Related Terms: Business Appraisers; Valuation
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.
Financial Information
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.
Legal Information
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.
