Many small business owners eventually decide to sell their companies. Some wish to retire, while others are impatient to investigate new challenges—whether in business or in some other sector—or they have grown weary of the frustrations that come with business. Others decide to sell for reasons more closely associated with the health of the business itself. Disputes with partners, incapacitation or death of principals, or downturns in the company's financial performance can all spur business owners to ponder putting the business on the block. Whatever their ultimate reason, business owners can get the most out of selling their company by carefully considering a number of factors.
TIMING THE SALE
The financial performance and history of the company in question are often the most important factors in determining price at the time of sale. A business owner who chooses to sell after posting several years of steady growth will naturally command a higher price than will the business owner who decides to sell only a year or two into that growth trend, even if the environment continues to appear friendly to the business for the foreseeable future.
The business environment in which the company operates is also an important factor in determining the asking price that the market will bear. If the company in question operates in an industry struggling through a downturn, the owner should wait for better times if possible. Few companies are able to buck the tide when the industry in which they operate is stuck in a sluggish cycle, and even attractive businesses will lose their luster in such times. Of course, some industries never post a recovery; business owners engaged in underperforming industries need to determine whether the downturns they experience are simply an inevitable part of the business cycle within a basically healthy industry or whether times are leaving an industry behind. There was a time once to hurry to establish a miniature golf course or to expand that business in men's hats. There are times when it's best to make a graceful exit.
The stock market is a third factor that can signal good and bad times to sell. A surging market tends to produce energetic buying activity because others are ambitious to expand. A slumping market is a good time to hunker down.
STOCK SALES AND ASSET SALES
Business owners need to decide early whether to sell stock or assets—a choice available if the company is incorporated. Sole proprietorships and partnerships undergo asset sales. Under the terms of a stock sale, the seller receives an agreed-upon price for his or her shares in the company. After ownership of the stock changes hands, the buyer steps in and operates the still-running business. Typically, such a purchase means that the buyer receives not only all company assets, but all company liabilities as well. This arrangement is often appealing to the seller because of its tax advantages. The sale of stock qualifies as a capital gain, and it enables the seller to avoid double taxation, since sale proceeds flow directly to the seller without passing through the corporation. In addition, a stock sale frees the seller from any future legal action that might be leveled against the company. Lawsuits and claims against the company become the sole responsibility of the new stock owner(s).
Partnerships and sole proprietorships must change hands by means of asset sale arrangements; stock is not a part of the picture. Under asset sale agreements, the seller hands over business equipment, inventory, trademarks and patents, trade names, "goodwill," and other assets for an agreed-upon price. The seller then uses the money to pay off any debts; the remainder is his or her profit. Changes in ownership accomplished through asset transactions are generally favored by buyers. First, the transaction sometimes allows the buyer to claim larger depreciation deductions on his or her taxes. Second, an asset sale provides the buyer with greater protection from unknown or undisclosed liabilities—such as lawsuits or problems with income taxes or payroll withholding taxes—incurred by the previous owner.
PREPARING TO SELL
When preparing to sell a business, owners need to gather a wide variety of information for potential buyers to review. Financial, legal, marketing, and operations information all need to be prepared for examination.
Most privately held businesses are operated in ways that serve to minimize the seller's tax liability. As John A. Johansen observed in the SBA brochure How to Buy or Sell a Business, however, "the same operating techniques and accounting practices that minimize tax liability also minimize the value of a business'¦. It is possible to reconstruct financial statements to reflect the actual operating performance of the business, [but] this process may also put the owner in a position of having to pay back income taxes and penalties. Therefore, plans to sell a business should be made years in advance of the actual sale." Such a period of time allows the owner to make the accounting changes that will put his or her business in the best financial light. Certainly, a business venture that can point to several years of optimum fiscal success is apt to receive more inquiries than a business whose accounting practices—while quite sensible in terms of creating a favorable tax environment for the owner—blunt those bottom line financial numbers.
Would-be business sellers also need to prepare financial statements and other documents for potential buyers to review. These include a complete balance sheet (with detailed information on accounts receivable and payable, inventory, real estate, machinery and other equipment, liabilities, marketable securities, and schedules of notes payable and mortgages payable), an income statement, and a valuation report. The latter is an appraisal of the business's market value.
The seller should also prepare the necessary information on legal issues pertaining to the company. These range from such basic operating documents as articles of incorporation, bylaws, partnership agreements, supplier agreements, and franchise agreements to data on regulatory requirements (and whether they are being adhered to), current or pending legal actions against the company, zoning requirements, lease terms, and stock status.
