The 12 Stages of Selling a Business

Selling your company is at best an arduous and sometime difficult process. It has been described as a “contact sport”. It can be stressful and at times exhausting. Especially if you are not sufficiently prepared for the rigors of due diligence by a sophisticated buyer. Most business owners are not accustomed to any sort of audit or critique of their financials, business operations or management skills. However, if you think of the sale transaction as similar to a long-term strategic enterprise cycle, you will realize that it can be broken down into digestible component stages. Nobody eats an apple in one gulp, but rather one bite at a time. If you approach the transaction process in this manner you can achieve a profitable and happy result.

In the following article we will examine the key stages of a business sale and/or M&A sale process. These basic stages will be similar for a ‘main-street’ business, a lower middle market business, a large business, or anything in-between.

Stage 1: Defining Exit Strategies and Potential Options

There are a wide variety of potential transaction options. These options should be carefully evaluated by the Owner(s), CEO, and/or board of directors. Understanding your options (and selecting the best one) may be the most important strategic decision that the owner(s) will ever make when it comes to realizing value. Whether an outright sale, a minority recapitalization, or an ESOP, they all boil down to various methods by which owners of a business sell their interests in the business, and to whom they will sell.   Buyers can be defined into three basic types: financial, strategic, and family offices. All three have advantages and possibly certain disadvantages. Any one of them could be preferable depending on the seller’s situation. A good business broker or M&A advisor will work with the business owner to establish valuation, exit strategy alternatives, selecting the best buyer, and define the owner’s willingness for future involvement with the company after the sale.

Stage 2: Valuation: “How much is my company worth?”

Determining the company’s appropriate market value is a critical early step in the exit process. We (as the broker) can compile a “Broker’s Opinion of Value” from databases of prior transactions for businesses like yours. But we always advise owners to have a third-party “certified” appraisal commissioned for their business (we can refer you to qualified valuation specialists). This has several advantages: 1. It is an unbiased professional opinion suitable for lender purposes, 2. It is ‘defensible’ with buyers, and is useful in setting the initial deal boundaries. Too many transactions get derailed by sellers and buyers who have different expectations about the company’s value. Often the business broker/advisor can help to close this gap with thoughtful negotiation skills and transactional experience, but big gaps simply can’t be bridged regardless of the skill of the advisors involved. The most common valuation methodology is the “discounted cash flow method” (DCF), which represents the current value of future cash flows discounted to “present value”. This is represented by a multiple of EBITDA or adjusted EBITDA, also called “Seller’s Discretionary Earnings” (SDE). Sometimes “strategic buyers” will pay a premium price above market value, calculated on the future revenue-generating potential of the business within the buyer’s current customer base. Financial buyers (usually private equity groups) tend to value businesses based upon their own required rate of return on invested capital. In the end, the price you receive is determined in the market by the buyers and the quality of your communications, financial data, and personal engagement with them.

Stage 3: Pre-Marketing Analysis and Valuation Enhancement

As a seller you should analyze with your broker/advisor the company’s strategic operating and financial condition and invite suggestions for how the business, over a 6–12-month period, can make changes to make the company more desirable to buyers. Some call this “polishing the apple”. It is not advisable to make drastic changes too quickly—unless it becomes clear that these changes are long overdue or are needed immediately to address pressing competitive or industry challenges. Drastic changes can carry a high degree of risk, so incrementalism is advisable here. Many owners are “trigger happy” and just want to sell the business quickly, but it is better to make necessary prudent changes well in advance before going to market. Working with competent business coaches with relevant industry experience is recommended and is almost always beneficial.

Stage 4: Information Gathering, Data Collection, and Presentation:

You must spend the time and money to properly assemble, interpret, and present your company’s financial and business history and future prospects in a clear and understandable manner. This is probably the most crucial element of the sale process.  It will require some trust between the business owner and the broker/advisor because this is the point when all the good and bad points of the business will be disclosed and discussed frankly. Just know that all businesses have good and bad points. All information provided by the owner to the broker will be held in strict confidence. Business owners typically prepare their financial statements for tax purposes (usually cash-based) and not for business sale purposes. For valuation and sale purposes you will need at least 3 years of preferably accrual-based financials to accurately reflect the true cash flow of the business.  Cash-based financials may be suitable to minimize income taxes, but are not the best choice for sale purposes in most cases. Taking the time to properly present your company’s earning power will have a huge impact on how buyers view your business.

Stage 5: Marketing Materials Preparation

When serious buyers evaluate your company, they expect your records and facts to be well- organized and documented. Disorganized records delay the due diligence process and can kill a deal. Sloppy recordkeeping makes the owner look amateurish, and create doubts about the viability of the business. At minimum you need to have CPA-prepared financial documents, preferably review-level financials, and audited financials are well worth the expense and will almost always result in a higher sales price. Well-organized and accurate financials increase the buyer’s confidence and comfort level and greatly increase the likelihood of a successful sale.

You have spent years establishing your name, goodwill, market niche, vendor relationships, operations systems, management, personnel, distribution channels, customer loyalty and numerous other intangibles. This story needs to be told properly to educate potential buyers.

