Timing the Sale
How to know when its time to sell your business?
No one wants to hang the 'going out of business' sign up.
Your business is likely the result of many years of your hard work. But selling isn’t necessarily admitting failure. In fact, knowing when the best time to sell your business, whether it’s profitable or doing poorly, is actually smart business.
Don’t be like many business owners who tend to hang on to their businesses for too long.
Here are five ways to know when it’s time to sell your business:
1. Your business is performing poorly
Debt is the key factor here. Is your business falling deeper into debt each month? If you are borrowing money constantly to keep your business afloat, it’s time to seek other alternatives.
In most businesses, when the current liabilities become more than 200% of current assets, it is too difficult to recover.
However, finding a buyer with resources who can inject cash flow into the business could be just what it needs to sustain life.
Merging with a larger company or selling to a strategic buyer could solve your staffing, funding and inventory issues.
Don’t delay until the decision is made for you by allowing the business to run out of money and collapse.
As serial entrepreneur and founder of Gilt Kevin Ryan told Forbes:
“If your company is not getting the traction it needs to be really successful, the faster you can move on, the better for everyone involved.”
2. Your passion for the business is starting to fade
If you have been successful in the past, but could use new ideas to keep the business flourishing, it could be time to sell. Don’t wait until you start to hate your job to move on.
Ask yourself these five questions to see if your dream has become more of a burden:
- Am I passionate about this business?
- Is there something else I would rather be doing?
- Am I working more than I would like?
- Is my business model flawed?
- Do I simply need a vacation?
Based on your answers, you should be able to determine your next steps, whether that’s just taking a short break, restructuring your company so you have more help or selling to someone else.
3. You have a compelling reason to sell
Sometimes situations such as divorce, death or the dissolution of a partnership can force an involuntary sale. In these cases, you’ll need to do what you can to make the best of a bad situation.
4. You receive an offer you can’t refuse
You may not have been planning to sell your business, but the offer is so good that you simply cannot ignore it. Take the time to do your due diligence and make sure the deal is as good as it seems.
5. Your business is profitable
Buyers will be attracted to consistently upward profit and sales trends, especially for at least three years. If the valuation of your business is high, it could be a good time to cash out.
Deciding to sell your company is a very big deal, and the process typically doesn’t happen quickly. It usually takes between six months and a year to sell a business, so start planning for the deal much earlier.
A lot of entrepreneurs have a hard time letting go and moving on from owning their business. Only you can decide for yourself whether the time to do so is now.
Preparing your Business for Sale
Five top tips to get your business in shape to sell
If you are considering selling your business, it needs to be in great shape.
Consider how your company will look under the microscope of potential buyers. If you see some potential flaws, now is the time to get everything in order so that when it comes time to post the 'for sale' sign, you attract the right buyers and attain the highest price.
Here are our five top tips to get your business in shape to sell:
1. Plan your exit strategy
What are your motivations for selling your business? Business owners who are selling because they want to pursue another opportunity or are seeking a lifestyle change can usually take the time to develop a strategic plan. This includes developing a timeline and goals.
Don’t wait until you are ready to retire or can no longer manage the operations of the business to sell it. Sellers who must sell under distressed conditions such as illness or old age are often taken advantage of by buyers.
2. Get your books in order
When selling a business, it is advisable to get an audit for the past few years. This can be a costly investment, but well worth it to be able to show your business' profit history to potential buyers.
Make sure all taxes are paid and any lawsuits are settled. Continue to keep your records up to date, and don’t let things slide in the final year or months of your leadership.
3. Spring clean
Now is the time to clean up and get your business in order so that you can provide the best first impression to potential buyers.
Spruce up the place by doing any needed repair work and replacing equipment or fixtures. Just as if you were selling a house, you want your business to show well to potential buyers. If it looks neglected, it won’t be appealing.
4. Determine what you are selling
Selling a business not only consists of the physical inventory and space. Your business’ history of profitability, competitive advantage, customer base, growth opportunities, brand loyalty, intellectual property rights, licenses and issued patents are all valuable in the eyes of a potential buyer.
If your business is incorporated, you’ll need to decide whether to sell your business as an asset sale or a share sale. The difference is that the incorporated company is included in a share sale.
5. Know what your business is worth
Consider the current market, economic trends and research what other similar businesses have recently sold for.
It’s important to get a formal valuation from a professional appraiser so that you know what you can offer a potential buyer. A professional business valuation will be regarded more favorably by potential buyers and could prevent legal trouble down the road.
