viable source of information on companies for sale. Almost every industry has a trade association or one or more publications.
Evaluating the company
The first thing a buyer will do is evaluate the company by its history. The buyer needs to understand certain key aspects of the company such as:
- The company’s method of acquiring and serving it’s customers
- How the sales, marketing and finances inter-relate
To do this the company’s financial statements, operating practices and other documents must be reviewed. These include:
- The balance sheets
- Income statements
- Sales journals
Other assessments based on various aspects of the company’s operations must also be made upon:
- Personnel- for example, what are the responsibilities, rates of pay etc of each employee?
- Marketing- for example, who is the geographic market area?
- Patents- a list of patents and copyrights should be reviews in terms of when they expire.
- Taxes- for example, what was the outcome of the last tax return?
- Legal issues- for example, are all state registration requirements being met?
- Competitors- for example, what disadvantages/ advantages does the company have over its competitors?
Financing the purchase
The purchase of a business requires a certain amount of cash, depending on the size of the company. Sometimes the financing of the purchase is done primarily by the seller however the buyer must then provide equity in the form of a down-payment. Often the transaction must be financed by the buyer who will likely need an outside source of financing.
Lenders of outside sources of financing will usually require personal collateral for the loan. Personal collateral can include real estate, marketable securities and cash value of life insurance policies. Having a clear source of repayment, a good business plan and demonstrating good character are also viable ways of making the right impression on your potential lender.
It is important to be well prepared when applying for financing. Make sure you are informed on both the questions you should ask and the information you need to bring.
There are many different types of financing that buyers can acquire, including term financing, revolving debt and unsecured debt. When asking lenders such as commercial banks or investments banks about financing, ask them to explain to you how their financing works including whether they have any loan conditions or will place any restrictions on your businesses activities.
An essential item to bring to any loan interview is a loan proposal. This should include information on the following:
- Purpose of the loan
- Amount required
- Term desired
- Source of repayment
- Collateral available
- Sources of repayment
- History and nature of the business
- Age, experience and education of management
- Key advisors
- Market area and method of distribution
- Major customers
- Employees and unions
- Three years of business financial statements
- Three years of business tax returns
- Current personal financial statement
- Business income statement, balance sheet and cash budget
Pricing the company
Pricing a company is what is known as business valuation. Business owners will usually use an intermediary such as an accountant in order to get the most accurate business valuation. This is because business valuation is a hugely complex issue involving a number of variables and assumptions such as;
- The recent profit history of your company
- General condition of your company. For example the condition of your facilities, books and records
- Market demand for the particular type of business
- Economic conditions; the cost and availability of capital and any economic factors that directly affect the business
- Ability to transfer goodwill or other intangible values to a new owner
- Future profit potential
These six factors determine the fair market value. Fair market value is important because overvaluing the business will discourage buyers.
A good way to ensure a high price is to create competition between potential buyers. You can reject any bids that fail to reach your estimated value, obliging other bidders to increase their offers.
The art of negotiation plays one of the most essential roles in the act of buying or selling a business. It can be a long and difficult process but there are ways to speed it up whilst achieving a successful outcome.
Firstly, differing perspectives must be taken into account. Differences of opinion are inherent in the negotiation process and only realistic negotiators can find creative solutions to such differences. Buyers will not be able to easily see from the perspectives of the sellers and vice-versa, which is why it is helpful to have a third party, such as a business broker to negotiate in their place.
Secondly, all the elements of the transaction should be considered. Price is just one aspect of the transaction to be negotiated. Other terms are also important such as the period of time debts are to be repaid and the allocation of the purchase price for tax purposes.
Thirdly, give yourself the best advantage. Whilst sellers usually have the upper hand because they know they company best, buyers can gain advantage by learning as much as possible about the other company. The parties must understand each others motivation for wanting to buy or sell the company and each other’s plans after the transition. This saves time and lessons the difficulty of coming to an agreement.
It is in the buyer’s interests to ask that the seller not negotiate with other buyers at the same time. On the other hand it is to the seller’s advantage to negotiate with more than one buyer at a time.
Lastly, have a good strategy. A good start for a buyer or seller in any negotiation is to develop a negotiating strategy. This means that each party must know the others position as well as their own position, preparing a list for why they hold this position. In doing this, each party is better equipped to anticipate and respond to objections from the other.
Making and evaluating offers
After a buyer has investigated a number of companies, they will then make an offer. An offer may take the form of a purchase and sale agreement or a letter of intent. Although they have different names, the two documents serve the same purpose; both are means of documenting a buyer’s expression of interest.
