The Realities Of Selling A Small Business

Business owners are generally very busy, so let’s get right to the point. If you are interested in (or curious about) selling your business, there are plenty of people, professional and non-professional, who will encourage you or discourage you. Ultimately, the decision is yours to make. It is important, therefore, to understand some of the “realities” or the “truths” of selling a small business that you must consider in making your decision.

The reality is selling a small business is NOT a simple matter of putting a business up for sale, naming a price, and waiting for a buyer to pay that price. It is, rather, a complex venture that involves several considerations beyond just the asking price, although the asking price is, perhaps, the one most underestimated. 

This article is intended to address a number of those considerations and, especially, the reality of matching asking price to what buyers will reasonably consider, or be willing to pay and not what the seller would like to receive.

Selling a small business can require that you make available the services of an accountant and an attorney, although that is best done after there is an offer on your business rather than before, both to save unnecessary expense and to not give you unrealistic expectations, whether too low or too high, as you proceed. Usually, the services of an “intermediary” – an experienced professional to market the business confidentially, to determine the quality and qualification of a potential buyer, to assist you in understanding the buyer’s focus and questions, to help you respond to appropriate requests, to make sure the documents and documentation to explain the business and/or defend the asking price are in order, and, generally, to facilitate and expedite the whole process to a successful conclusion is important to find the right, qualified buyer and to get the highest fair market price for your business.

Whether you profit, or actually sell, will depend on the reason for the sale, the timing of the sale, the strength of the business's operation, its structure, its cash flow and/or profitability, even its location or ability to be moved, and the reasonableness of the asking price to invite buyer prospects to take a serious look. It will often require having professionally prepared documentation of both the business elements and its recast financials to attract a buyer and to make financing available to a prospective buyer. The business sale will also require a commitment, not only of your time but also an emotional decision to sell and to make decisions quickly.  Once the business is sold, you'll need to determine some smart ways to handle the proceeds. Reviewing these considerations can help you build a solid plan and make negotiations a success.

1. Reasons for the Sale: You've decided to sell your business. Why? That's one of the first questions a potential buyer will ask. Owners commonly sell their businesses for any of the following reasons: 

• Retirement
• Partnership disputes
• Illness and death
• Becoming overworked
• Boredom 
• Business is decreasing
• Competition is too strong
• Undercapitalized
• Problems with help

Some owners consider selling the business when it is not profitable, but this can make it harder to attract buyers. Consider the business's ability to sell, its readiness and your timing.

There are many attributes that can make your business appear more attractive, including:

• Increasing profits
• Consistent income figures
• A strong customer base
• A major contract that spans several years
• A growing business in terms of revenues or profits
• Exclusive vendor contracts or contacts
• In a growing industry
• In an attractive location to buyers
• Offering a substantial R.O.I. (Return On Investment)
• Accepting some owner financing
• Capable staff in place
• Owner willingness to stay for a reasonable period

2. Timing of the Sale: Prepare for the sale as early as possible; it’s rarely too early to start the exit process and often too late!. If financials are not appealing because of “creative” expense deductions, rework the financials to reflect the real profitability of the business, preferably a year or two ahead of time. An intermediary will have those financials professionally recast so that you don’t need to go through the expense and extended time to reinvent your financials. Selling a business takes time, sometimes months, sometimes years.  The preparation will help you to improve your financial records, business structure and customer base to make the business more profitable. These improvements will make the discussion of the opportunity much more likely to have positive results and will also ease the transition for the buyer and keep the business running smoothly. 

3. Business Valuation vis-à-vis Asking Price: Next, you'll want to determine the worth of your business to make sure you don't price it too high or too low. You’ll want a professionally accredited, well experienced appraiser to get a valuation that is more than some software output that takes minutes. A professionally prepared valuation is a multi-page document with multiple approaches and research included that will draw up a detailed explanation of the business's worth. The document will bring credibility to the asking price and can serve as a gauge for your listing price.  However, regardless of the business valuation, to attract buyer prospects initially, the asking price has to be seen as reasonable to a prospective buyer. That reality means that most buyers are interested in getting: (a) a reasonable return on investment, usually between 2 and 4 times the owner’s discretionary earnings (or EBITDA – Earnings Before Income, Tax, Depreciation, and Amortization); (b) the risk reduced by only putting part of the selling price as a down payment, with a professional intermediary who can bring financing to buyers, that is usually the bulk of the purchase price and having the seller carry some of the balance.

            This “reality” is very important to understand. The asking price must be seen as “reasonable” (compared to the risk) to a buyer. The general idea is for the buyer to get a 20% (for low risk) to 50% (for higher risk) return on their invested down payment. That means taking the owner’s discretionary earnings, the net profit plus the salary the owner takes plus depreciation, such discretionary items as contributions, interest payments or other expenses that will not pass on to the buyer, etc. - and subtracting a reasonable salary for replacing the owner’s labor, whether that’s personally for the new buyer or for the buyer to hire someone to replace the owner’s contribution to the business, to determine just how much cash there will be at the end of the year. From that number the buyer will deduct the amount of the annual payments to the seller. What’s left is the return on investment. 

            If that remaining cash is 1/5th of the money originally paid down by the buyer, that’s a 20% return on investment.  If it is half of the down payment, it’s a 50% R.O.I. However, if it’s only 1/20th (a 5% R.O.I.) or even 1/10th(a 10% R.O.I.), a sale is unlikely to occur. A professional intermediary has the experts to create a deal scenario that works for both the buyer and seller. The alternative is that it may just then be a “fire sale”, a price less than the wholesale and advantageous to the new owner if there are assets that are usable, necessary, or marketable. Purchase of the assets (such as inventory or equipment) rather than of the cash flow (profitability) of the business significantly reduces the pool of prospective buyers for the business to ones already in the business who want to buy the assets at a bargain to incorporate into their own business. 

