How to Sale a Small Business: Part II

Stepwise Sale Procedure: Part 2

Step 1: Financial Documents

Make sure your bookkeeping is perfect before exploring any potential scenarios in which selling your small business becomes a reality. This is essential advice for achieving a fair bargain for your business as well as for maintaining your personal sanity throughout the sales process. When you sell a small business, many people will be looking at your financial records, including potential buyers, lawyers, accountants, business valuation experts, and others who may be involved in the sale.

Make sure your financial data is accurate by working with your small business accountant (or hiring one if you don’t currently have one). Three years’ worth of tax returns and financial documents are typically required as part of a sale. Additionally, be prepared to account for all business revenue during this time period as well, as any missing funds raise suspicions in the eyes of potential buyers. When selling your small firm, don’t be shocked if you’re asked for year-to-date financials as well: Owners prefer to invest in a growing business than one that is experiencing financial difficulties.

AUDITS OF FINANCIAL STATEMENTS

When you sell your business, the business valuation process is driven by your financial statements, so it’s critical to comprehend why these documents are audited. Even if you aren’t ready to sell your business just yet, you should think about paying for an audit every year because it is highly probable that a prospective buyer will demand to view audited financial statements.

• Qualified vs. unqualified audit opinions: A qualified opinion identifies some audit-related concerns while an unqualified opinion says that there are no major misstatements in the financial statements. Consider, for instance, that the auditor lacked the necessary audit evidence to do a physical count of inventory at year’s end. A qualified audit opinion would disclose the problem.
• Related party transactions: These are exchanges with companies connected in some way to the audited company. Consider the scenario when your business purchases raw materials from a business that a board member owns. Because the acquisition was not made at “arm’s length,” or in a deal with a third party, an audit report will make this information public.
• Contingencies: Contingencies may be mentioned in the audit report, either through a footnote or an adjustment to the financial statements. For instance, the outcome of an unresolved legal matter depends on a future event, and legal disputes are frequently the subject of commercial contingencies.

Step 2: Professional Valuation 

The process of valuing a business is not always simple; to ascertain your company’s genuine worth, you may want the assistance of a valuation firm. Additionally, hiring a third-party company for the valuation will give the asking price credibility.

To find prospects and determine a fair price, the appraiser will consider everything from inventories to sales, debts, and other business assets.

ENTERPRISE VALUATION 

According to statistics, 80% of the average business owner’s net worth is related to their company, therefore getting it in the best possible shape for a sale is essential to their ability to continue operating after the sale. Depending on their location, market demand, financial health, eight main value drivers, etc., small businesses can be valued at two to five times their yearly cash flow, plus any optional add-backs. The primary concern for many small firms is cash flow, and it is extremely likely that the value of their physical assets will be restricted to the contribution they provide to the business’s profits. Small firms with yearly cash flows of under $100,000 obtained sales prices that were roughly 1.90 times their annual cash flows, according to BizBuySell. Additionally, those with $300,000 in cash on hand or more received a multiple of 2.81.

It’s vital to remember that smart business buyers won’t be satisfied with cash flow alone; you may need to give potential purchasers a plan for how the company may expand and prosper without you at the helm.

INCLUDE A VALUE EXPERT

There are simple techniques to estimate the value of your small business if you decide to sell it, but this does not imply that these methods are the best or simplest. You should plan to ask between three and six times your present cash flow when selling a small firm. Although that’s a good place to start, the low and high ends of this range are very different. Particularly when you take into account additional factors like the market for comparable sales and general industry expectations. You can obtain a more accurate figure with the aid of independent appraisers. These companies will assist you in determining the true value of your business based on sales, revenue, unpaid invoices, inventory, and debts for a flat cost. [1] A third-party valuation also reduces the possibility of a seller challenging your company’s value because you’ve hired a specialist to assist you in determining a reasonable price based on the company’s actual worth and market circumstances.

VALUE OF YOUR COMPANY: THE VALUATION PROCESS

A team of experts, including an accountant, an attorney, a business broker, and a value specialist, will evaluate your company. A company is assessed using a number of different metrics, and the buyer and seller may hold differing opinions regarding the significance of each metric.

THE ROLES OF PROFESSIONALS

The following professionals work with the majority of corporate sales:

• Certified Valuation Appraiser (CVA): An individual with the CVA credential has finished coursework on the methodology and valuation procedure for businesses. CVAs evaluate a company using a variety of measures, and they formally submit their findings.
• Accountant and/or Tax Preparer: As was previously said, you might hire an accountant to work for your company or have them check your monthly financial accounts and accounting activity. In the majority of cases, accounting firms are also used to prepare business tax returns.
• Attorney: A business may employ one lawyer for regular business dealings and contracts and another lawyer for the paperwork related to a business sale.