Use this valuation to assist in setting your asking price, but figuring out that formula can be tricky. Set the price too low and you may lose out on opportunities, while setting the price too high could scare away potential buyers.
Selling a business is a lengthy process that requires careful preparation even before it’s time to advertise the sale. By following these tips to make sure your business is ready to sell, you are ensuring a successful start to the search for the perfect buyer.
The Ultimate Guide to Business Valuation: Part 1
Buying or selling a business will probably be the largest financial transaction you ever take on.
Settling on the right price is crucial for both sides of the transaction.
As the seller, you will have worked hard over years, maybe even decades, and will want to maximize the amount you receive. As the buyer, you will want to ensure you’re receiving maximum value for your dollar, and feel reasonably secure in the eventual profitability of the transaction.
To accomplish those goals, both parties need to be able to effectively arrive at a realistic valuation for the business in question. This guide is designed to give you the basic guidelines and powerful tips to help you do just that, no matter what unique circumstances are involved.
When and why a business sells
Most advisors recommend formulating an exit strategy before you even start a business.
The exit strategy is a strategic plan for how you will eventually cash out, or otherwise devolve yourself of ownership, since no one person can expect to own and run a business forever. Understandably, selling it when you have achieved your objectives — financial or otherwise — is the most common strategy entrepreneurs pursue.
While planning when and how you’ll sell your business years in advance is ideal, even a successful business may wind up unexpectedly for sale due to other factors like personal problems (sickness, divorce, or needing to relocate) or disagreements among business partners.
You could potentially receive an unsolicited offer from another company, often a competitor. Or, you might realize that the current economic climate is good for a seller and decide to take advantage of it.
Of course, some business opportunities are sold because the owner feels they are unsuccessful or are likely to become so in the future — but that doesn't mean their businesses are worthless.
Even during difficult economic times, entrepreneurs with cash are in the market to buy. That’s because, in most cases, businesses have some form of assets, real or otherwise, that will represent value to the right buyer.
Understanding the valuation process is important for sellers because it will allow you to understand the mindset of that optimal business buyer. It will also help you to maximize the value of the business by learning and applying what you need to do to prepare your unique business for sale.
Understanding business valuation is vital for buyers because it can help you determine if a seller is being fair and realistic in their asking price. And, if that’s not the case, this knowledge provides powerful leverage during negotiations. It also serves as a key means of identifying great buys and prioritizing potential purchases over time.
So, let’s dive into exactly what business valuation is, how it’s accomplished, and what you, as a prospective buyer or seller, should be doing to get the most out of this valuable skill.
What is business valuation?
Put simply, business valuation is a broad umbrella term that covers numerous methods buyers and sellers can use to place a dollar figure on the total quantifiable and unquantifiable value of a company. Since both tangible and intangible assets and liabilities are often included in the transaction, business valuation is far from a simple, straightforward equation. In fact, calculating figures is only a small part of the total process.
Many experts claim business valuation is more of an art than a science. What they mean is that valuation involves a lot of educated guesswork and creative thinking.
There is truly no right answer, because the same exact business could be worth half as much to one buyer as another. So, valuations are often presented as reasonably wide ranges with qualifying factors included. This provides the best negotiating tool for buyers and sellers alike, although in most cases, buyers and sellers will arrive at different overall ranges and may still need to settle outside of them.
This is a challenge known as “the valuation gap,” which is discussed in more detail in the next section.
Due to all the factors involved, and the highly unpredictable human side of the equation, business valuation is a specialized skill that smart business owners and buyers will outsource to experts with plenty of experience. These can include business brokers experienced attorneys, or accountants that specialize in business sales transactions.
To accommodate these varied factors, there are numerous models you can consider using to estimate the right price for a business. Some are more appropriate to particular sectors or company types, but there’s no “best” approach for any one business.
The Ultimate Guide to Business Valuation: Part 2
Unlike most tangible objects, such as a house or a car, determining the value of a business is complicated.
This is by the fact that there are no truly comparable sold properties to research in most cases.
The difference between two companies in the same industry, providing the same service, even with the same revenue, can still be so great that it’s almost a meaningless comparison.
Characteristics such as customer concentration, amount of revenue, geography, management strength, etc., are all big factors in determining a purchase price for a buyer.
This is being further exacerbated by the economic cycle.