Regardless of which form of documentation is used, it should contain the following:
- Total price to be offered
- Components of the price (for example, the amount of security deposit and down payment, amount of seller financed debt)
- A list of all liabilities and assets being purchased. The minimum amount of accounts receivable to be collected and the maximum amount of accounts payable to be assumed may be specified.
- The operating condition of equipment at settlement
- The right to offset the purchase price in the amount of any undisclosed liabilities that come due after settlement and in the amount of any variance in inventory from that stated in the agreement
- A provision that the company will be able to pass all necessary inspections
- Warranties and representations of clear and marketable title
- A provision (where appropriate) to make the sale conditional on lease assignment.
- A provision for any appropriate proportions such as rent, utilities, wages and for prepaid expenses such as insurance, utility deposits and license fees
- A noncompetition covenant. This document is sometimes part of and sometimes a separate exhibit to the purchase and sales agreement.
- Allocation of the purchase price
- Restrictions on how the company is to be operated until settlement.
- A date for settlement.
The purchase and sales agreement is a complex document and it is essential to get professional help in drafting it.
When evaluating an offer the seller should look for the same provisions in the agreement document. A seller should also ask for a resume and a financial statement from the potential buyer. Great potential buyers are those who:
- Have a commitment to the work ethic
- Successful related work experience
- Has a logical reason for acquisition of the business
- Are willing to provide a post-acquisition plan
It is also important for a seller to carefully study the offer in order to determine what assets and liabilities are being purchased. An offer for the assets of a business may be worth considerably less than an offer for its stock, even though the price offered for its stock is considerably higher.
Closing the transaction
The final legal procedure by which a company changes hands is a business settlement or closing. Good settlement solicitors may be acquired to represent all parties and solve the final barriers.
After a buyer and seller have entered into a contract of sale there are then a number of conditions which must be met before the sale can be closed. These may address issues such as the assignment of lease, verification of financial statements, transfer of licenses or obtaining financing. The agreement will become invalid if these conditions are not met within the date specified.
A number of documents are also required to close a transaction. The purchase and sale agreement (discussed in ‘Making and evaluating offers’) is the basic document from which all these are drawn. These may include:
- A settlement sheet
- Bill of sale
- Promissory note
- Security agreement
- Promissory note
- Financing statement
- Covenant not to complete
- Employment agreement
These are all documents a qualified accountant can help businesses to draft.
Planning Your Business Exit
For some people their business is a separate entity that will continue after they retire or leave. For others it is so closely dependent upon their personal input that it will simply come to an end when they stop working. Either way, you need a carefully planned exit strategy that will enable you to optimise your position when the time comes.
Here are some possible scenarios:
Passing on your business to your children or other members of the family. You will need to be careful in your choice of successor, especially if some of your capital will remain tied up in the company, for example in shares. You will need to put in place the right mechanism to effect the transfer and make sure your plan is tax effective. It is important to consider how much control you are prepared to give up on retirement.
In some cases it will not be possible to retain control once you retire, though you may still have a degree of influence. If you are passing the business on to family members, do not overlook the fact that you can appoint them as directors and hand over the day-to-day running of the business while retaining control of the company through your shareholding.
Also you may wish to consider using trusts as a way to pass an interest in the company on to family members while continuing to exercise some control.
Selling your share in the business to your co-owners or partners. This might already have been considered and incorporated into your partnership or shareholders agreement. You will need to be able to place a value on your share in the business – or accept a return of capital plus an annuity from your partnership. We can help by advising on agreements and also by valuing your business.
Selling the business to a third party. Again, you need to know the value of your business and how the funds released by the sale can best be invested to provide you with a comfortable retirement or to begin a new business venture. Valuable tax reliefs are at stake here, so consult us early in your planning to avoid an unnecessary tax bill.
Public listing or sale to a public company. This might be an option if you have a sufficiently large business, or a niche business attractive to a larger company seeking to expand its activities. A great deal of care and planning is required if you are to make the most of such an opportunity.
Selling your business to some or all of the workforce. Through company share schemes and pre-sale agreements you can reward your workforce on an ongoing basis in the form of equity – a stake in the business. One possible conclusion of widening ownership of the company in this way might be to pass control of the company to the workforce on your retirement.
Winding up the business. If the business is simply going to come to an end when you retire you need to ensure that when the time comes you collect all monies owed to you and realise the value of the business assets. After all, these are an important part of your ‘retirement fund’. Again you will need to arrange this properly to minimise your tax liabilities and maximise your income in retirement.
Whatever plans you make for retirement, or for withdrawing from your current business, careful planning and the right advice are essential.
Careful planning and professional advice are essential at every stage of your business life. The best time to start planning is now. We would be happy to advise you further on developing SMART strategies for you and your business.