How, when and to whom to sell a business that has been built over many years is perhaps the most important decision of a business owner’s professional life. Questions abound. Why might I want — or need — to sell my business? What is the best way to go about selling my business? When is the best time to sell? To whom should I sell?
In this article, we explore and discuss some of the critical factors that impact these and other important questions that business owners may have concerning this vitally important topic. Understanding these basic principles is a must for business owners, whether they are thinking of selling now or 10 years from now.
Because every situation is different and the questions contemplated in this article can be complex and complicated, there are no cookie-cutter or simple answers. Readers are encouraged therefore to consult with their own advisers or to submit questions confidentially to the authors that may be specific to their own company or personal situation and needs.
How Should I Sell My Business?
1) Plan. Planning is critical when it comes to selling a business.
An overarching issue to consider when preparing your company for sale — one that is too frequently ignored — is the corporate structure of your company. The reason for this is because corporate structure impacts the tax consequences of the sales transaction for both buyer and seller. Failure to take into account tax implications is a leading cause for merger and acquisition (M&A) transactions to crater. The underlying market value of your business is one thing, and it is important; some of the key factors affecting market valuation will be discussed later in this article. However, as with annual earnings and cash flow, it’s not what a buyer pays you for your company that counts. It’s what you get to keep after taxes that counts.
Whether your company is a C-corporation, an S-corporation, a limited liability company, or a sole proprietorship will impact how transaction proceeds are taxed, as well as the near- and long-term tax implications for both buyer and seller. Also, corporate structure affects the transaction structure options available to help mitigate or defer such taxes and tax effects.
Every transaction, every company, and every personal situation is different, with varying degrees of complication. Before you decide to sell your company or recapitalize its equity, therefore, you would be wise to consult with your M&A advisory, legal, accounting, and tax professionals to better understand your situation and your options. This will enable you to better anticipate how you and your company will be taxed on the proceeds of any transaction you might be considering, and thereby plan accordingly for the optimal outcome. The sooner you do this, the better. In the long run, it will save you time, expense, and aggravation.
2) Prepare. When it comes to ascribing value to a business, sellers can expect buyers to focus on three things: quality of personnel, quality of assets, and quality of earnings. The reasons for this are straightforward. First, regardless of the analytical methodologies employed, earnings, earnings trends, and the demonstrable sustainability of earnings growth are among the critical drivers of indication of market value. Second, quality of personnel and quality of assets are important elements and indicators of the sustainability of earnings growth. As a result, all three are important to a buyer, and therefore all three are carefully scrutinized.
Other important indicators of earnings quality are profit margins — gross margins, operating margins, and EBITDA (earnings before interest, taxes, depreciation and amortization) margins — as well as debt-to-equity ratios. Companies with narrow profit margins or excessive amounts of debt are more likely to encounter difficulties during business downturns.
Get your financial house in order. The first thing buyers look at when attempting to determine the sustainability of earnings growth and estimation of market value are your financial statements. Therefore, have at least three years of good financial statements — income, cash flow, and balance sheet — prepared. It is best if they are audited. At the very least, it will serve you well to have them reviewed by your accounting professional.
If possible, pay down excessive debt: long-term debt, trade payables, unfunded liabilities, etc. Similarly, reduce or eliminate unnecessary direct, indirect, and overhead costs and expenses where possible and practical.
Your financial statements tell a big part of the story, but buyers look for the things that are driving those numbers, particularly earnings growth. The demonstrable sustainability of a company’s earnings growth can be influenced by many factors. Some of these may be external to the company and therefore out of your control. Others, such as the quality of your personnel and the quality of your assets, are well within your control. These are critical internal factors influencing a company’s ability to demonstrate its sustainability of earnings growth.
Have the right people in place. Is your current team of managers, supervisors and employees capable of taking your company to the next level? This is a question buyers will be asking. While there are many metrics by which the quality of a company’s personnel may be measured, a track record of success, low employee turnover, and the presence of a practical and pragmatic management succession plan are important indicators. Make sure your company’s policies, work conditions and environment, compensation and benefits packages, and opportunities for advancement are consistent with facilitating the continued profitable growth of your company.