Each of these experts has a part to play in the evaluation and selling of a business.

THE BUSINESS BROKER’S ROLE

A business broker is the expert who might be most involved in the appraisal and selling of your company. An expert broker can add significant value to the sale of a business and might carry out the following responsibilities for a seller:

• Pricing and Valuation: The broker can do research and provide an explanation of the measures used to assess the worth of your business and the pricing other firms in your industry.
• Market research: Your broker can examine the sales of comparable businesses and pinpoint sales patterns in your sector.
• Purchasers: Perhaps most importantly, a broker can locate possible buyers and inform them about your company through their network of contacts.
• Negotiate the final price: To negotiate the final selling price, the broker can also draw on his or her understanding of the business and previous transactions.

Ask your network of professional contacts and your industry peers for assistance in locating a business broker.

FACTORS THAT AFFECT VALUE

A buyer may value some types of information more than other metrics, and a business valuation is based on both financial and non-financial data. Additionally, a vendor could value particular measures above others. A company’s genuine value is based on judgement and opinions.

The tools used to determine a business’s value are covered in this part, along with the reasons why buyers and sellers think the information is important for a transaction.

1. EARNINGS PRIOR TO TAXATION, INTERESTS, DEPRECIATION, AND AMORTIZATION (EBITDA)

The most popular valuation indicator may be earnings before interest, tax, depreciation, and amortisation (EBITDA), and you may hear about companies that are valued at multiples of EBITDA (“3 times EBITDA,” etc.). The earnings balance includes all expenses, while the earnings total refers to net income, which is calculated as (revenue less expenses). EBITDA adds back expenses for interest, tax, depreciation, and amortisation to earnings. Take a look at each of those items separately:

• Interest cost: The cost of interest on all loan balances.
• Tax expense: The amount of federal, state, and perhaps municipal taxes paid on business profits.
• Depreciation expense: Fixed assets degrade as they are worn out over time. Assets are resources used in a firm. For instance, a truck costing $30,000 might depreciate at a rate of $5,000 per year for six years.
• Amortization cost: As intangible assets, like a patent or copyright, are used to generate revenue, amortisation costs are incurred. Consider a scenario where a business purchases a patent for $100,000 and is required to amortise it over a 20-year period per accounting standards. A $5,000 annual amortisation expense is permissible for the company. The EBITDA balance exceeds the net income after adding back (removing) these costs.

1. CASH FLOW VS. PROFIT

A bigger cash balance does not always follow from making a profit. As no organisation can function without a sufficient amount of cash, the inflow and outflow of cash should be taken into account during the valuation process.

When comparing the growth in sales to the growth in accounts receivable, a prospective buyer will pay special attention. A company will eventually run out of cash if sales are growing at a 15% rate and accounts receivable are rising at a 30% rate. Although the business is selling more products, the typical client is paying more slowly. A cash-strapped company may eventually need to borrow money to operate, which may result in interest costs. A company could also sell equity and raise money from an investor. The most valuable enterprises to a buyer are those that are profitable and have a quick cash flow.

1. PROFIT AND MARKET SHARE TRENDS

A prospective buyer examines several years’ worth of financial data to evaluate business trends, especially profit trends. How can the buyer increase sales even further, say, if a certain product’s sales are rising? A buyer will also take your market’s size and your company’s place in it into account. If you compete in a developing industry where no company holds more than 5% of the market, a potential buyer might perceive room for increased sales, which would increase the value of your company. The variety of your product offers will also be taken into account by potential customers. You can deal with a slowdown in one product line if you sell mountain bikes along with hiking and camping gear. Conversely, if all you sell are hiking boots and apparel, a fall in the hiking market puts you at more danger.

Other elements that affect valuation include the following:

• Return-on-investment (ROI) and relative risk: A lot of buyers create a formal assessment of the return received on the investment and contrast it with a formal calculation of relative risk.
• A small number of essential clients: Many small firms begin by catering to the requirements of a select group of clients. To raise your company’s value to a buyer, you must gradually broaden your clientele. Buyers will take customer concentration into account when evaluating an offer for your company if any one client accounts for above fifteen percent (15%) of your annual sales.
• Credit history: A seller must exhibit a solid credit history and the capacity to make on-time payments to vendors. An organisation can retain great connections with vendors by making payments on time.
• Management team: Retaining competent managers offers value to a buyer. An experienced management team can make wise judgments to boost earnings and grow sales.
• Synergy with a possible buyer: A buyer may need your company to complete their deal. As an illustration, many firms make purchases from suppliers of essential raw materials.

