Selling Your Business
A primer on getting your company ready, understanding buyers' motivations, and dealing with brokers
Getting your company ready to sell means sprucing up operations and mimicking the professional standards of public companies--first-class financial statements, budgets, business plans, and management that's not dependent on one person. At the very least, running your business as if you were preparing to sell it will improve your management practices and increase the value of your company. And should an offer come through that you can't refuse, being prepared will put you in a great position to close a deal quickly.
In researching my book ( How to Sell Your Business--And Get What You Want!, Gwent Press, 1998), I interviewed 57 former business owners who had sold their companies. Some issues came up repeatedly that have little to do with the mechanics of getting your company ready to sell but that instead require you to do some soul-searching. What do you want for yourself--and for your employees--in the future? How much of your self-esteem is tied up with owning and running your company? Could you report to someone else? Thinking through the implications of a sale for you, your family, and your employees will go a long way toward helping you select the sort of buyer you'd be most comfortable with.
There are two basic types of buyers, financial and strategic. Financial buyers make up an enormous segment of the market. They look for businesses they can buy using debt financing for 50% to 75% of the price, and that have sufficient cash flow to service that debt. With few exceptions they value a business by using a multiple of four to six times earnings before interest and taxes (after making adjustments for expenses that would not continue for a new owner). They deduct from the price any interest-bearing debt that they will assume. There are disadvantages to selling to a financial buyer: there are no synergies--such as access to a larger sales force, or complementary activities in production, engineering, or any other part of the business; and there are pressures to increase the cash flow because of the added debt. Financial buyers are in business to make deals, so they may overlook some weaknesses. They often leave day-to-day operations unchanged, but they buy with a view to selling, which could disrupt your business life a second time.
Strategic buyers expect synergies with their other holdings. They can afford to pay a premium, but they may not need to because they know the market. Buyers offering premium prices are in short supply. The best match sometimes comes about if they seek you out after having determined that your business fits their plans. Strategic buyers may diminish your role, and their goals may differ from yours.
Financial statements are the best indicator of the future performance of the business, and audited financial statements are much more reassuring to a buyer--and to the bankers financing a purchase--than unaudited ones. Many buyers have fiduciary responsibilities--that is, they are accountable to shareholders or to others who have placed funds in their hands. Therefore, the buyers have an obligation to avoid undue risk. That means they will prefer, or maybe even require, audited financial statements. You help yourself by reducing risk for a buyer.
The buyer will put your financial statements under a microscope. Audited numbers strengthen your hand in the negotiations and allow you to demand better terms and to switch suitors more readily--and threatening to do so is one of your strongest weapons.
Buyers might question the quality of your earnings, meaning that your accounting may be too aggressive. For example, capitalizing product-development costs can be controversial, as can the presence of onetime gains in operating income. Be ready to point out those areas in which your accounting might be conservative, such as profits that have been understated because of accelerated instead of straight-line depreciation, or last-in-first-out inventory valuations.
To avoid the cost of an audit--roughly $25,000 for a manufacturing business with sales of $10 million--some owners have their financial statements reviewed by outside accountants. Buyers know the difference, but at least the review provides a professional presentation. One other step is vital if you have inventory and think you might need retroactive audited statements: have outside accountants observe a year-end inventory count for a year or two so that later they can express an opinion about the fairness of the statements.
Management depth adds value. A business that is excessively dependent on the owner is risky for a prospective buyer. Appointing a second-in-command and department managers enhances a company's value by alleviating that risk.
Focus on the strengths of your business. Eliminating weak product lines should increase your overall profit margins and improve your return on assets. Buyers don't want diversified businesses; they want resources concentrated in your strongest activity. Also, buyers like to see data showing gross profit (and return on assets) by activity or product line, so making optimal use of computers will be a measure of your competence.
Are there other assets in the business (such as land) that are not contributing to earning power? Your proceeds will probably be higher, and you will improve your overall financial ratios, if you sell those assets before talking to prospective buyers.
Who owns the real estate? If your company does, consider buying it yourself or moving it to another corporation. The price for the business might not change much without the real estate, and you will have kept a significant asset.
You can sell the stock of your corporation, or you can sell the assets and liabilities--the tax consequences are quite different. Buyers like to buy assets, because they can usually write them up and thereby increase depreciation or amortization on the books, thus reducing future taxes. But sellers usually pay more taxes when they sell assets. Ask your accountant for an analysis of the difference, which you can use in price negotiations with the buyer.