Intelligent buyers will want detailed marketing information on the company as well, including data on the business's chief market area, its market share, and marketing expenditures (on advertising, consultants, etc.). In addition, product line information will also be expected. Buyers, for instance, will want to know whether any of the company's products are proprietary, or whether there are potentially valuable new goods in the production pipeline. Descriptions of pricing strategies, customer demographics, and competition should also be available for potential buyers to review.
Finally, business owners looking to sell their companies should be prepared to provide detailed information on various aspects of the business's day-to-day operations. The "operations" umbrella encompasses everything from company policies to historical hours of operation to personnel listings, including organizational chart (if applicable), job descriptions, rates of pay, and benefits. Other factors that can potentially impact one or more aspects of the company's operations, such as the presence or absence of an employee union, will also have to be detailed.
Once information on all facets of the business has been gathered, it should be organized into a comprehensive business presentation package. A complete business presentation package, remarked Johansen, should include the following:
- History of the business
- Description of business operations
- Description of physical facilities
- Discussion of suppliers (if any) and agreements with those suppliers
- Review of current and historical marketing practices
- Description of competition
- Coverage of personnel and employee issues
- Identification of owners
- Description of insurance coverage for business
- Discussion of pending legal issues or contingent liabilities
- Financial statements for the past three to five years
LOCATING PROSPECTIVE BUYERS
Most business owners sell their companies to external buyers—buyers other than current partners or employees in the organization. The seller can advertise the business, use his or her industry contacts to the get the word out, or engage intermediaries. Increasingly, online services with many options are available for advertising the business. Examples of sites, one on which a business can be advertised for sale directly (cityfeetBiz) and of one of brokers (United Business Brokers, serving cities in Utah, Nevada, California, and Idaho) able to act as intermediaries, are provided in the references; there are many more.
Many people hoping to sell their businesses make arrangements for advertisements in the Thursday edition of the Wall Street Journal, which produces several regional versions of its paper around the country. The Journal is a particularly popular option for owners of large, privately held businesses. Owners of smaller businesses, meanwhile, often turn to the classified sections of their own local newspapers to advertise the availability of their company for acquisition. When submitting a "business opportunity" advertisement for publication in the newspaper, however, sellers need to take a sensible approach. Ads must be framed to convey essential information without details that let others (including competitors) guess who the seller actually is. Advertisements should provide a brief description of the type of business for sale, its primary assets (location, popularity, profitability, etc.), and a way interested buyers can make contact. Sellers who wish to maintain some degree of anonymity while looking for a buyer may wish to arrange for a post office box rather than include their telephone number.
Industry sources also can be valuable when a business owner decides to sell his or her business. Suppliers may know of potential buyers elsewhere in the industry or the community. In addition, trade associations and trade journals can be used to get the word out about a company's availability.
A third option is to secure the services of a business broker or merger and acquisition consultant. Business brokers, who generally handle the sale of smaller companies (though this is by no means an absolute rule), typically charge the seller a fee of about 10% of the final purchase price. Merger and acquisition consultants typically specialize in handling larger middle-market companies. Payments to "M&A" consultants are usually less than 10%, but this is in part because of the larger scale of the deals in which they are typically involved. In addition, many consultants ask for a monthly retainer fee. One of the benefits of securing the services of a merger and acquisition consultant is that he or she will typically provide help in preparing presentation packages, valuing businesses, and negotiating with prospective buyers.
A well-chosen business broker or merger and acquisition consultant can save the seller of a business a considerable amount of time and effort. However, both groups include hucksters who prey on unwary business owners, so it is important for sellers to conduct the appropriate background research before soliciting services in these areas.
Another option sometimes available to business owners is to sell the company to "internal" buyers—employees, business partners, or family members. Selling to employees through employee stock ownership plans (ESOPs) or other arrangements are particularly attractive because they accrue significant tax advantages for owners through such sales. Employees interested in assuming ownership of the company by a management buyout (MBO) could range from a single key employee, such as a general manager who already has a good grasp on many aspects of the enterprise, to a group of employees (or even all of the company's employees). MBOs that rely on external financing typically require that one or more members of the purchasing group have management training in all aspects of the business; if such expertise is lacking, the seller will need to implement a training schedule for one or more employees to fulfill this requirement.