Step 3: Boost your sales

You must enhance your firm’s entire performance in order to increase earnings and, eventually, the worth of your company because businesses with robust income streams and varied revenue sources are appealing. Remember that selling your company at a period of diminishing sales can reduce your profits. The majority of buyers examine sales and gross profit data to assess a business’s profitability. They prefer organisations that have revenue growth of 30% or more year over year, which shows that buyers want to buy growing companies rather than ones that are just hanging on. Buyers that are knowledgeable will also ask you about the contracts you have in place and whether they are transferable. They will also assess the possibility of your future revenue streams, identifying chances for recurring revenue that point to continuing sales years in the future. A business with few clients is one thing that can deter a prospective purchase. Many buyers consider the quantity of clients a business has when negotiating because each one of those customers would represent a sizable loss in revenue. You must increase sales and, if necessary, diversify your clientele in order to make your business more appealing to customers. Your company’s value will rise if you have a wide range of clients, different streams of revenue, and a capable management team. Before attempting to sell their secondhand cars, they polish them for a reason. Prior to a sale, improving the appearance of your asset can help you raise your asking price. When selling a small business, the same holds true. Potential buyers will understand that your business is in excellent financial form and has plenty of room to grow if you can demonstrate that your sales are increasing as you get ready to sell. In turn, this aids in raising the selling price. Make a small extra effort to increase your sales by additional marketing, advertising, or referral programmes with current customers. When you’re prepared to close a deal, this can assist you boost your sales numbers. Additionally, it puts your buyer in a strong position to maintain momentum once they take control.

Step 4: Use Current Strategy

Business owners are advised to plan their exit a year or two in advance by experts. Being organised can help you improve your sales, financial records, and clientele, which will increase the appeal of your company to potential purchasers. Being organised will also help you get everything in order. Timing is crucial because about 20–30% of businesses listed for sale really do, according to statistics. It makes sense to sell your company while times are favourable. Buyers prefer to invest in expanding, successful businesses. Experts cautioned against expecting to sell your business for a respectable profit right away. Markets change frequently, thus it is your obligation to be informed of the most recent developments so that you can position your business as an industry leader. Don’t put off selling your firm until a catastrophe occurs. If you permit that to occur, your business’ worth will decrease or you risk suffering a big loss. According to experts, the optimum moment to sell a business is when it is financially sound. Lack of an escape plan is the worst error you can make. Before an unanticipated circumstance compels you to sell your firm, implement an exit strategy if you want to receive the most for it. Smart business owners should be clear on their strategy for reducing their engagement in the company they own after selling. Even better, every owner of a small business should have a backup plan in place in case they have to part ways with their firm unannouncedly or find themselves in a position where selling is the best—though unanticipated—course of action. You should have a plan in place for how you would sell your business and how this decision would affect your personal finances whenever you have established your company to be superior to your competitors in terms of financial strength, standing in the market, or long-term viability. Every exit strategy should include a few key components: a succession plan for who would take over day-to-day operations in the event that you sold (and the buyer kept the current staff), knowledge of any potential pain points or pitfalls and how to address or manage them, and an estimation of the amount you would need to make from the sale to support your family.

Step 5: Find a third-party business broker

The finest resource for helping you sell your company for the highest possible price and finding the right buyer is a business broker. You can get aid from a business broker with the following:

• Business valuation, bargaining, and investigation.
• Assisting you in performing sell-side due diligence to guarantee a smooth close.
• Finding potential buyers and marketing to them, including putting your business on numerous markets to broaden the buyer base and secure the greatest price.
• By utilising the extensive network of private lenders and financial institutions they work with, they may assist purchasers in obtaining financing.
• Assist in negotiating advantageous sale terms.
• Screening potential purchasers and maintaining the process’ confidentiality are two additional important responsibilities of a broker.
• Carrying out due diligence is one of the most difficult steps in the selling process. That’s where most transactions fail. Deals fail in almost 50% of cases because of inadequate due diligence. A skilled broker will guide you through the entire process and keep you on track so you can concentrate on running your business.