4. Selling on Your Own vs. Using a Broker: Selling the business yourself might allow you to save money and avoid paying a broker's or intermediary’s commission, but that assumes you’d get the same sales price for the business, and it may make the likelihood of finding qualified buyers or getting full market value far less likely. Additionally, trying to sell yourself makes confidentiality almost impossible and takes your concentration away from operating your business. A reputable business intermediary can help free up time for you to keep the business up and running, keep the sale quiet and get the highest price (because they will want to maximize their commission).  

            While most intermediary companies charge a fee initially to provide the professional documentation that is often essential to the sale success, make sure this fee is for the documentation you’ll need. Also, many brokers want “exclusivity” for three years or more (meaning they receive the commission whether you find a buyer or they introduce the buyer). Exclusivity for one year is reasonable; three years is standard but can be negotiated to leave them a two year extension (beyond the first year of exclusivity) for their commission if and only if the sale is made to a buyer they introduced. In other words, it is reasonable for an intermediary or a broker to want to protect themselves if they are going to invest the time and money into promoting your business for sale. One year is a protection for them and a reasonable compromise for you as the business owner.  

            Businesses are NOT sold overnight unless you already have a buyer in the wings.  “Due diligence” by prospective buyers alone can take time, typically 90 days or more, so one year is minimally acceptable on the part of both parties. Another “reality” is that before “due diligence” can occur, the prospective buyer must submit an LOI (Letter of Intent) that you accept and that process also takes time.

5. Preparing Documents: Gather your financial statements and tax returns dating back three to five years and review them with an accountant (or, if you engage an intermediary, with the professionals that recast those financials to reflect reality).  In addition, develop a list of equipment or assets that are being sold with the business. Also, create a list of contacts related to sales transactions and supplies, and dig up any relevant paperwork such as your current lease. Create copies of these documents to distribute to financially qualified, potential buyers once they sign an NDA (non-disclosure document) to insure confidentiality, or which the intermediary will provide once they have vetted a buyer and gotten a confidentiality and non-disclosure agreement. Your information packet should also provide a summary describing how the business is conducted and/or an up-to-date operating manual.  Again, that is something that a professional business intermediary provides that is so important to attract qualified buyers and to stimulate reasonable offers. You'll also want to make sure the business is presentable. Any areas of the business or equipment that are broken or run down should be fixed or replaced prior to the sale. 

            Speaking of documents, it is always a good idea to have a prepared Offering Memorandum (an “offering” document that is part sales presentation, part financial information that attracts the buyer’s interest and informs the buyer of the possible opportunity and profitability in purchasing your business). This is typically best prepared by the reputable business intermediary who do this routinely and have experience in what attracts a buyer. It should be just enough to get them interested but not too long or detailed so the prospective buyer still needs to ask questions.

6. Finding a Buyer: A business sale may take between six months and two years according to SCORE, a nonprofit association for entrepreneurs and partner of the U.S. Small Business Administration. Finding the right buyer can be a challenge. If you’re going it alone, try not to limit your advertising, and you'll attract more potential buyers. Of course, there is a cost to advertising. The alternative, and for many the most successful one in terms of getting a “qualified” buyer and keeping the transaction “confidential” during the process, is getting a reputable intermediary firm, preferably one that already has buyers in place and buyer mandates for businesses in your industry, to market your business and act as the go-between.  Once you have prospective buyers, keep the process moving along: 

• If possible, get two to three potential buyers just in case the initial deal falters.
• Stay in contact with the potential buyers.
• Find out whether the potential buyer prequalifies for financing before giving out information about your business. If you plan to finance the sale, work out the details with an accountant or lawyer so you can reach an agreement with the buyer.
• Allow some room to negotiate, but stand firm on the price that is reasonable and considers the company's present and future worth.
• Put any agreements in writing. The potential buyers should sign a nondisclosure/confidentiality agreement to protect your information.
• Try to get the signed purchase agreement and initial down payment into escrow as protection from their backing out without specific cause.

You may require the following documents after the sale:

• The bill of the sale, which transfers the business assets to the buyer.
• A promissory note to pay the balance of the sales price and the terms related to it.
• An assignment of a lease.
• A security agreement, which has a seller retain a lien on the business. 

In addition, the buyer may have you sign a non-compete agreement, in which you would agree to not start a new, competing business and woo away customers.

7. Handling the Proceeds:  Take some time, at least few months, before spending the profits from the sale. Create a plan outlining your financial goals, and learn about any tax consequences associated with the sudden wealth. Speak with your accountant, your lawyer, or a financial professional to determine how you want to invest the money and focus on long-term benefits, such as getting out of debt and saving for retirement. 

Conclusion: Selling a business is time-consuming and for many, an emotional venture. A good reason to sell or the existence of a "hot" market or the right timing can ease the burden, as can the help of professionals. It may also be possible to receive free counseling from organizations such as SCORE, and your local Chamber of Commerce may offer relevant seminars and workshops. When all is said and done, the large sum of money in your bank account and your newfound free time will make the grueling process seem worthwhile.

Erik Bergman - Business Analyst - IAG M&A Advisors - (208) 930-1239