I’ve been an entrepreneur all my life. I’ll save the details for another blog, but for now I’ve wanted to educate fellow entrepreneurs on the (basic) ins and out of buying or selling an existing business.
While I was going to school for my (first) MBA, I had the opportunity to work in the office of a business broker. I was welcomed with open arms — young, hungry, and craving opportunity — I fit in rather well. To my surprise, most of them were fellow entrepreneurs, many of whom had previously sold their own businesses.
What more could I have asked for? It was environment ripe for learning how business was done in the real world. Ironically (nobody knew this at the time), the fact that the two office owners were complete and utter frauds provided even better learning opportunities. I got to see the wicked games these business brokers play from the inside.
If you’re wondering what happened, once I (and several others) pieced together just how bad the owners’ unscrupulous business practices were, we left the office immediately. It was incredibly unfortunate because I do believe in the service that was being provided. Small business owners of all shapes and sizes came to these people because they had no idea where they should / could go to sell their businesses. It was typical that they had worked for decades on their companies, but never gave much thought to an exit or succession strategy, and when their children did not want the company, they had few options. In essence, we were their retirement plan, and that’s something I took very seriously.
Being a business broker was one of those atypical experiences I speak of in my blog: The New ROI. At the time, it didn’t produce a very positive outcome, but over the long-term, I cannot tell how how much it has helped me (as an accountant) when I have to guide my clients through their acquisition or sale. I’d like to following to serve as some helpful tips to those thinking about buying or selling a business.
PRO TIP:
If you decide to use a business broker, they should NEVER speak in lieu of your lawyer or accountant. You should have legal and financial professionals in your corner, and if you don’t — find them! The business broker should merely facilitate communication amongst each side’s professional ‘teams,’ but should never take the place of them.
In general, I think the main purpose of a business broker would be to market a business that is for sale. I look at them as having more exposure to potential buyers in the market than just a single-post on a listing site. I’d hope the broker would have a good volume of qualified buyers combing their listings.
This might be an appropriate point to briefly explain the first few steps of the business-listing-and-buying process.
1. The seller first discovers a realistic asking price and ‘lists’ his or her business for sale. In order to do this, there’s a few expectations that should be laid out. One of the main expectations I would tell a seller is that unfortunately their blood, sweat, and tears throughout the years aren’t worth anything. I have the utmost respect for the owners and the business they built, but selling their business is an objective activity. Buyers won’t / don’t care what they ‘put into’ the business or how many years they have been slaving away. What matters is how much the business is worth RIGHT NOW.
If you think you might sell your business at some point, it’s a really good idea to start planning 5-10 years beforehand. This will give you plenty of time to get enough information on your particular industry and groom the business for an eventual sale. With proper planning, you’ll have WAY more options available.
Another expectation I might mention is the fact that a seller should be open to ‘holding some paper,’ or in other words be willing to receive payments on some amount of the purchase price of the business (instead of getting the whole amount up front). Nowadays, it’s good for sellers to have some skin in the game, and nearly any bank financing a deal would want to see the same thing. I have found that the single most critical variable in completing this transaction is the reasonableness of the seller. They should keep an open mind and be open to creative solutions.
As for how much the business might be worth, there’s several ways on how to value a business (this will be discussed in detail in a separate blog post). Each depends on the size and industry of the business and the particular situation of the owner. When in doubt I’d suggest consulting with a Business Valuation Analyst. These professionals are the ‘appraisers’ of the business world and would give an objective, independent look at what the business might be worth.
To give you a really quick idea of some of the terminology used — you might hear someone say “businesses in that particular industry are selling for one times revenue.” This means that the (typical) sale price is the same as the gross revenues (or sales) that the business brings in over one year. You might also hear “in this particular industry, business sell for two (or three or four) times EBITDA.” EBITDA means Earnings Before Interest, Taxes, Depreciation, and Amortization. Lastly, many businesses can sell for the value of their assets. One method isn’t superior, but again depends on the industry and situation.
2. Determine the level of confidentiality! This step might be included during the ‘listing’ phase, but I find it important enough to list separately. It’s a conversation that NEEDS to happen — deciding how much information is safe to divulge to vendors, employees, and for the listing. Unfortunately, I don’t have a consistent recommendation on what approach to take, other than “it depends on the situation.”