Business brokers are experts at obtaining their customers great bargains when selling a small business, just like you are in your sector. You can get assistance from business brokers with all the major and minor processes involved in selling your business. They will assess your business, put together a prospectus for purchasers, and research the market to locate you potential customers. On the buyer’s side, brokers can frequently assist potential buyers in getting the financing they need to purchase a small firm. Of course, this assistance isn’t always free: Broker fees can range from 5% to 10% of the whole sale price, so you’ll need to be willing to part with some of the proceeds in exchange for the additional assistance.

Step 6: Evaluate Possible Buyers 

The majority of new business acquisitions are partially financed by outside lenders. And one of the reasons why so many transactions fail is that after buyers and sellers reach an agreement, they are unable to obtain credit. Therefore, it’s crucial to pre-qualify prospective customers before communicating with them. There won’t always be an honest offer to buy your company. Owners must divulge a tonne of confidential financial and proprietary information when selling a small business. In the event that their offer isn’t real, your competitors may be able to learn more about your business from these information, which are extremely valuable to them. Early in the process, you run the danger of disclosing information to a competitor without making a sale. The same holds true if you attempt to safeguard your data on your own without seeking the assistance of a third party. Know who you’re working with and how committed they are to buying your company if you receive a purchase offer. Of course, not every business rival will have evil motives, but it’s still crucial to recognise who you’re dealing with and whether the buyer’s goals seem to match the offer they make. A non-disclosure agreement is one technique to help protect your trade secrets. NDAs limit the sharing of information with third parties while they are in effect and stop buyers and sellers from exploiting sensitive information against one another. Asking a lawyer to act as an arbitrator might be a good idea. Legal experts frequently hold private records in their offices and only permit parties to examine these records there. This makes it harder for someone to look through your finances without your knowledge.

Asking the following questions is only one of many things you should think about before doing business with a potential buyer:

• Does the buyer have the required capital or has he or she received funding? Request financial documentation from prospective purchasers proving they have the means and resources to pay the down payment as well as the first six months’ worth of operating capital.
• Does the buyer have commercial experience and the ability to run the company? Though a lack of experience shouldn’t be a bar to qualification, the majority of eligible buyers are leaders in the sector the company operates in.
• Is the buyer’s timeframe reasonable? Ask potential purchasers if they are prepared to make a purchase right away or if they are still several months away from doing so.

A business sale may take six months or longer, according to various estimates. Depending on the size of your company, how carefully your records are kept, the health of the economy right now, and other factors, your timeline may vary significantly. Once you begin to discover potential customers, you must decide how much and in what format you will give them information. You should collaborate with your business broker to develop negotiation techniques for the sale because the selling structure has a significant impact on the sale price.

MARKETING YOUR FIRM TO POTENTIAL CLIENTS

There are a variety of places where a prospective business buyer might appear, but these three are typical:

• C-suite executive departing a company: An executive with a high net worth decides to use his or her wealth to buy a company after leaving a company.
• Peers or competitors in your industry: People who work in your industry are more likely to appreciate your company’s value or see a way to make it better.
• Private equity firms: These organizations invest in privately held businesses by pooling funds from affluent individuals, foundations, and other sources. Over a five- to ten-year period, they become deeply involved in management and try to provide large returns for investors.

One or more of these three groups may be interested in your company.

ADDITIONAL ELEMENTS IN SELECTING A BUYER

As you proceed with the buyer-finding process, give the following issues great consideration:

• Creating a prospectus: A prospectus is a detailed report that details your company’s operations, products and services, industry, and financials. However, the amount of information you offer prospective buyers can vary substantially, so speak with your business broker about this matter.
• Pre-qualified financing for a buyer: Does a prospective buyer possess the resources necessary to purchase your company? Find out if a potential buyer has funding in place, either from a lender or through investors, if they show interest.
• Equity vs. asset purchase: In an equity purchase, the buyer buys the business’s full equity (assets minus liabilities). In contrast, an asset purchase means that the buyer is merely purchasing specific assets and may not be purchasing the whole company. For information on the tax and legal ramifications of each buying option, speak with your accountant and lawyer.
• Earnouts: When will you, as a vendor, receive payment? When the sale is finalized, will you be paid in one lump sum or over the course of several years through earnouts? In many instances, a seller remains with the company for a while and may be eligible for additional remuneration based on the company’s financial performance.
• Negotiation tactics: Since you only have one chance to negotiate a sale successfully with a specific buyer, work with your broker and other professionals to comprehend negotiation tactics. Learn the meaning of the phrase zone of possible agreement (ZOPA), which refers to the probable price range for a deal between two parties. The phrase “best alternative to negotiated agreement” is also crucial (BATNA).