In a downturn, for example, buyers are seeking to buy at the rock-bottom price because of the economy. And because of the overall economic situation, they perceive additional risk and seller desperation that would not likely come into the conversation in better economic times.
Sellers, on the other hand, may point to deals and valuations from prior to the downturn since it’s not viable for them to exit their business at the price the buyers are offering today.
This "valuation gap" is larger than ever, and it’s unlikely to be effectively narrowed because, as noted above, there’s no real standard for buying companies.
Both the buyer and the seller feel the other is being unrealistic, when it’s actually impossible to define what realistic is.
This seeming roadblock can be rectified, however, by a skilled business broker or other experienced intermediary. We’ll discuss more about how that generally works out in the next section.
10 Methods for Business Valuation
Because of the inherent complexity of the task at hand, there are probably far more than ten business valuation methods used throughout the world.
Experts may argue semantics or group two or more of the following methods under the same umbrella, but every generalized list of methods you can find is likely to include reference to all of the following:
One rule of thumb for valuation uses a simple formula to estimate the value of the business through pricing guidelines based on the industry it’s in.
For example, fast-food businesses could be historically valued based on 40% of their annual revenue, while motels may be based on a set price of $20,000 per room.
Certainly, this method gains instant points for simplicity, but a seller must keep in mind that — even within the same industry — each business has unique qualities which can raise or lower these set values.
Therefore, industry-based valuation of this nature is rarely used as anything more than a ballpark estimate or starting point early in the valuation process.
The exception may be a transaction with extremely tight time constraints or a very low price point, in which neither the buyer or the seller feels a more thorough valuation is worth the time, effort, or expense.
Comparable business-based valuation
With the availability to check out dozens upon dozens of businesses listed for sale online, owners can search for comparable businesses to base their valuation on.
This is a great source of free data on businesses that are currently for sale or have recently sold. Owners and buyers alike can look for comparable businesses, then assess what a given business is potentially worse.
If you’ve ever bought or sold a house, you’ll recognize this as the most common means of setting a reasonable price for residential real estate.
Buyers and sellers can use the sale price of other similar houses in the same neighborhood that were recently sold to reach a fair asking price.
But, like the industry-based valuation, this method does not work well in valuing a business.
Because of the natural differences between every company, it’s unlikely that even one truly comparable business can be found. Much less one with the same number of employees, same basic revenue, same market share, and in the same part of the country that’s been sold within the past month.
The asset-based approach is the most conservative of all valuation models.
It is appropriate for businesses such as property companies or manufacturers, where assets form a large percentage of the 'worth' of the business.
In the former case, buildings or development sites; in the latter case, expensive tools or machines.
This method gives you a rough idea of the minimum price you can expect to negotiate — a financial comfort blanket.
To use this method, you simply add up the value of your assets and subtract any liabilities. Using the figures in your accounts — the net book value — is a good starting point, but remember that financial advisors are obliged to be prudent; they must give the minimum the assets could be sold for.
You will need to adjust those figures to reflect changing circumstances and market value.
For example, have assets gone up in value? Or would they be difficult to dispose of, whatever the original cost? Has your accountant exaggerated the possibility of bad debts? In your calculation of liabilities, remember to include the company's obligations - for example, rent or redundancy payments.
"Because the market determines value, business intermediaries are the most qualified professionals to value your business. They have the most complete and current information on actual business sales and pricing formulas, and can therefore provide businesses with accurate market values."- Joann Lombardi, VR Business Broker President
Asset liquidation-based valuation
A variation of the asset-based method would be to determine the liquidation cost of the business.
In this method, the value of the business would be based on the estimated cost that any equipment, inventory, receivables etc., would fetch on the open market if sold immediately.
It is often applied to companies with considerable tangible assets, such as real estate properties, but this approach can be misleading if the book value of assets (like buildings and equipment) is inflated for some reason.
The problem can be addressed by adjusting the book value to factor in asset depreciation and maintenance or replacement expenses. Fluctuations in market price of real estate should also be considered.
Other variations to the formula include tangible or economic value.
Tangible book value is calculated as total assets minus soft assets (those less tangible assets described above.) Economic book value comprises both tangible and intangible assets and adjusts their values according to current market prices.
For a business on the brink of shutting down, this is likely the best of the simple valuation methods, since it clearly itemizes the minimum value the buyer is likely to receive if the company ceases to function following the sale.
It’s therefore a popular choice for business sales that take place in lieu of filing bankruptcy or another collapse.
