We are often asked when is the best time for our clients to begin preparing their business for sale. Frankly, I don’t think it’s ever too early. Ideally, an owner starts preparing for the process between 1-3 years before the actual sale starts to take shape. The sooner the planning starts, generally the higher the purchase price and the more organized the transition from the buyer to the seller will be. This post doesn’t attempt to describe all of the steps that should be taken to get a business ready for sale, but we’ll go through some of the key areas that should be considered. Please check out some of our prior posts on mergers and acquisitions.
1. What Price do You Want, What Price Do You Need
The price a business owner wants and the price a business owner needs are not always the same thing. Keep in mind, the purchase price is going to probably form the foundation of the owner’s retirement. It could also be seed money for another venture. It’s important for business owners to think hard about the value they want to get out of their business when they sell it. Next, it’s time to get a professional evaluation. Getting a business valuation can serve a number of functions. First, it can validate the price that’s being asked and can be used as a negotiating point with potential buyers. If the valuation comes in under what the owner needs, then it can serve as a basis for defining where the business needs to improve in order to maximize its value. For the seller it’s critical to know what the business is actually worth.
2. Assemble Your Team of Advisors
It’s very likely that this will be the single biggest and most complicated transaction that the company has ever entered into. You are going to need: legal, tax, and financial advisors at a minimum. You may need additional, more specialized, team members down the road. You need to assemble a team of advisors that you trust and who can work together. Their involvement and ability to work together efficiently will be critical to getting the deal done, maximizing your value, and reducing your liability. If you can avoid using a business broker, do so. They’re extremely expensive, often asking for 10% of the total purchase price and many provide very few unique services other than finding potential buyers. Business broker’s aren’t generally regulated or licensed. Unless you absolutely need one to find potential buyers, you will get more sophisticated advice from specific advisors (tax, legal, business valuation, etc.) at a fraction of the price. Start putting the team together early and assigning roles and responsibilities.
3. Indentify Potential Buyers.
This can be as specific as actually identifying potential buyers who may be interested in acquiring your business. Generally speaking though, it’s worthwhile to determine the types of buyers that might be interested in buying the business. There are two types of buyers, financial buyers and strategic buyers. Financial buyers are interested in buying your business for the revenues/profits that it generates. Financial buyers are usually going to come up with a purchase price based on an EBITA multiplier. Strategic buyers (often competitors), are interested in buying your business because it offers them a competitive advantage or operational efficiency for their existing business. Strategic buyers may be willing to pay a higher multiplier and may factor in increases in their own business’s profits when calculating their purchase price.
4. Review and Organize the Company’s Corporate Documents.
A detailed review of the company’s corporate records and documents should be done. Catch-up minutes should be prepared. Missing stock certificates remedied. Missing or late filings with state and local authorities need to be remedied. Foreign entity registrations, trade name and trademark registrations should be current. A tax review should be undertaken to make sure there aren’t any significant, unexpected, tax implications to the business’s sale.
5. Determine the After-Tax Take Away From a Stock Or Asset Sale
There are generally two ways to sell a business, a stock sale (or membership interest sale in the case of an LLC) or an asset sale. Have an accountant crunch the numbers from the purchase price valuation figures and determine what the actual, after tax, take home amount will be from both structures. These figures will help guide the decision regarding the type of transaction (asset or stock sale), that will take place and may also significantly impact the type of buyer who will be willing to acquire the business. Most buyers will want an asset sale. It allows them to purchase the business’s assets, take the ‘step up’ in the basis of the assets, and recognize the benefit of depreciating them. They also avoid having to assume liability for the company’s past operations. Stock sales allow the seller to realize the purchase price at cap gain. Also, it makes the transition between the buyer and the seller smoother. However, there are far fewer tax advantages for the buyer. Depending on the seller and buyer’s corporate structures an 338(h)(10) exchange might be a viable alternative. This is a best of both worlds situation which allows the seller to sell the stock for legal purposes and the buyer to acquire the assets for tax purposes. There are very specific tax and legal elements that must be met to qualify for a 338(h)(10) exchange. These should be explored early in the process with legal and tax advisors.
6. Perform Due Diligence
Start performing due diligence on your own company now. Take a look at the contracts that the company has with key suppliers, key customers, and key employees. Are there any? If not, get things formalized. Review pending legal issues, non-compliance, late filings, insurance claims, etc. Is the company in the midst of any lawsuits? Does the company plan on filing any lawsuits? Is the company owed money? Does the company owe money? Put yourself in a potential buyer’s shoes and start addressing issues of concern with your legal counsel.
7. Get Initial Documents Ready
Start identifying general terms that need to be included in a purchase agreement. This could be a purchase price range, the type of transaction, earn-out terms, consulting agreements, etc. Identify the key terms and conditions that will need to be included in a buyer’s initial letter of intent (often a heavily negotiated document). Also, prepare a confidentiality agreement that will be presented to all potential buyers prior to sharing any information with them. The information that will be shared with potential buyers is extremely sensitive, and many potential buyers do not have the best of intentions. A solid non-disclosure agreement is critical. It’s your information, it’s your form. Get it ready to go early.
8. Company Real Estate
Does the company own real estate? Do the company owners own real estate used by the company? Decisions need to be made regarding how that real estate will be treated after the sale of the company. Are you going to sell it? Do you want to sell it to the buyer of the business or list it on the open market? If so, valuations should be made. Are you going to lease it to the new buyer? Discussions should be made regarding key lease terms and tax implications/benefits.
9. Personal Financial Advisor
Get your personal financial advisor involved early. If you don’t have one, now is the time to look for one. Once the deal closes, you will need to come up with sound, creative ways to manage the money you’ve earned selling your business. Thinking long term about retirement, health care, inheritance, and general quality of life issues is ultimately what the deal is all about. You need to make sure that once your business is sold, you have enough money to live the life you’ve been working so hard towards.
(Mallon Lonnquist Morris & Watrous, LLC, is a business, employment, real estate, and litigation law firm. Craig T. Watrous is a Colorado M&A attorney and partner at MLMW, based in Denver, Colorado. Craig regularly represents clients on both sides of business purchase transactions. Craig can be reached at email@example.com and (303) 722-2165.)