Stage 6: Buyer Research and Buyer Outreach Strategy

Large multi-billion-dollar companies will by definition only attract a small ‘universe’ of relevant and sufficiently capitalized acquirers. Main-street and lower middle-market companies can have a potentially large universe of potential buyers. Some of these buyers may be known to the business owner, some might be known by the broker, but nobody’s Rolodex is big enough to know every potential buyer. This means that the broker and the owner must utilize tools and resources to research and access the largest and most qualified set of relevant buyers. Databases and tools of varying qualities exist out there, but there is no single ‘magic bullet’. Well-crafted advertising campaigns can generate buyers who aren’t on anyone’s list and can be very effective. The broker will research and review competitors, vendors, customers, strategic buyers, private equity firms with relevant acquisition criteria, and other sources of qualified buyers. This is one of the most time-intensive elements of the sale process but it often determines the overall success of the sale process.

Stage 7: Qualification of Potential Buyers

Many potential buyers that express an interest in a business simply will not be qualified to purchase the company. These buyers are referred to as “tire kickers”.  A good broker will know the right process and questions to ask and possess enough market intelligence to weed out these kinds of buyers.  We as brokers have experience dealing with buyer inquiries and we know how to pre-qualify buyers so as not to waste the owner’s time and resources dealing with unqualified buyers. Normally we require “proof of funds” from buyers before we release any confidential information about the company. We always require a Non-Disclosure Agreement to be executed by all buyers. Any meetings with potential buyers are carefully planned and coordinated by the broker and conducted under controlled circumstances. A meeting agenda is usually crafted by the broker and sent to the buyer to keep the meeting on-track and to avoid prematurely releasing proprietary information about the company. As a buyer’s interest becomes more serious, there is an appropriate time to carefully release information required for the buyer to make an offer. Detailed financial examinations are conducted during formal due diligence, after an offer has been made and agreed upon by the parties.

Stage 8: The Negotiation Process

There are many schools of thought about how to conduct a negotiation and buyer engagement process.  Generally, sellers are more likely to achieve a better outcome when negotiating with multiple buyers. One strategy is to approach a carefully curated targeted list of buyers, culminating in an auction process. This is called a “competitive environment” in transaction parlance, and is an approach which is more suitable for businesses with EBITDA of over $1,000,000/year and which generate a sufficiently large pool of participating buyers. If two or three buyers can be brought into an auction process, it can culminate in a premium price for the seller. However, it is not guaranteed that such a pool of buyers can be identified and targeted in a short enough time frame to make an auction deadline feasible. Caution must also be employed here, as some buyers will object if they think they are being manipulated into bidding against other buyers. The broker will use total transparency in this process and be forthright with all buyers that the broker’s job is to maximize value for his client—the seller. Most buyers understand this approach and are respectful of the broker’s objective to maximize value if stated clearly in the beginning of the dialogue.

Stage 9: Transaction Structure

The sale of a business has many financial and professional considerations for the owner, partners, and possibly the management team. The purchase price is only one of these components. Other decisions may include how the assets are conveyed, how the terms are structured, potential earnout timetables, any partial owner-financing and at what interest rate, what if any liabilities will be assumed by the buyer, employment contracts for key employees, non-compete agreements, current assets retained by the seller (such as accounts receivable), employee retention holdbacks, layoffs, etc.

Stage 10: IOI’s, LOI’s, Asset Purchase Agreements, and Closing

For smaller main-street businesses a jointly-drafted Purchase Agreement is usually preferred and is more appropriate. For larger companies (over $1mm/year EBITDA) a buyer will usually express interest through the use of three documents: the IOI, LOI, and Purchase Agreement. The “IOI” is called an ‘Indication of Interest’ document. It is non-binding and contains the basic proposed terms, valuation, and structure for the transaction. The owner will review this with the broker and make a determination whether or not to accept, decline, or make a counter offer. If initial agreement can be reached between the parties, the seller will invite the seller the buyer to learn more about the company and become more serious. “LOI’s” or “Letters of Intent” are a more serious document of interest from the buyer, and once executed by both parties the seller is typically under exclusivity to the buyer, stating that the seller cannot sell the business to another buyer until such time as the buyer declines to proceed with the transaction. This is referred to as ‘first position’ for the buyer. Some buyers will insist upon a period of exclusivity or ‘no-shop’ clause which means that the seller cannot advertise the business or even meet with other buyers for a stated period of time. Meanwhile, the buyer begins formal due-diligence on the business with the stated intent of acquiring it. During this ‘exclusivity period’ the buyer agrees to move quickly under a defined due-diligence timetable to determine if they want to proceed to closing.  If so, the final Purchase Agreement must be drafted to define the complete details of the transaction such as: legal, financial, representations, warranties, etc.  The Purchase Agreement is the ‘definitive document’ which contains all the terms of the sale. The transaction is ‘closed’ by either an experienced escrow company or attorney. All monies are held by the escrow officer and distributed to the owner after all the transfer documents have been signed by both parties. This is called the “Close of Escrow”. Immediately upon the Close of Escrow the buyer will take possession of the business and will be introduced to the employees.

Stage 11: Post-Closing Issues & Business Transition

The post-closing transition period is a period of time after the sale of a length negotiated as part of the purchase agreement. This is a period of cooperation and training by the seller to help the buyer seamlessly integrate themselves as managers/owners of the business. Sometimes sellers are reluctant to commit for a long period, however, this unwillingness to ease the transition usually results in a lower buyer valuation and sale price. Part of what the buyer is purchasing is your expertise and experience. Post-closing commitments will include transferring customer relationships, instructing the buyers on key management processes, market dynamics, and other proprietary trade secrets essential to operating the business optimally.

Stage 12:

This is the stage when you deposit the check and enjoy the rest of your life!