Preparing a Business for Sale
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By Cara Lowe, Esq.
Business owners who are interested in selling their companies often don’t anticipate the outside factors that can quickly influence a deal. By taking proactive measures far in advance, potential sellers can help ensure success and avoid getting blindsided by deal-killing surprises.
Plan, plan, plan
Since most privately held businesses don’t have a dedicated in-house team to handle the due diligence, negotiation and documentation process, the owner will often have to lead the sale process, confidentially resolve complex deal issues on the fly and continue to manage company operations successfully. The best way to juggle all of these demands is establishing a thoughtful plan for managing the process in advance.
Know your story
As you develop the plan for marketing your company, consider the big picture issues and prioritize your objectives. This will let you identify which terms are absolute and which items can be subject to negotiation. For example, understand why you’re selling, what you want out of the sale, how long you’re willing to continue working for the buyer post-closing and whether you need all cash or are willing to finance all or part of the purchase price. Also, this exercise will prepare you to articulate the reason for selling your company. Buyers always want to know why a seller wants to exit a business (in other words, if it’s so great, why are you leaving?). Anticipate how other invested stakeholders will respond to the news post-closing. How will customers and employees react?
Get a business valuation
A professional valuation will provide a baseline for assessing buyer offers (purchase price, payment terms and other key terms) and will give you a foundation for your financial expectations. This helps avoid holding out for an unrealistic price or accepting a below-market offer. A third-party valuation also will identify your business’ market position, financial situation, strengths and weaknesses. You can obtain valuations from numerous sources including local accounting firms, regional business brokers and investment banking firms. The evaluator should have access to the most current national data regarding privately held transactions in your industry and have experience in selling companies of your type. Also, the transaction structure (a stock deal versus an asset deal, for example) can have a material impact on the valuation proposed by a buyer and the net sale proceeds available to you after taxes. Relevant factors that influence perceived and future value include:
• If the target business model revolves around a repeatable income stream;
• If the seller has multiple products the buyer can sell or develop;
• If the company’s gross margins are increasing or decreasing; and
• If the seller has standardized processes and procedures that can be followed easily.
Take time now to address any nagging problems and prepare responses to a potential buyer’s questions about them. The most obvious issues are liabilities such as existing or threatened litigation, contractual disputes, inadequately documented business arrangements, employee problems and other unresolved legal, tax or financial issues. You should also properly clean up and resolve all ownership and title issues, ranging from confirming equity ownership of the company (for example, are there any “lost founders” who might pop out of the shadows?), to perfecting the ownership and registration of intellectual property rights and ensuring compliance with any legal requirements. Further, you need to review, update and complete the company’s minute books, stock books and other corporate records. Since many small businesses take an informal approach toward recordkeeping, you’ll likely need to devote some time and money taking necessary corrective measures to fill gaps in minutes and to ensure that all tax returns, other government filings and licenses have been completed, filed and are current.
You’ll need to confirm that all material contracts are properly documented, because the buyer will want to understand the scope of rights and liabilities that will exist after closing. Relevant contracts include at-will employment agreements, key customer agreements, lease agreements, loan agreements, license agreements and non-competes. Also, you should review the term for each of the company’s key agreements to ensure they don’t expire during anticipated negotiation periods. Further, you’ll need to know in advance which contracts require that the other party consent to assignment of its contract to your purchaser party. Deals can get delayed until receipt of that “elusive” missing consent.
Provide financial statements
A buyer will want proof of the target’s profitability. To maximize pricing of the company, the seller usually will need to show three to five years of consistent results and profitability. Although in smaller deals tax returns may suffice, having a formal company statement, accountant-reviewed or -prepared versus internally generated, puts the seller in a stronger position. A seller should be able to demonstrate the true profitability and cash flow of the target business with supporting documentation.
Retain an experienced adviser team
The assembled team should include, at a minimum, an accountant, an attorney (with deal experience) and a tax adviser (often with the accountant or attorney also serving as the tax adviser) and, depending on the business, an investment banker, business broker, business valuation expert and other consultants. Keep in mind that accountants and attorneys usually bill on an hourly basis. The intermediaries (business broker and investment banker) charge a fee as a percentage of the purchase price (typically 10 percent for business brokers and lower percentage fees for investment bankers, since the transactions they work on are larger). Due to the fee structure, intermediaries ordinarily will seek a six-month or longer exclusive right to sell the business.
Ensure employee loyalty
You should have a detailed plan for managing employee morale. Employees can be upset by change even if the acquirer offers better terms and conditions of employment. Sellers often address this issue by offering retention bonuses and other benefits to keep employees. Most buyers are keenly sensitive to retaining valued employees after closing. A departure of one or more key employees before the deal closes can adversely affect the buyer’s overall willingness to proceed.
Keep a clear head
No matter how close you get to a final deal, don’t get so distracted by the negotiations that you let your company’s business performance decline. If profits or revenues drop, the buyer may ask to reprice the deal, convert a portion of the price to a contingent payment or otherwise revise the deal terms.
With proper planning, sellers can tidy up problems that typically undermine the deal process. Doing so will provide owners with a better base to focus on the deal terms more clearly and take more control over the negotiation process.
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Cara Lowe is a corporate partner in the business department of Stein & Lubin LLP inSan Francisco, where her practice consists of representing high net worth individuals and acting as outside counsel to startups and middle market companies. She served as the firm’s Managing Partner from 2007 through 2010. You can reach her at (415) 981-0550 or firstname.lastname@example.org. The article was originally published in Northbay Biz Magazine and has been reprinted here with permission from the author.
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