Successful business owners may use this method when buying out failing competitors, with the value being the competitor’s existing stock, equipment, facilities, and/or customer list.
However, the asset liquidation method again falls short in circumstances where the company being sold is still a viable business, or can easily be made such through restructuring or investment.
That’s because much of the value in a business isn't included in the raw cost of the business assets. For example, an established customer base, goodwill, brand equity, and future growth potential.
Calculating entry cost gives you an idea of how much it would cost to start and build a business to the same size and with the same profits as the one being sold.
To do this, you have to work out how much it would cost to develop the products, recruit and train the workforce, and build up a customer base — all from scratch.
Other entry expenses include purchase or lease of the premises, facilities, research and development, branding and advertising.
As a seller, this method requires being brutally honest with yourself and putting yourself in the buyer's shoes: if the business was located elsewhere, or used different raw materials, would it have a lower entry cost?
While this itemized approach attaches a monetary value to hard assets, it fails to effectively account for the intangible components that the owner puts into establishing the business and nurturing its growth.
As a result, it tends to lean more heavily toward the buyer’s benefit, rather than being a highly equitable valuation method. It’s often used, therefore, when the seller is highly motivated and/or under a tight time constraint.
Discretionary income-based valuation
Another simple but effective way of valuing small businesses involves determining the current owner’s discretionary income.
This offers valuable insight into what a buyer can expect to earn on a monthly or yearly basis (assuming no substantial changes are made to the company’s current situation), what their ROI is likely to be and how long it will take to realize that return.
To determine discretionary income, take the amount the owner has declared on their income tax, add in any discretionary expenses such as automobile expenses, travel expenses, salaries, interest costs for business loans and depreciation.
Then, add those discretionary expenses back into the owner’s declared income and multiply the result by 1.5 to 2.5 to come up with the final value for the business.
The multiplier provides a significant range in which to negotiate the final price based on intangible items that the equation does not factor in, as described in previous methods.
This valuation method’s greatest limitation is its assumption that the business will continue to operate unchanged after changing ownership.
This assumption depends largely on how the company is currently set up and run.
If the current owner plays in integral role in daily operations (rather than a more distant oversight role), a prospective buyer will need to very careful to determine if he or she can fill that same role in the same way. If not, the discretionary income method of valuation is likely to be misleading.
Price/earnings ratio valuation
The price/earnings (P/E) ratio is one of the most common business valuation methods, and tends to be a go-to strategy for professionals.
It's the most common way analysts compare the values of companies quoted on the stock exchange, so sellers and buyers can both place confidence in its validity.
A value is determined using this method by dividing the market value per share by the post-tax earnings per share.
So if the value of a single share on the stock market is $1.00 and the post-tax earnings per share are $.05, then the price/earnings ratio is 20. This means then that the business will be valued at $.20 for each $.01 of current earnings.
The higher the ratio, the higher the value you place on the business.
You could look at financial newspapers to gauge historic price/earnings ratios for companies in your sector, and adjust them accordingly — the P/E ratio for a small private company is around half of that of a listed company in the same sector.
It is very difficult to get figures for comparison for other privately owned enterprises, as the details of the actual deal will remain confidential, with speculation in the trade press or clauses tying in the vendor often inflating the real figure.
It's not always appropriate for smaller, unlisted businesses as it can only really represent the value of established companies with a history of steady profit.
A small unquoted business is usually valued at between five and 10 times its annual profit, depending on its history, potential and other market factors; a large, growing quoted company with good prospects can have a P/E ratio of over 20.
Regardless of the size or age of the business, however, it should be possible to get at least a rough range for the P/E ratio, making it a solid choice for most circumstances.
Discounted cash flow
Discounted cash flow valuation is among the more complex methods available, as it focuses heavily on the intangible side of a company’s value.
It’s appropriate for companies that have growth potential but lack hard assets and a financial track record.
The most common modern day example is the Web-based startup. The method deducts intangible criteria from projected cash flows or NPV (net present value).
Forecasting cash flow is not an easy task, and it’s really far more art than science.
The gamble works both ways, and sometimes, actual cash flow ends up being far greater than forecast, which is how billionaires are made in the 21st century.
Clearly, the discounted cash flow method of business valuation is not one a DIY entrepreneur or investor should focus on. For the best chance at winning this bet, you should be relying on the professionals.
To calculate the discounted cash flow, establish the estimated profits for a given time period in the future. You then adjust this figure to take account of the diminishing value of money over time.
