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7 Issues to Consider When Selling Your Business

This article has been prepared to familiarize business owners with some of the issues and considerations inherent in selling their business. It is not intended to be a comprehensive discussion but can be used as a tool in helping a business owner understand the selling process.


1. PREPARING YOUR BUSINESS FOR SALE

It is critical you take the time to enhance the attractiveness of your business and show potential buyers the benefits of buying your business. The impression of a well-managed business increases the company’s salability and its value.

The first step in preparing your business for sale is to look at your business from a buyer’s perspective. Factors to consider include the following.


Building and Equipment

The grounds should be well groomed, and the building and equipment should be clean and well maintained.


Management and Employees

If possible, have a management team in place that can run the business without you. Document all your employment policies and procedures. Clearly define and document each employee’s responsibility. Prepare bios on key employees. Create a procedure manual and systematize all your business functions.


Business Records

Accurate and up-to-date financial records are critical to a business sale. These documents establish credibility for you and help prevent problems during negotiations.

You should have monthly or quarterly financial statements. Interim financial reports help demonstrate your ability to monitor and manage the performance of your business. You should be able to reconcile your internal financial statements with your tax returns. In addition, you should consider having a CPA compile, review, or audit your financial statements.


Business Relationships

You should document existing contracts with customers and suppliers. If possible, convert verbal agreements into written agreements. Examine existing contracts with suppliers and customers to ensure they will not expire or require renegotiation during the time when you plan to sell the business.


If the business includes real estate, you should discuss possible alternatives for lease or sale with your attorney and third-party representative.


Business Enhancement Strategies

To enhance the attractiveness and value of your business you should consider the following strategies:

  • Maximize profitability by reducing or eliminating personal (e.g., excess owner’s compensation and perks) and non-recurring and one-time expenses.

  • Improve operating margins by implementing cost-saving measures.

  • Sell all slow moving or obsolete inventory.

  • Sell any excess or obsolete machinery and equipment.

These strategies will enhance the value of your business and eliminate disputes about potential cost savings and the value of inventory and machinery and equipment.


2. HOW TO SELL YOUR BUSINESS

At this point, you must decide whether to sell the business yourself or engage a third-party (i.e., investment banker or business broker). Selling the business, yourself can save you money by avoiding paying a broker’s commission. This route is frequently used when selling to a family member or current employee.


In other situations, a third-party is generally preferred. Hiring a third-party allows you to run your business while they focus on contacting and qualifying potential buyers, marketing, and helping negotiate the business sale transaction.


A business broker is an individual who acts as an intermediary between buyers and sellers of small businesses. Generally, business brokers focus on transactions with a price under $5 million. Business brokers assist sellers of closely held small businesses in the selling process. They typically estimate the selling price of the business; advertise it for sale with or without disclosing its identity; handle the initial potential buyer interviews; facilitate the progress of the due diligence investigation, and generally assist with the business sale. (Source: Wikipedia)


An investment banker is a firm who represents a seller in the sale of the seller’s business. Most investment bankers focus on middle market companies with annual sales of $10 million and up. An investment banker maintains strict confidentiality through the sale process. An investment banker typically works with the seller to prepare an offering memorandum; compiles a prospective buyer list, which includes strategic buyers, financial buyers, and private equity investment funds; markets the business to potential buyers; negotiates terms; and facilitates the due diligence and closing process.


3. ESTIMATED SALE PRICE

One of the most widely used metrics to estimate the sale price of small to mid-size companies is EBITDA multiples (earnings before interest, taxes, depreciation and amortization). The calculation of EBITDA is as follows:


Adjusted net income*

+ Income taxes

+ Interest expense

+- Other income

+ Depreciation and amortization expense

= EBITDA (sustainable)

* Excludes non-operating (e.g., excess owners’ compensation and perks) and one-time expenses and income


Once sustainable EBITDA is determined, it is necessary to determine an appropriate multiplier to arrive at the business’s value. Valuation multiples vary significantly depending upon industry and a variety of factors (e.g., trend in sales and profits, sales mix, competition). “Typical” multipliers range from 3 to 8 times EBITDA.