Step 7: Contracts and due diligence

In particular, if you’ve managed to get an NDA in functioning condition, it’s likely that you already have a lawyer on hand who has assisted you in guiding the agreement toward conclusion. By this time, you’re getting closer and closer to the actual sale, so you’ll want to make sure you have legal counsel on your side to assist with the drafting and review of your sales contract. Of course, you could draught your own sales contract, but doing so exposes you to potential risks that could have been avoided with legal advice. Great if your business already has a small business attorney on staff. Given that not all lawyers have the same areas of expertise, you might want to confirm that they are knowledgeable about and at ease with contract law. Consider requesting a referral for a lawyer who specialises in contract law if yours isn’t one. Spending for any unforeseen repercussions that result from putting a less-than-stellar contract with a buyer into action will not hurt nearly as much as paying to bring another lawyer into the mix.

1. DUETIPLICITY

If you come across a serious buyer candidate, you may give them permission to conduct due diligence. A formal, confidential agreement known as due diligence between you and a prospective buyer gives the buyer access to far more information about your company.

This procedure is intended to provide the buyer with sufficient details to enable them to make a purchase offer for your company. These are some of the documents that are typically presented during a due diligence procedure.

2. RELATED INFORMATION

You will include a company organizational chart as well as other general details, such the number of employees.

3. ACCORDS AND CONTRACTS

Several different forms of agreements that your company might have in place must be reviewed by a buyer, including:

• Employment contracts: You might have contracts in place with your management team and other important personnel. A buyer’s decision regarding the design of an incentive plan to encourage key personnel to remain at the company will be aided by reviewing these agreements.
• Customer agreements: Businesses frequently have written contracts with their clients that specify pricing and the amount of units that will be sold to them annually.
• Vendor agreements: Your business may have an agreement with suppliers that provide you with goods and services. Additionally, you can have a lease for an office or a lease for equipment.

FINALIZING STEP 8 OF THE BUSINESS SALE AGREEMENT

You’re almost there, finished: Your financial records are in order, a buyer has been found, and your contracts are being reviewed and are almost ready to be executed. You must now take care of the real sale terms. Make sure your contract stipulates that you will receive payment in advance. You’ll need the cash up front for a number of reasons, including letting you leave the company in accordance with your exit strategy, assisting with transaction-related costs, and making sure your buyer has the funds necessary to complete their end of the bargain. For a seller, not getting paid upfront can present a number of difficulties. You run the danger of your buyer not paying you the whole sale price over time, which only makes it harder to get once the deal is closed and you aren’t dealing with the buyer face-to-face on a regular basis. Allowing the buyer to pay over time also exposes you to any monetary problems the company may experience under new ownership. Imagine, for instance, that the buyer is unable to continue funding the company. If that happens, there simply won’t be any money left to hand to you, which could result in drawn-out legal proceedings or you leaving with only part of the money you’re owed.

The culmination of all your work is the sale of your business. It’s critical to comprehend the terms of the contract as well as what occurs when the organisation is transferred to a new owner.

• At closing, you might sign paperwork pertaining to the sale of particular assets, and your contract might call for you to sign a non-compete pact that will last for a predetermined time. The sale contract is a different document.
• If you agree to stay on during a transition period, you might spend a lot of time with the purchaser’s company’s top executives. They could assist you in keeping your customer base by using your best business practises.
• The shift in company culture is a challenging issue for sellers who stay on for a while. As a seller, you must recognize that the buyer will have a significant influence over corporate culture and that you are no longer in charge.
• Lastly, consult your accountant to understand the tax implications of the sale and schedule a meeting with a financial advisor to discuss investing the proceeds.

THE PAYMENT

The pinnacle of years of work and effort may be selling your firm, which may also be the most significant financial choice you ever make. Assemble a team, conduct research, and increase the price at which your company can be sold.

Before the transaction is finalized, keep the following in mind:

• Request non-disclosure agreements from prospective buyers.
• Consult with your business advising team to ensure you don’t disclose more information than is necessary at the beginning of the process.
• A letter of intent (LOI) outlines the proposed parameters of the deal in a mostly non-binding document. The transaction is still very much in progress!
• Changes inside the company (important workers leaving) or outside (regulation concerns, industry upheavals), which can destroy the sale, are your enemy.
• Discuss the tax ramifications of various deal structures and your potential tax liability with your M&A lawyer and CPA (examples: asset vs stock purchase, Section 1202 gain exclusion, state tax implications)