Want to Sell Your Business? Start Early and Consider these Five Steps.

Businesses of course are in business to make profits and when it comes time to sell, owners want the best price possible.  I discuss here five typical steps  in preparing for a sale and positioning for best valuation. The following concerns small businesses – a closely-held business – not publicly owned. It is best to prepare for a sale well in advance, depending on the size of the company and complexity of the business. While most require two or three months or more to two years of work in advance, I have completed a sale to family members in a month for a family owned firm. I discuss below: 1) how to maximize the sales price that a buyer will pay, 2) preparing for buyer’s due diligence well in advance so important items are in order for the buyer, 3) key employment and other documents and policies, 4) marketing, business brokers and negotiating, 5) four common forms of sale, letters of intent v. “IOIs” and sale agreements.  Future posts will cover related matters: such as details of valuation methods and sales agreements. Potential buyers will benefit from review of the following which mirror buyer’s considerations.

 

 SIX IMPORTANT STEPS TO PREPARE FOR THE SALE OF YOUR BUSINESS
 
These steps that I recommend are small business best practices that makes sense for every small business to institute, given the necessary resources and time.  Keep in mind that a buyer will review all parts of the business, “due diligence,” to determine if a purchase makes sense and determine how much to offer. If your company has family involved in the business who are to buy, the process of sale can be simpler. Your company should engage a small business attorney to help with sale preparation, among the following:

 

1.)   Getting the Most for Your Business – Making your business as profitable as possible in the three to five (3-5) years before the sale. The valuation of your business is key. The buyer will want to examine tax returns and financial records to determine profitability and to see a trend or at least a stable financial picture and with potential for growth. There are special cases – when profitability is not key – ownership of a book of business or patents, etc. that the buyer can build upon. Some buyers, often larger companies, can add potential growth through cost saving “synergies,” e.g. using their sales force or excess production capacity, etc. You should work with your CPA to determine what you can do to improve your bottom line.  To maximize and get a credible valuation, selling your business may involve working with a certified business valuation expert. Your accountant may be able to determine your business valuation, but without a professional valuation, in many instances, you may not be able to present your company’s highest value. You prepare your financial statements and tax returns for tax (and other) purposes, not to show the value of your business – often quite the opposite since tax reduction is a goal. Un-adjusted financial statements and assumptions and rules of thumb valuations can miss the projected future earnings part of a business valuation.  A valid professional appraisal may help buyers see not only past income and expenses, but also the potential value. Appraisal experts have the tools and methods for business valuations, most commonly one or more of the following:
  1. Comparable Company Analysis,
  2. Discounted Cash Flow Analysis
  3. Precedent Transaction Analysis
If costs of such a professional appraisal are not affordable, there are rules of thumb, multipliers of  revenues or some form of earnings or cash flow. These valuation methods have a multiplier number based on comparable businesses in the same industry.

 

Of course, the seller can go too far in different ways and lose credibility, so have your accountant review and validate any business valuation and financial data to help preserve confidence in all aspects of the sale process. There are potential costs in failing to reveal some material matter, e.g. a pending claim or other material fact or trend that does not look good. The consequences may be a lawsuit based upon breach of contract and / or fraud.  If misrepresentations are egregious enough, one may expect being sued on claims under the business to business part of the state’s Consumer Protection Act Ch. 93A §11. It provides penalties of  up to double to triple damages and the other side’s attorney’s fees.  Remember that any valuation is a tool; the highest value of a business is what a willing and able buyer will pay. Valuation methods or reports provide a starting point for negotiations.

 

2.)  Prepare for a Buyer’s Due Diligence – The Review of all Aspects of the Business.  Keep up to date your company records and do all proper filings at the Local, State and Federal level. The risk of problems impact value or saleability; have legal requirements been met?  If you are already incorporated or are a limited liability company, keep or update annual reports with the Secretary of State and minutes showing votes of shareholders, directors, and members.  If you do business in other states, complete registration as a “foreign” business doing business in that state(s) – if you contemplate needing to sue in that other state on a contract or to collect unpaid receivables.  If you have not done so, set up your business as a separate entity such as a Sub S corporation or  limited liability company both for protection of your personal assets from a lawsuit and for protection of any buyer. Buyers of course are usually unwilling to purchase liabilities and want asset sale agreements backed up by seller’s warranties and representations in the Sale Agreement.  These provisions are even more important with stock sales where all is sold. Keep up your company filings at the Local, State and Federal level.