How much would you have to leave in an account, at current bank interest rates, to produce those profits over that period of time?
This will give you a 'base figure' for how much a person might be prepared to pay - but any company will be riskier than investing in a savings account.
So replace the bank interest rate with a higher figure reflecting that greater risk (which will produce a lower initial sum).
To help clarify, here’s an example using simple, round figures:
A company makes a profit of $10k annually, which is forecast to remain steady for the next 10 years.
Let’s assume our potential buyer wants to achieve a 10% rate of return.
$10k received in five years time is not worth the same as $10k received today — because if I received that $10k today I could put it in a bank (where let us assume there is a 5% interest rate) and in five years time it would be worth $12,763.
Working backwards, $10k received in five years' time is actually worth $7,835 today, whereas $10k in 10 years' time is actually worth $6,139 today.
Adding all these figures together will give the buyer an idea of how much they should pay now to receive the returns from the business in the future.
Multiplier valuation by sales
The above valuation applies the multiplier method to estimate how much a business is worth.
Average sales figures in a particular industry may be used to arrive at a standard multiplier factor. Trade or financial publications, industry associations and business brokers can usually provide current multiples used per industry.
The basic formula is a company's gross sales times the multiplier; for example, $50,000 gross sales x 0.25 multiplier = $12,500 value of the business.
The formula may be modified by adding other components to the equation. For a retail business, the value of its inventory is added to gross sales before multiplying it by the industry multiple.
These adjustments require experience and current knowledge if they’re going to effectively reflect the real value of the assets in question.
For instance, the stock of a retail store may be overpriced at the moment, as in the case of fashion merchandise whose value declines at the end of the season. In this case, the timing of the sale has a huge bearing on the valuation.
The validity of the industry standard multiplier is questionable because this basis alone does not give the complete financial picture.
Companies across an industry vary by size, scope of operations, production output, market share or brand value. Moreover, a host of other differentiating factors, such as cash flow and profitability, are not taken into account.
Multiplier valuation by profits
Alternatively, the multiplier number may be based on a company's profits. The price to earnings ratio can range from five to 10 times the after-tax profit.
Small businesses will fall into the lower range, while enterprises with better prospects will be assigned a higher multiple.
Business income valuation seems straightforward and easy to understand, since it uses recent profitability numbers as the benchmark. However, the reported return on investment may not reflect an accurate financial status or looming external threats.
For example, earnings can be overstated by deliberately pending a necessary capital investment.
The actual profit margin may not be as high as claimed if the owner has drawn a salary for managing the business. A rival business may set up shop in town, lure customers away and take a big bite of the profit pie.
The Ultimate Guide to Business Valuation: Part 3
After reviewing all of the different methods of business valuation, you’ve likely picked out some things you can do to improve the value of your own business before putting it up for sale
How to boost the value of your business
By reviewing all these different methods of business valuation, you’ve likely picked out some things you can do to improve the value of your own business before putting it up for sale.
Likewise, if you’re considering buying a business, you can probably identify some fairly inexpensive improvements you could make to the company you’re investigating in order to improve the return on your investment and/or negotiate a better deal.
Here’s some pro tips that can help you accomplish this:
Stay with the company
If you or your colleagues are clearly a key ingredient of the company's success, buyers may well offer a higher price if you are prepared to commit to staying on as an employee or consultant for a fixed period of time.
This reduces disruption and smooths the transition to new owners. Alternately, buyers may offer to pay a second sum at the end of that period, but this is a risky route if they already own companies that are not entirely solvent.
Whatever the sector, buyers tend to regard bigger businesses as more secure.
Larger organizations are perceived as having greater resources with which to weather any unforeseen economic storms. Buyers will pay more for such reliability.
If you’re planning to sell, look at the current situation and see if it may be possible (and profitable) to merge with or acquire one or more companies before putting the business on the market.
Patents, trademarks, and copyrights
Businesses can have other advantages that will increase the security of their profits.
For example, a business might have intellectual property rights over a particular manufacturing process, recipe or marketing logo.
Just consider if the famous Coca-Cola Co. went up for sale.
Without a doubt, its value on the market would be far more than the combined value of all their physical assets because the secret recipe of their iconic soft drink and the unequaled brand recognition they’ve created are worth more than all their factories and bottling plants combined.
Different buyer types
Finally, the value of a business will also depend on the nature of the buyer.
Buyers will generally fall into two categories: financial and strategic.