Don’t forget your assets. Buyers will carefully examine the quality of your assets — fixed, rolling, facilities, IT — because asset quality impacts future earnings potential. Aging or poorly maintained assets negatively impact future profitability due to the increased need for capital expenditures for replacement or increased expenses for maintenance. Other considerations include potential safety issues and possibly increased insurance costs to guard against third-party liability. Worker morale and performance can also be negatively impacted by old or poorly maintained assets. Different businesses operate under different philosophies when it comes to how and when assets are replaced, upgraded, and maintained. When contemplating the sale of your business, you must objectively analyze and take into account how the age and condition of your asset base will either help or hurt your market value, and decide for yourself what to do about it.
3) Process. Once you have decided and are ready to go to market, a decision needs to be made as to the process you will employ to sell your company. Broadly speaking, there are two approaches to do this. One is to negotiate one-on-one with a prospective buyer. The other is to conduct a competitive process involving any number of prospective buyers.
Negotiated process. The decision to sell your business via a negotiated process may be influenced by several factors. You may have been approached unsolicited by a prospective buyer interested in your business. You may have a pre-existing relationship with a prospective buyer whom you approached. Or you may have been introduced to a prospective buyer through a mutual relationship. Sometimes, negotiating one-on-one can be beneficial to both parties. But there is an adage in our business: If you have one buyer at the table, they control the transaction. If you have two or more buyers at the table, you control the transaction.
Competitive process. In a competitive process, multiple prospective buyers are identified, scrutinized, and prioritized based on a to-be-determined set of criteria. Qualified prospects are invited to submit purchase offers for analysis and comparison. The details of how such processes are conducted vary depending upon circumstances, but the goals of conducting a competitive process are generally the same: increase value, improve deal structure, and drive the schedule.
There are pluses and minuses to each approach. The process you ultimately decide to employ when selling your business is up to you, so you will want to consult with M&A advisory and legal professionals to help explore and analyze which approach best suits your needs.
When Should I Sell My Business?
Determining the right time to sell a business can be difficult. This decision may be influenced by multiple factors: the personal circumstances of the seller; the performance, condition, and life cycle of the business and the industry it is in; general economic conditions and trends; and the condition of capital markets — for example, the availability and cost of acquisition capital for prospective buyers. All of these factors need to be taken into account and, where appropriate, discussed with your advisers to help determine when the time is right to go to market, keeping in mind there is never a perfect time to do so.
When it comes to the timing of selling your business, there is one imperative, however: to ensure that your valuation expectations as a seller are consistent with market realities. If they are not, your attempts to sell your business could result in a waste of time, money, and effort. In such cases, it is best to simply wait, either for market conditions or the performance of your business to improve, or for your expectations (often driven by need or want) to change.
To Whom Should I Sell My Business?
It depends. How’s that for an answer?
What are you trying to accomplish? Are you trying to sell your business for as much money as you possibly can? Are you trying to make sure the interests your stakeholders — employees, customers, suppliers, neighbors — are properly attended to for the foreseeable future? Do you want to retain some ownership in the business and stay involved in some capacity? Do you want to transfer some portion of the ownership to your management team or heirs?
How you answer these questions will help determine whom you should consider as a prospective buyer or investor, and whether you should consider strategic buyers, financial buyers, or both. In any case, there are multiple factors you will want to take into account: level of interest; compatibility with you and your company in terms of goals, strategic focus and direction, operational capabilities, and culture; and financial wherewithal and capitalization plans.
If your goal is to sell your business outright, you will want to consider strategic as well as financial buyers. If your goal is to retain some portion of ownership in your business for yourself, your employees, or your heirs, a financial buyer or investor may be a better choice. But there are exceptions, depending on the buyer.
One thing all buyers have in common is they are interested in growing your business and increasing its value. The question is whether the means by which they plan to accomplish such growth are consistent with your goals and values.
Asking prospective buyers the right questions will help guide your thinking and lead you toward the right choice. Again, consultation with your M&A, legal, and other advisers — not to mention your own conscience — is in order.
Plan and prepare properly, because failing to do so could cost you time and money. Go to market when the time is right. This will improve your chances of successfully completing a transaction. Find the right buyer for you and your company. These things are easier said than done, but with a good team of advisers, proper counsel, and thoughtful deliberation, successfully reaching your goals is readily achievable.
Bert Rosica is a managing principal with A.E. Rosica & Co., a boutique M&A and capital formation advisory firm. He may be contacted at email@example.com.
Ed Schiff is of counsel to the law firm Sheppard Mullin, where he is a member in both the Corporate and Finance and Bankruptcy Practice Groups. He may be contacted at firstname.lastname@example.org.