Many brokers and other intermediaries prepare selling memoranda (also called "books") to describe businesses for sale. They assemble all the data and present the reasons the company is an attractive investment. It's better, though, to sell your story yourself by doing up a business plan. Financial projections are of primary interest to buyers, and sellers rarely give them the attention they deserve. A business plan has several advantages. It does not signal to employees that the company is for sale. It does not send any messages about how long you may have been talking to buyers. And a good plan reflects well on a company's management--you are describing an enterprise with continuity independent of the owner's instincts. A business plan is a perfect tool to show to prospective buyers without signaling an intense desire to make a deal soon.
It's a sellers' market, but buyers are the aggressors. Buyers and their brokers are relentlessly calling on business owners to lure them into talks. Beware: flattery is part of the pitch. If you receive a misspelled, careless letter from a broker describing many clients, it's probably worthless. "Clients" in the plural signals the broker's intent to look for a buyer if you respond with interest. A broker writing and describing the specific interests of one buyer may merit attention. You could ask for details, saying you are not interested in selling now but might be one day.
A broker may claim to represent a given buyer, but that can be misleading. Some buyers enter into agreements with dozens of brokers, agreeing to pay them if they initiate deals that are consummated. Be cautious. If you seem interested, you could find people calling your customers and competitors to check out your reputation, and the resulting rumors could hurt your business.
If an inquiry tempts you, think through what will follow. If you want to sell, don't tie your fate for months to a single buyer without making comparisons. Nothing protects a seller's position better than having a competitive buyer in the wings. Moreover, hearing "Thanks, but no thanks" is the ultimate insult after you have revealed all your secrets during months of talks, and it's also vexing to explain to employees. Although the termination of the deal could easily be attributed to problems in the buyer's business, your company could end up tainted after employees, customers, competitors, and other potential suitors learn that a deal collapsed.
When the inquiry comes in and you make your initial response, everything is confidential and low risk. But to reach the point of a closed sale, certain steps are inevitable. After some gentle fencing, you agree on a price, which is usually incorporated into a letter of intent (also called an agreement in principle). At that point the buyer asks you to stop all efforts to sell to anyone else in exchange for the buyer's commitment of time and money to try to complete the deal. Now the buyer wants to begin due diligence, the investigation of your business to verify that you portrayed it accurately. It is unrealistic to continue believing that you can keep a possible sale secret from your employees. You'll begin a period of uncertainty for a minimum of 8 to 12 weeks, during which time the buyer in effect has an option to buy your business at the negotiated price but is not irrevocably committed. Sellers should remember that many deals collapse, or undergo major changes in their economics, after a handshake on the price.
Colin Gabriel is a business broker in Westport, Conn., and the author of How to Sell Your Business--And Get What You Want!
Agreement in principle. An outline of the understanding between the parties, including the price and the major terms. It is often referred to as a letter of intent. Usually, the agreement is subject to the negotiation of a mutually acceptable definitive agreement.
Auction. An invitation for bids on a business by a specified date. In practice, the date is often extended for the three or four top bidders, who then are invited to improve their offers.
Basket. A designated sum below which claims will not be made for breaches of representation and warranties (or other indemnification claims).
Book. The term used for the memorandum that describes a business for sale.
Comfort letter. A letter provided by independent accountants reporting on the financial condition of a company, usually for an interim period since the last audit.
Flipping. The sale of a company within a year or two of its being bought.
No-shop clause. An agreement between the prospective buyer and the potential seller to stop discussing for a defined period the sale of the business to others.
Pure play. An acquired company that is in only one business.
Selling memorandum. A description of the business including its history, products, markets, management, facilities, competition, financial statements, product literature, and a review of its prospects.
Tips from the Trenches
Price is not everything. Feeling right overall about the sale a year later matters too.
Experienced professionals may and should coach you, but you must control the negotiations. You have the big economic stake, and you, unlike your advisers, may go to work--for years--for the new company.
Talk to people who have sold businesses to your buyer. If no names of sellers are made available to you, you might legitimately question why.
Get bids for an audit. Some reputable accounting firms discount their fees to attract young, growing clients.
Disclose everything. Problems uncovered late impugn your integrity and threaten the price--and the deal.
Run the business, right up to the closing, as if it will be yours indefinitely. It might be. Resist the urge to accommodate the buyer--protecting your business is a higher priority.
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