A financial buyer, such as a venture capitalist, will typically look at your business in isolation, analyze the viability of its profits, and examine whether he could increase them streamlining the company.
A strategic buyer, on the other hand, will likely be in the same or a related sector: a direct competitor, a supplier or vendor, or the owner of a tangentially related business.
Combining your business with theirs, might enable them to cut costs in a way not possible for the financial buyer.
They could centralize the sales and marketing function, for example. This type of buyer is also likely to have a greater understanding of — and faith in — the sector, and consequently, your business model.
While strategic buyers tend to be able to offer higher sums, they are necessarily few and far between.
Approaches from competitors can also be dangerous. Do you really want to divulge the mechanics of your business to a potential buyer, only for them to abort the sale and remain a competitor?
In that instance they would be equipped with knowledge of your weak points, which they could then exploit. And also, your strengths which they could then replicate.
Clearly, the best option for a motivated business owner looking to sell their business is to get professional help arriving at a reasonable valuation.
Business valuation pros will be able to look at the big picture of each unique company’s situation to determine which valuation method is going to be the most effective to carry out.
One of the great advantages of knowing about valuation techniques is that it allows you to see what steps you can take to increase the value of your business.
Here are four areas to consider once you have a legitimate valuation in your hand.
With the right actions and investments, you can likely boost the value of your company in preparation for putting it on the market.
Financial factors are likely to be key to the value of your business.
They include your past, current and projected profits and cash flow, and whether or not there is need to capital investment in the business in the future.
Tip: Review all your current holdings, including equipment, supplies, facilities, licenses, and anything else you can reasonably predict, then ask yourself whether you will need to upgrade or replace them anytime.
If so, would it boost your valuation to do so prior to trying to sell?
2. Intangible factors
These are harder to measure than concrete factors, but they’re still capable of influencing your profitability.
For example, do you hold key patents that can prevent competition? Do you have a key process or methodology that’s able to be trademarked?
Tip: Ask yourself tough questions and concentrate on improving the answers before selling.
Some examples are: How strong are my customer relationships? Is my company’s unique selling proposition obvious to an outsider? Can I rely on my staff to run things flawlessly without me here?
3. Assets and liabilities
Obviously, your company’s assets and liabilities play a huge role in determining its value. Anything you can do to increase the value of your assets and/or lessen your liabilities can have a positive impact on business value.
Tip: Focus on debt reduction prior to putting your company on the market. Undertake “low hanging fruit” investments to boost the value of your assets as well, such as inexpensive facility repairs and upgrades, renew equipment warranties or service contracts, software upgrades, and the like.
The people your business employs (especially their achievements and experience) are important to the value of your business.
This includes your contribution - you should make clear to potential buyers whether the business depends on you, and if it will require your input in future.
Tip: In most cases, it’s best for the seller to arrange affairs to ensure you are not integral to the running of the business.
Psychologically, this makes it far easier for prospective buyers to envision themselves successfully filling your shoes. However, the business value can increase even more if you’re willing to stay on in a consultative role through an initial transition period (unsalaried, of course).
5. The Market
Finally, no matter how well your business is doing, the state of the wider market will affect its value and how likely it is to sell.
If there are a lot of similar businesses for sale at the same time, this could negatively impact your business value. Likewise, if there is high demand from potential purchasers, your business could be worth a lot more. Market factors include the state of the economy, inflation and interest rates.
Tip: If you’re not being forced to sell due to circumstances outside your control and have the luxury of choosing when you put your company up for sale, spend at least two years investigating the market with your sale in mind.
Discuss the situation with local professionals who can advise you. Then, pull the trigger when market conditions appear optimal.
After reading this in-depth guide to business valuation, you’re in an excellent position to determine a realistic value for the company you currently own or you’re currently interested in purchasing.
Be sure to rely on valuation professionals to help you, especially when handling the more complex valuation methods.
The due diligence process when selling your business
Mutual trust established during negotiations can easily collapse when the buyer begins trawling your accounts, speaking to customers and auditing employees. Here’s how to navigate due diligence safely.
A thorough buyer will conduct due diligence to confirm information presented in the initial sales pitch and identify any red flags.
Being prepared for questions a buyer might have, and having all supporting documentation ready, will greatly aid the process.
Just put yourself in the buyer’s shoes and be prepared to answer the questions you would want answered.
What to expect during due diligence
An investigation into business history and trends
The purchaser will want to look at sales targets, profit margins, overheads and working capital to see if there is consistency in the numbers and if any areas can be improved.