I’ve seen several approaches. On one hand, I’ve seen absolutely nobody know that a particular business has been sold until the day the buyer walks in and is introduced as the new owner. On the other hand, I’ve seen owners shout the business listing from the rooftops and find a qualified internal candidate that ends up purchasing the business.
If you’re afraid that employees will leave or vendors will no longer do business with you, then I’d consider a more confidential approach. Buyers would have to tour after-hours and you would opt for a more general business listing that does not divulge the name of the company. For example, a particular listing might say, “Liquor Store in Western New York Suburb.”
If you believe that full transparency might resonate with your employees and vendors, then you could scrap the confidentiality and formally tell everyone that you’re planning on selling the company. I’d recommend mentioning how you might consider internal candidates, but will do your best to ensure the new buyer is someone qualified that will respect everyone currently within the organization.
PRO TIP:
Beware of the business broker’s “sole and exclusive right to sell” AND “listing contract auto-renewal.” These might seem self explanatory, but some business brokers will demand a sole and exclusive right to sell listing agreement. This means that wherever a buyer might have came from, they will get their commission. That’s right — even if your brother-in-law decides to purchase the company, or if the broker doesn’t have to lift a finger, they still get paid. This might be acceptable to some sellers (and that’s ok), but never made sense to me. I think that the broker should be motivated to find a suitable candidate and not necessarily rely on the seller’s network or hard work. There should be incentive for equal effort in my opinion.
Another thing I didn’t like was the auto-renewal feature on the listing agreement. So even if communication with the broker goes dark, their contract would renew and they could still have claim to a commission long after their active involvement ceases. Now I’m no lawyer, so I’m not even sure something like this is legal, but I don’t think it is a good business practice for the broker. Again, the incentive should be to remain active and create a situation where the seller WANTS to renew.
WATCH OUT!!!!! —– The listing contracts I’ve seen would be varying in length, but would average one to two years. Realistically, it’s possible but not very common for a business to sell sooner. I remember that a dirty trick the brokers would play is that a few months before contract renewal came, they would parade FAKE buyers through the business to show how activity was ramping up and they should keep the relationship with the broker. And it worked — all the time.
Clients would believe that if they canceled their contract with the broker these buyers would vanish, and I don’t blame them, how could they risk not having buyers when they have (usually) waited so long to find one. If you haven’t talked to your business broker all year and all of a sudden lots of buyers show up right before contract renewal — take note and verify their validity!
3. After the business has been valued and listed, this is when the first round of potential buyer screening takes place. In my experience, this was usually done by the business broker, especially when dealing with a more confidential listing. The most basic function of the initial screening is to eliminate competitors looking for inside information and for ‘tire kickers,’ or buyers without the qualifications or financial wherewithal to complete the sale.
Most the time, an in-depth conversation (with lots of questions) would be appropriate, but I’d also recommend that if the potential buyer wants more information, they agree to an in-person meeting with the expectation of signing a Non-Disclosure Agreement (NDA) and discussing their personal financial situation. This is a show of good faith and might weed out a good percentage of buyers that are not serious. You’d be surprised at how few people actually showed for these meetings, but if they did, it was a good indication of their commitment to actually move forward with the process.
4. Having the potential buyer sign the Non-Disclosure Agreement (NDA). I’m no lawyer, but I’ll do my best to explain my understanding of this document. Ultimately, it is a reminder that the business being listed, all of its financials, and any other proprietary / sensitive information MUST BE KEPT CONFIDENTIAL. And if it is not kept confidential, legal action will be taken. In some cases, if the business listed for sale is made known to the public, there could be serious repercussions like employees, customers, and suppliers leaving or not being willing to do business with the company. The introductory information being disclosed is incredibly sensitive and should be treated very seriously.
5. Once the NDA is signed (and its seriousness understood), the conversation gets much better! The actual business name and location can be disclosed, as well as any financial statements and tax returns. Usually we see the seller give three to five years worth of tax return and financials (profit & loss and balance sheet). This information is usually adequate for the potential buyer to validate the listing price and make an offer.
This is also when a tour of the business is scheduled, usually outside of normal business hours. The seller can also be available for an introduction and further questioning during the tour.
PRO TIP:
If you are a potential buyer at this stage of the game — looking at the financials and tax returns can be an overwhelming experience. Be sure to call your accountant or financial representative to help you during this process, they should be able to help you understand what certain ‘items’ mean. In the meantime, I recommend taking a common sense approach. When you look at each line item, ask yourself “given this type of business and given what I’m observing, does this expense make sense?” Asking DOES THIS MAKE SENSE, should help you identify red flags or items that require further questioning.
