KEY GUIDELINES IN SELLING A BUSINESS (PART 1)
Many business owners eventually decide to sell their companies, though the reasons for such divestment vary widely from individual to individual. Some owners may simply wish to retire, while others are impatient to investigate new challenges – whether in business or some other area – or tired of the frustrations of the business in which they find themselves. Others decide to sell for reasons more closely associated with the health of the business itself; dispute with partners; incapacitation or death of principals; or downturns in the company’s financial performance can all spur business owners to ponder putting their business on the block. Whatever their ultimate reason for selling, though, business owners can get the most out of their company by carefully considering a number of factors.
TIMING THE SALE OF A BUSINESS
External economic forces, together with internal financial performance, will determine when you should put your company on the market so as to achieve the maximum results. If the timing isn’t right, it will take much longer to sell the business, and the price you negotiate will invariably be less than what you should get.
The financial performance and history of the company in question is often the most important factor in determining price at the time of sale. A business owner who chooses to sell after posting several years of steady growth will naturally command a higher price than will the business owner who decides to sell only a year or two into that growth trend, even if the environment continues to appear friendly to the business for the foreseeable future.
The business environment in which the company operates is also an important factor in determining the asking price that the market will bear. If the company in question operates in an industry that is suffering through a downturn, the owner should delay selling the business if at all possible. Few companies are able to buck up the tide when the industry in which they operate is stuck in a sluggish cycle, and even attractive businesses will not shine as brightly during such periods.
For most business owners looking to sell their company, it is usually wise to ride out the trough and put the company up for sale after the industry enters a more robust cycle. Of course, some industries never post a recovery; business owners engaged in underperforming industries need to determine whether the downturns they experience are simply an inevitable part of the business cycle within a basically healthy industry, or whether changes in the marketplace are fundamentally altering the strength of the industry.
The stock market is a third factor that should be analyzed when pondering whether to put up a company for sale. Stock market averages and trends reflect not only the current health of the national economy, but the projected conditions for the near future. Major corporate decisions for capital appropriations, expansion or contraction moves, and new product and service introductions are strongly influenced by the perceived wellbeing of the economy. In turn, the magnitude of these corporate decisions affects investor confidence in the stock market. The price an entrepreneur can get for his company will be heavily influenced by public investor attitudes.
Stock Sales and Asset Sales
Another decision that some business owners need to make early in the selling process is whether to hand over the company through a stock sale or an asset sale. If a business has been incorporated, the owner has the option of making a stock sale or an asset sale. Under the terms of a stock sale, the seller receives an agreed -upon price for his or her shares in the company, and after ownership of those stocks has been transferred, the buyers steps in and operates the still-running business.
Typically, such a purchase means that the buyer receives not only all company assets, but all company liabilities as well. This arrangement is often appealing to the seller because of its tax advantages. The sale of stock qualifies as a capital gain, and it enables the seller to avoid double taxation, since sale proceeds flow directly to the seller without passing through the corporation. In addition, a stock sale frees the seller from any future legal action that might be leveled against the company. Lawsuits and claims against the company become the sole responsibility of the new stockowner(s).
Partnerships and sole proprietorships, meanwhile, must change hands via asset sale arrangements, since stocks are not a part of the picture. Under asset sale agreements, the seller hands over business equipment, inventory, trademarks, and patents, trade name, “goodwill,” and other assets for an agreed-upon price. The seller then uses the money to pay of any debts; the remainder is his or her profit. Changes in ownership accomplished through asset transactions are generally favored by buyers for two reasons. First, the transaction sometimes allows the buyer to claim larger depreciation deductions on his or her taxes. Second, an asset sale provides the buyer with greater protection from unknown or undisclosed liabilities – such as lawsuits or problems with income taxes or payroll withholding taxes – incurred by the previous owner.
PREPARING TO SELL
When preparing to sell a business, owners need to gather a wide variety of information for potential buyers to review. Financial, legal, marketing, and operations information all need to be prepared for examination.
Most privately held businesses are operated in ways that serve to minimize the seller’s tax liability. The same operating techniques and accounting practices that minimize tax liability also minimize the value of a business. It is possible to reconstruct financial statements to reflect the actual operating performance of the business, but this process may also put the owner in a position of having to pay back income taxes and liabilities. Therefore, plans to sell a business should be made years in advance of the actual sale.
Such a period of time allows the owner to make the accounting changes that will put his or her business in the best financial light. Certainly, a business venture that can point to several years of optimum fiscal success is apt to receive more enquiries than a business whose accounting practices – while quite sensible in terms of creating a favorable tax environment for the owner – blunt those bottom line financial numbers.
Would-be business sellers also need to prepare financial statements and other documents for potential buyers to review. These include a complete balance sheet (with detailed information on accounting receivable and payment, inventory, real estate, machinery and other equipment, liabilities, market securities, and schedules of notes payable and mortgages payable), an income statement, and a valuation report. The latter is an appraisal of the business’s market value.
The seller should also prepare the necessary information on legal issues pertaining to the company. These range from such basic operating documents as articles of incorporation, bylaws, partnership agreements, supplier agreements, and franchise agreements to data on regulatory requirements (and whether they are being adhered to), current or pending legal actions against the company, zoning requirements, lease terms, and stock status.
Intelligent buyers will want detailed marketing information on the company as well, including data on the business’s chief market area, its market share, and marketing expenditure (on advertising, consultants, etc.). In addition, product line information will also be expected. Buyers, for instance, will want to know whether any of the company’s products are proprietary, or whether there are potentially valuable new goods in the production pipeline. Description of pricing strategies, customer demographics, and competition should also be available for potential buyers to review.
Finally, business owners looking to sell their company should be prepared to provide detailed information on various aspects of the business’s day-to-day operations. The “operations” umbrella encompasses everything from company policies to historical hours of operation to personnel listings, including organizational charts (if applicable), job descriptions, rate of pay, and benefits. Other factors that can potentially impact one or more aspects of the company’s operations, such as the presence or absence of an employee union, will also have to be detailed.
Once information on all facets of the business has been gathered, it should be organized into a comprehensive business presentation package. A complete business presentation package should include the following:
- History of the business
- Description of business operations
- Description of physical facilities
- Discussion of suppliers (if any) and agreements with those suppliers
- Review of current and historical marketing practices
- Description of competition
- Coverage of personnel and employee issues
- Identification of owners
- Description of insurance coverage for business
- Discussion of pending legal issues or contingent liabilities
- Financial statements for the past three to five years
Further reading continues in Part 2
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