If there have been irregularities – perhaps there was a downturn in numbers for a short period – a purchaser will ask for explanations.
Talking to customers
The best way for a buyer to rate products and services is to talk to current customers.
How long have they been a customer? Do they use the competition and, if so, why?
The buyer will also assess your relationship with customers, the impact a change in ownership may have, and gauge how much they want you to help post-sale for a smooth transition.
Talking to suppliers
Similar to the customer conversation, due diligence will also uncover outstanding debts, how the business is perceived by its suppliers, how it compares to any competitors with whom they have a supplier relationship, and if a change of ownership would impact on supplier agreements.
Investigating and comparing financials
Due diligence allows a potential buyer to check that sales forecasts and projections are realistic.
Any customer and supplier comments could be tallied against information supplied by the business itself and any industry benchmarks available. Are the pictures being painted similar?
Balance sheets will be compared, and the buyer may request a comprehensive audit and assess whether any outstanding debts are manageable.
Talking to and auditing employees
A buyer will audit employees against any industry pay agreements – are they above award rate? They will also check employee turnover against industry norms.
Employees may be asked if they will stay or leave following a change of ownership. A buyer will also want to know which employees can help them most in effecting a seamless transition.
Smoothing out the due diligence process
Due diligence pays off, with angel investors reporting that those who invested 20 hours or more in due diligence were five times more likely to get a return. So it’s worth taking a few steps to pre-empt due diligence in order to achieve the best sale negotiation.
So it’s worth taking a few steps to pre-empt due diligence in order to achieve the best sale negotiation.
Set up a digital due diligence folder
Create a digital folder – using a cloud storage provider like Dropbox or Google Drive – containing documents related to your company and requests made in the due diligence process.
You can then share this folder in response to a due diligence request.
This online repository of information allows you to define information flow in advance rather than prepare each piece on demand. It also makes you look professional to your prospective buyer, helping to solidify their initial interest.
And preparing ahead of time forces you take a hard look at the inner workings of your business before you sell, and gives you time to make any necessary adjustments.
Typical things requested from sellers as part of a due diligence checklist:
- Organizational charts
- Past financials and projections
- Management reports
- Stockholder communications
- Customer and supplier agreements
- Credit agreements and loan obligations
- Partnership or joint venture agreements
- Articles of incorporation
- Shareholder arrangements
- IP-related agreements
- Government authorizations
And preparing ahead of time forces you take a hard look at the inner workings of your business before you sell and gives you time to make any necessary adjustments.
Other useful, customized documents you can include:
- Customer acquisition channels
- Case studies of key customers
- A list of customers in your sales pipeline
- A spreadsheet with your company’s key metrics: your revenue, users, growth rates, customer acquisition cost, lifetime value, etc.
- A financial plan for the next three years
Other useful, customized documents you may wish to include:
- Customer acquisition channels
- Case studies of key customers
- A list of customers in your sales pipeline
- A spreadsheet with your company’s key metrics: your revenue, users, growth rates, customer acquisition cost, lifetime value, etc.
- A financial plan for the next three years
It may appear overwhelming but being prepared saves you time and gives you a better chance of sales success.
If due diligence proceeds without a hitch, then you can finalize the sale with the help of a solicitor with expertise in business sales.
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Negotiating the Sale
Negotiating the price gap between buyers and sellers
Sellers generally desire all-cash transactions; but partial seller financing is necessary in typical middle market company transactions.
Sellers who demand all-cash deals typically receive a lower purchase price than they would have if the deal were structured differently.
Although buyers may be able to pay all-cash at closing, they often want to structure a deal where the seller has left some portion of the price on the table, either in the form of a note or an earnout.
Deferring some of the owner's remuneration from the transaction will provide leverage in the event that the owner has misrepresented the business.
An earnout is a mechanism to provide payment based on future performance. Acquirers like to suggest that, if the business is as it is represented, there should be no problem with this type of payout.
The owner's retort is that he or she knows the business is sound under his or her management but does not know whether the buyer will be as successful in operating the business.
The owner has taken the business risk while owning the business; why would they continue to be at risk with someone else at the helm? There are circumstances in which an earnout can be quite useful in recognizing full value.
For example, suppose that a company had spent three years and vast sums developing a new product and had just launched the product at the time of a sale.
A certain value could be arrived at for the current business. An earnout could be structured to compensate the owner for the effort and expense of developing the new product if and when the sales of the new product materialize. Under this scenario everyone wins.