For example, if you’re purchasing a storage unit complex and there is a huge number being expensed for fuel, you might want to ask why. Is there a company vehicle? Or is the owner just fueling up his personal vehicle — in which case, that’s useful information because that’s cash that the business is currently using now, that might not need to leave the business under different ownership. This is what I would consider ‘discretionary spending.’ This means that the current owner spends these funds because they WANT TO, not necessarily because they NEED TO in order to maintain normal business operations.
Another expense item that would be similar is non-recurring expenses. For example, if a roof is installed or large repair made, that’s presumably something that is not going to be done every year, and so under normal circumstances the profit of the business would usually be higher. Don’t be afraid to take it page-by-page, line-by-line, or to ask questions. As they say, the devil is in the details and you might not know what might be ‘buried’ in the tax return.
6. The NDA is signed and the buyer has seen the financials. The next step is for the buyer to start drafting the Letter of Intent (LOI). The LOI is the basic precursor to the actual purchase contract. To my knowledge, it does not legally bind either party to the sale, but rather lays out the basic items of the deal. I would expect to see a line like this — “The parties agree that this Letter merely is an expression of intent and that neither party is under any legal obligation to the other unless and until a definitive Purchase Agreement is executed.”
The LOI does not have to go into a great deal of detail, but should be enough for each party to feel comfortable moving forward with the conversation. Some of the items it discusses:
- Purchase Price – This price may or may not be the same as the asking price, and is subject to change as the result of Due Diligence.
- Financing Terms – How will the buyer finance this deal? How much paper will the seller hold (and at what rate)?
- Payment Period – How long will payments be made to the seller?
- Transition Period – How long will the seller ‘stay on’ and work for the company after the sale?
- Retention Period – Are the payments to the seller based on the retention of a certain number / percentage of clients (or maybe sales)? If so, for how long?
The LOI can pause the seller from engaging with other buyers or accepting other offers. For instance, look for verbiage like this — “For so long as neither Buyer nor Sellers have provided the other with written notice of the termination of this Letter, Sellers agree not to accept competing offers or to enter into discussions with any potential purchasers other than Buyer.”
Finally, the LOI usually begins the clock for the due diligence period.
PRO TIP:
The LOI can be a critical step. The more detail you go into and more you negotiate in the LOI, the less painful it will be when having future negotiations for the Purchase Agreement. Personally, I like getting the difficult conversations done sooner than later. I wouldn’t want to invest a great deal of time into a deal that will fall apart later on when the difficult items are discussed. I recommend being transparent and respectful, but forward enough to ask the difficult questions early on in the process.
7. Due Diligence! This is one of my favorite steps of the process. During due diligence, the seller opens their books and business to the potential buyer and their financial team. Everything is scrutinized to make sure there will be no surprises after the sale is complete.
There are two main forms of a ‘sale.’ An asset sale and a stock sale. With an asset sale, only the assets of the business will be sold, meaning the new buyer will have to create a new business entity and re-establish things like insurance policies and supplier/vendor contracts. On the other hand, since only the assets are changing hands any previous liabilities will ultimately stay with the seller. With a stock sale, things are a bit more seamless in that the new buyer ‘steps into’ the previous business entity via the purchase of the company’s stock. If this is the type of transaction you’re looking for, due diligence is a critical step because you really need to make sure there aren’t things that will come back to haunt you.
A few of these ‘things’ are:
- Pending Lawsuits / Legal Action(s)
- Open Insurance Claims
- Unpaid Taxes
This list certainly is not exhaustive, but it includes the really big points to consider. In my experience, if those things are considered, other obstacles that might arise are totally do-able and most likely wouldn’t jeopardize the deal. And if you’re Warren Buffett, you can live with the price being all the due diligence you need!
When in doubt, your lawyer and accountant should both have boilerplate due diligence checklists for these types of occasions. Combine them into one master checklist, label each category with a different number or letter, and save all the documents accordingly.
PRO TIP:
If you’re using a business broker, they might be helpful during this step, but (AGAIN) do NOT have them speak on behalf of your legal or financial team. It might be really tempting because the broker usually will be able to process things faster than an attorney or accountant, but it’s not a good idea. I recommend having your business broker facilitate things and have regular check-ins with each side’s professional teams to keep things moving in a timely way.