Shown below is a simple example of a business’s value using EBITDA. Assume ABC manufacturing has $2 million in sustainable EBITDA. Further, assume a buyer is willing to pay an acquisition premium (multiple) of “4 to 6” times EBITDA for the company. This yields an implied enterprise value of $8 to $12 million. This is the initial range of your company’s market value.


EBITDA $2,000,000 $2,000,000

Valuation multiple 4 6

Enterprise value $8,000,000 $12,000,000

Enterprise value represents the value of the company that is attributable to all investors (debt and equity).


Note: smart buyers will subtract a normalized level of capital expenditures from EBITDA to arrive at an estimated range of your company’s market value.


EBITDA $2,000,000 $2,000,000

Less: normalized cap ex $ 200,000 $ 200,000

Adjusted EBITDA $1,800,00 $1,800,000

Valuation multiple 4 6

Enterprise value $7,200,000 $10,800,000

Valuation multiples are generally estimated by business appraisers, investment bankers, and business brokers.


4. Offering Memorandum

Potential buyers will require preliminary information concerning the business to decide if they are interested in learning more about the business. An example of the content of an offering memorandum prepared by an investment banker includes:

  • Executive summary

  • Investment highlights

  • Business description (e.g., history; market and competition; customers; products and services; organization, personnel and benefits; marketing and sales; operations; facilities)

  • Future growth opportunities

  • Financial information

  • Conclusion and transaction objective

5. Due Diligence

Due diligence is an investigation or audit of a potential investment. Due diligence serves to confirm all material facts regarding a sale. (Source: Investopedia)


As part of the due diligence process, you will receive a request for information including company history and outlook, past financial statements, forecasts, tax returns, shareholder salaries and benefits, and details of amounts paid to related parties. A buyer and his/her represent will request a site visit and interviews with key management and possibly external advisors (accountants and lawyers).


Examples of information frequently requested include the following:

  • Last three to five years’ balance sheets and income statements

  • Year-to-date income statement and current balance sheet

  • Last three to five years’ tax returns

  • List of competitors

  • List of customers

  • Aging of accounts receivable and accounts payable

  • Listing of servicing banks

  • Details of notes receivable and copies of the notes

  • Details of prepaid expenses

  • Listing of all assets being sold (e.g., inventory, fixed assets, intangible assets)

  • Copies of property appraisals, lease agreements, and equipment leases

  • Employment contracts and compensation agreements

  • Details of any and all contingent liabilities

  • Last three years’ personal expenses, including payroll for family members

  • Corporate records: articles of incorporation, by-laws, organizational resolutions and any buy-sell or redemption agreements

Disclose everything and avoid making any guarantees. Full disclosure will help eliminate disputes and keep the negotiations on track.


When selling a business, obtain professional financial and legal advice to prepare the required information and documentation.


6. SELLER FINANCING A BUSINESS SALE

Business owners would prefer an all-cash transaction. However, business sales frequently involve some type of financing. Generally, financing will come from a third-party lender (e.g., bank), seller financing, or a combination.


Seller financing allows the buyer to pay a portion of the purchase price in cash and the seller takes a promissory note for the remaining balance. For example: the transaction might be structured with a 40 percent down payment while the remaining 60 percent is financed by the seller. The seller note typically would run for a period of five to seven years and carry an above average market interest rate. In addition, security provisions may be added. Security provisions may include personal guarantees, first mortgage on any real restate, first security agreements on personal property, life and disability insurance policies, and business restrictions.


When selling a business, obtain professional legal advice to prepare the required information and documentation.


7. USE OF PROFESSIONAL ADVISORS

When preparing a business for sale, professional counsel (i.e., legal, accounting, tax, investment banker, business broker, and/or business appraiser) should be consulted to insure the most current and pertinent information is being utilized. The use of experienced, knowledgeable professionals will add credibility to your negotiations and asking price. It may also reduce the actual time needed to close the transaction.


This article was written by Dennis Bingham, one of the mentors at Minneapolis Business Mentors. Need help in buying or selling your business? We offer FREE mentoring advice! Contact us at info@mbmentors.org


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