The terms of the deal are extremely important to both parties involved in the transaction. Many times, the buyers, sellers, and their advisors, are in agreement with all the terms of the transaction, except for the price.
Although the variance on price may seem to be a ‘deal killer’, the price gap can often be resolved so that both parties can move forward to complete the transaction.
Listed below are some suggestions on how to bridge the price gap:
If the real estate was originally included in the deal, the seller may choose to rent the premises to the acquirer rather than sell it outright.
This will decrease the price of the transaction by the value of the real estate. The buyer might also choose to pay a higher rent in order to decrease the "goodwill" portion of the sale.
The seller may choose to retain title to certain machinery and equipment and lease it back to the buyer.
Option to buy
The purchaser can acquire less than 100% of the company initially and have the option to buy the remaining interest in the future.
For example, a buyer could purchase 70% of the seller's stock with an option to acquire an additional 10% a year for three years based on a predetermined formula.
The seller will enjoy 30% of the profits plus a multiple of the earnings at the end of the period. The buyer will be able to complete the transaction in a two-step process, making the purchase easier to accomplish.
The seller may also have a ‘put’ which will force the buyer to purchase the remaining 30% at some future date.
A subsidiary can be created for the fastest growing portion of the business being acquired.
The buyer and seller can then share 50/50 in the part of the business that was spun-off until the original transaction is paid off.
A royalty can be structured based on revenue, gross margins, EBIT, or EBITDA. This is usually easier to structure than an earnout.
Certain assets, such as automobiles or non-business-related real estate, can be carved out of the sale to reduce the actual purchase price.
Although the above suggestions will not solve all of the pricing gap problems, they may lead the participants in the necessary direction to resolve them.
The ability to structure successful transactions that satisfy both buyer and seller requires an immense amount of time, skill, experience and most of all - imagination.
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Using a Broker
Should you sell on your own or use a broker?
If you’re planning to sell your business, who should sell it? You, a broker or an associate? How do you make that call?
The first question business owners interested in selling often ask is: "How much is my business worth?" Their next question may well be: "Can I sell it myself or should I use a broker?"
That depends on the circumstances. Whether an owner sells the business themselves or employs professional assistance, they will be engaged at some level in the process.
Owners selling businesses with revenues from $500,000 to $25 million generally choose from among these four options to sell their businesses:
1. For sale by owner
If the owner has sold a business in the past, is comfortable making the initial approaches, will not allow selling the business to distract them from running the business, and can achieve their desired outcome, then going it alone may be an acceptable approach.
If the business's appeal is limited only to buyer candidates known by the owner (e.g. a few competitors, financial firms, etc.), then the owner may want to consider selling it themselves. In such cases the owner may make the initial approach, negotiate terms, and use the company's accountant and attorney to draft financial and legal documents.
However, even an owner who knows potential buyers may be reluctant to pick up the phone and tell a competitor that he is thinking of selling. He also may want buyers to compete for his business.
2. Current service providers
Occasionally an owner's current service provider (e.g. accountant or attorney) knows a potential buyer.
In such a case the owner or service provider may take the lead in contacting the buyer, managing due diligence, negotiating, and preparing financial and legal documents.
In these first two options the business owner will need to consider whether or not they can keep the process confidential from employees, clients and competitors and whether they have the free time available to execute the tasks involved in closing the transaction.
If the owner plans to stay with the buyer, then it may be difficult to engage in the tough, sometimes adversarial negotiations required to sell the business and then show up for work as a friendly member of the buyer's team.
3. Local or speciality broker
Local or specialty brokers can bring substantial value to a business for sale, if they are already involved in the industry and have sold similar companies.
These brokers market the business for sale to their data bases of pre-qualified buyers.
They take the lead in executing the many tasks in the process to sell a business and seldom "co-broker" which does limit their marketing to only those buyers that they can identify.
4. Nationally networked brokers
Owners should check out business brokers as carefully as they do the other professionals they hire.
Business owners who interview business brokers will learn that there is a vast range in the capabilities and qualities of brokers.
Good brokers bring a combination of assets to the process, including knowledge of the marketplace, data bases of pre-qualified buyers, proven track records, sources of buyer financing, and relationships with other professionals who can help secure the sale.
The bottom line is, circumstances are different with every business for sale. Owners are best served by considering how much time they can commit to lead the process and their experience level at selling a business, then choosing the option that delivers the most advantageous outcome for their circumstances.
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