Business partners, meanwhile, are often ideal business buyers when an owner is ready to get out. Indeed, many business owners—especially in professional practices—bring in partners for this express purpose. The advantages of selling to a partner are numerous: the need to search for a buyer—or to use an intermediary—is obviated; terms of payment are often easier to arrange; and the business transition is eased because of the familiarity that already exists between the partner and the enterprise's suppliers, clients, and customers. Small business owners looking to hand over the reins of a company to a partner, however, need to adequately prepare for such a step. Locating a suitable partner, structuring a partnership buyout, and financing a partnership buyout are all important and complex issues that require care and attention.
Finally, business owners also groom people within their organization to take over the business upon their retirement (or death or disability). Family-owned businesses often hand over the reins from generation to generation in this fashion. In many cases this transfer of ownership is made as a gift or included as part of the owner's estate.
MAKING THE SALE
Once the seller has found a buyer for his or her company, the next step is to arrange the structure of the transaction. In addition to determining whether to make a stock or asset sale (in the case of corporations), the seller and the buyer need to reach agreement on other terms of the sale as well.
An earn out is an agreement wherein the seller takes a portion of the selling price each year for a fixed period of time out of the earnings of the company under its new ownership. These agreements are sometimes employed when a seller cannot get his or her full asking price because of buyer concerns about some aspect of the business. As a result, some sellers insist on minimum payment amounts. In addition, since the seller's total compensation under this arrangement depends on the company's performance during the specified earn-out period, sellers often require that they be involved in management decisions during this period. Earn-outs can be calculated as a percentage of gross profit, net profit, sales, or some other mutually agreed-upon figure. Sellers, however, need to make sure that the measurement used is fair and easily verifiable.
Under this common arrangement, the seller of the business receives some cash, but the majority of the purchase price is received over a period of years. The down payment for small businesses may range from as little as 10 to as much as 40 percent or more, with the rest paid out—with interest—over a period of 3-15 years.
A leveraged buyout or LBO is the purchase of a company through a loan secured by using the assets of the business as collateral. This option, however, places a greater debt burden on the company than do other types of financing.
In instances where a large, publicly held company is the purchaser, business owners sometimes ask to be compensated with stock in the purchasing corporation. In such cases, the seller is usually required to hold on to the stock for a certain period of time—usually two years—before he or she has the option to resell it.
Buyers sometimes insist on a noncompetition clause as well. Such a covenant, which can be incorporated into the purchase and sale agreement or created as a separate document, usually stipulates a market area and/or a period of time (three to five years is common) in which the seller may not open a business that would compete with the enterprise that he or she previously sold.
CLOSING THE DEAL
Once a deal has been struck between the seller and the buyer of the business, various conditions of sale often have to be addressed before the deal is closed. These include verification of financial statements, transfer of licenses, obtaining financing, and other conditions. Most contracts call for these conditions of sale to be addressed by a specified date; if one or more of these conditions is not taken care of by that time, the agreement is no longer valid.
Provided that these conditions have been attended to, however, the parties can move on to the closing. Closings are generally done either via an escrow settlement or via an attorney who performs settlement. In an escrow settlement, the money to be deposited, the bill of sale, and other relevant documents are placed with a neutral third party known as an escrow agent until all conditions of sale have been met. The escrow agent then distributes the held documents and funds in accordance with the terms of the contract.
If an attorney performs settlement, meanwhile, he or she—acting on behalf of both buyer or seller, or for the buyer—draws up a contract and acts as an escrow agent until all stipulated conditions of sale have been met. Whereas escrow settlements do not require the buyer and the seller to get together to sign the final documents, an attorney who performs settlements does include this step.
Several documents are required to complete the transaction between business seller and business buyer. The purchase and sale agreement is the most important of these, but other documents often used in closings include the escrow agreement; bill of sale; promissory note; security agreement; settlement sheet; financing statement; and employment agreement.
cityfeetBiz. Web Site. Available from http://www.cityfeetbusinessesforsale.com/. Retrieved on 26 May 2006.
Klueger, Robert F. Buying and Selling a Business: A Step-by-Step Guide. John Wiley & Sons, 2004.
Steingold, Fred. The Complete Guide to Selling a Business: The Step by Step Legal Guide. Nolo, 2005.
Tuttle, Samuel S. Small Business Primer: How To Buy, Sell, and Evaluate a Business. streetsmartbooks, 2002.
United Business Brokers. Web Site. Available from http://unitedbusinessbrokers.com/. Retrieved on 26 May 2006.
U.S. Small Business Administration. Johansen, John A. How to Buy or Sell a Business. n.a.