 

3.)   Put in Place Key Documents and Policies; Non-Disclosure Agreements (NDAs) for Key Employees and for Potential Buyers. It is often wise to have a review of your contracts or other forms, including warranty language and provisions for what happens if there is a breach of the provisions and / or non-payment. For key employees, these include having NDAs with non-compete and non-employee raiding language, intellectual property protection, including a trade secret program, in place for employees, maybe vendors and customers and certainly potential buyers. Consider a NDA for anyone with access to your company’s confidential information such as customer lists. Through NDAs, buyers can be prevented from using confidential information learned in the sale process if the deal falls through. Then you do not want a buyer having learned your private, valuable information such as trade secrets, taking your business. A buyer also wants to see NDAs signed by key employees. Sometimes line workers should sign them if they have knowledge  of confidential matters or access to trade secrets that you do not want to share.  These documents / policies should include:

 

      a) lawful, nondiscriminatory advertising for jobs and a job application that meets evolving state and   federal standards, a valid interview process, knowing the questions that you cannot ask, (for Massachusetts and some federal hiring rules, see  https://www.mass.gov/service-details/massachusetts-law-about-hiring-employees.)
     b) confidentiality agreements, covering matters referenced above. While similar, those for buyers and employees, have different purposes and protections.

 

     c) employee policies and handbooks (without these, your business faces potentially large losses from discrimination claims – lacking “affirmative defenses”)

 

4.)   Marketing, Business Brokers, Finding and Qualifying Buyers, Negotiations. The above practices will help you present and market your company in the best light.  Preparing well for a due diligence review and sprucing up your business and practices can contribute to a higher offer from buyers. Consider using a business broker if you are willing to pay a commission. Business brokers have the tools, website and established reputation to help in marketing and finding the likely buyers. Most buyers are a) other firms in the same and / or closely related businesses or b) groups of investors. While some owners want to do their own negotiating, it is best to have a professional like your attorney or a business broker well versed in negotiating and the art of advocacy. It is hard for an owner to be his or her own advocate and anxiety to sell may come through. An experienced, creative attorney has methods to be sure that the negotiations work toward achieving  clients’ goals and involving and obtaining authorization from the seller at each stage of the give and take. Such professionals on each side take the emotion out of the process and have a common goal to get a deal for their clients acceptable to both.

 

5)  Four Common Forms of Sale, Letters of Intent or IOI, and Sale Agreements.  Most sales are one of the following a) asset sales, b) stock sales, c) sometimes mergers of seller into buyer, and  4) Angel or Venture Funding investing agreements for purchase of part interests in a promising business.  The last expect to purchase preferred stock in C corporation which may have more than one class of stock.  S Corporations are required to have only one class of stock.  I have handled all four types of sales. Asset sales are very common – buyers do not want to buy the stock or other interests in the business since it will include everything, including any liabilities.  Other times buyers want a stock sale if the transfer of property is very complicated, e.g. needs innumerable  contract assignments and title searches, etc. Stock sales may be less costly and preferable for the seller and for transfers of interest among family members. While many terms of asset and stock sale agreements are similar, stock sales can be easier to accomplish. Sale agreements spell out what is being sold –  tangible and intangible properties, including “intellectual property”  –  patents, trademarks, copyrights and trade secrets. Tax issues – different treatment for different kinds of property sold makes necessary  negotiations over allocation of  the purchase price as buyer and seller have different interests. Sometimes sellers want a letter of intent – usually non-binding and not including price. Other times buyers submit an IOI – Indication of Interest – spelling out certain terms, including a price range and the structure of the sale, payment terms etc.  Many times the parties think it is most efficient to go right to negotiating the sale agreement.

 

If you have any questions or want a consult, feel free to call to set up a time to talk