It’s every entrepreneur’s dream, or at least a daydream. Your business has grown so successful you can sell it and drift off into the sunset (at least until the siren call of angel investing or another startup lures you in once again).
This week I met sale-side expert Rick Krebs, who managers mergers and acquisitions of high-potential companies with sales of $1-60 million. He’s spent the majority of the last four years as a principle in Business Sales Group helping entrepreneurs who are selling to achieve a successful transaction.
Having sold only one prior company, I was anxious to hear Krebs’ advice on the issues that generally trip sellers up. If you think you might want to sell your business someday, or at least to examine your options, here’s what Krebs suggests you know before you call in the experts or attempt to strike a deal on your own.
First off, before you pick up the phone, are you emotionally ready to be selling your business? And could the business survive without you? Entrepreneurs tend to think their willingness to stay is an asset. In contrast, a buyer is willing to pay a higher valuation for a company that is able to operate without the former owner attached. This means two things to you: 1) Be sure you’re emotionally able to “let go” of the former company before you head to the bargaining table, and 2) To achieve the highest price, be sure the company can continue to operate when you’re not around.
Rick Krebs is a sale side advisor for mergers and acquisitions, and a principal for the Business Sales Group in Salt Lake.
Secondly, when you sell, it is a near certainty that some of your staff will be fired. As contributor Holly Magister has noted, even in a well-run and profitable venture, the buyer’s eye will be alert to incompetent employees who hold high titles and take home paychecks they do not fully earn. They may be the second or third employees in the firm who were promoted as a reward for their loyalty during the company’s earliest days. Or perhaps it’s the founder’s son-in-law. Before you sell, take the time to assess these individuals yourself and see if they are up to the task of genuinely fulfilling their roles. If not, you should clean house yourself, in advance, as a seller will recognize the drag on the company and offer a lower price (and then cut loose the excess baggage themselves). Ultimately you are doing no favors to yourself or to anyone else by allowing dead weight employees, particularly in high paying positions, to remain on your staff.
Finally, remember that any sales price you negotiate will be affected by any outstanding debt. Even if you’ve used debt wisely, you may be surprised to learn how many transactions produce little cash for the owner after the accompanying debts are retired. (But for a buyer, perhaps existing debt presents a unique opportunity—many successful purchases take place with little or no money down beyond the willingness to take over the company’s debts for a stressed-out founder.)
So at this point, if you’ve checked these criteria and are still convinced you may be ready to roll, here are the top points to remember, according to Krebs:
Exclusivity is expected. Sale-side advisors will generally want exclusivity when they market and sell your business, as they will put an enormous amount of time into the preparation of your business for sale. Exclusivity is a good motivation for the sale-side advisor, Krebs says, but it doesn’t incentivize the seller to assist in finding a buyer. So perhaps you should create a contract that offers the advisor a discounted fee if you are able to bring the buyer to the table yourself. Now both sides will be motivated to move quickly and well.
Think about taxes. You should get all advice possible on strategies for minimizing and deferring income tax before you approach any sale. With a good advisor you may be able possibly even defer 100%. The time to consult your tax advisor is well before you discuss an offer or begin to structure a sale. For example,
Consider the implications of selling stock versus selling assets. As a general rule, asset sales are more favorable to a Buyer and stock sales are more favorable to the seller because asset sales create a higher income tax burden on the seller (they create ordinary income versus revenue that can be taxed as a capital gain).
Have a pricing strategy. Consider the implications of a cash sale versus a leveraged buyout. In recent years, buyouts have tended to be leveraged deals versus cash. Krebs suggests sellers consider offering a 20% discount for cash. This is wise counsel—in my own business sale the deal was entirely leveraged and as with many sales, the seller defaulted and negotiated a settlement long before the purchase was done.
Is the SBA involved? Here’s what to know:
- An SBA purchase will require you, as the seller, to carry 10-25% of the note. The banks won’t tell you this, Krebs says, but very seldom, if ever, do they approve an SBA loan without the seller having skin in the game for two years.
- If the deal includes a lease, it must be for a minimum of 10 years, renewable by the buyer.
- A business appraisal is usually required (but the buyer would pay).
- The seller can only work for the business for one year after closing—a potential “gotcha,” according to Krebs. This means that after one year a seller is not allowed to be involved in the business, yet will still have a note receivable from the business for an additional four years.
- The SBA will loan up to $5 million, but individual banks may have an internal limit that is smaller than this.
Should you do a Seller Note/Seller Carry? Only if you’re willing to bear a high level of risk, according to Krebs. Generally a seller carry deal gives the buyer two years of operation (during which interest accrues) before any payments are made. At the two-year point, the note can be paid off in as little as three years (five years total). The note is not secured by anything but the business, which makes these deals particularly risky for you.
Your first CPA and Attorney can’t be your final CPA and Attorney in a sale. Legal, accounting, and tax laws are extremely complex. In all, there are 73,924 pages of tax code (14,784 reams of paper), Krebs says. You will need to have specialized advice for a business sale. You can use your current CPA and attorney for the smaller matters as you prepare for the sale, but the bulk of the work will require an expert. “Think of successful business sale like open heart surgery,” says Krebs. “You wouldn’t dream of having a general practitioner do an open heart surgery.”
If you might sell, get your financial, legal and other business affairs in order now. Before you consider taking your business to the market meet with a mergers and acquisitions specialist well in advance. Learn your alternatives and determine if you really are ready and willing to prepare for a sale. If you are, expend the time and resources necessary in advance to clean up anything necessary. Remember that the buyer can offer you less money if he or she discovers problems during the due diligence phase.
Yes, there are happy endings, as thousands of entrepreneurs can attest. But I suggest every prospective seller take these points to heart well in advance of your exit to create an optimal sale of your own.
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