Finding a Buyer and Structuring the Sale
Once you've decided on the appropriate value for your business, the next step is to find a buyer. Potential buyers may be interested in your company solely for the money it will bring them; others may see it as a strategic fit for their existing businesses and yet others may wish to continue it as is. Preparing a selling memorandum is an important step in getting the message out to these buyers and conveying the important terms of sale.
Whether you are attempting to locate your own buyer or have retained a business broker to do the looking for you, you can jump start the process by thinking about the people or companies you come into contact with.
Think about your suppliers, customers, employees, and your local, regional, and national competitors. Do any seem to be possible candidates to be interested in purchasing your company? Are there any you would rule out, as someone you would not want to sell to?
Such a list can provide a starting point for your agent, although he or she should also have an extensive list of contacts in other regions or industries from which to draw.
Potential third-party buyers for your company can come from anywhere — your customers, suppliers, your community or industry competition. Buyers who are unrelated to you and who may be unearthed by your business broker can usually be divided into two groups: financial buyers and strategic buyers. A third group of potential buyers is composed of people you already know well: your family, managers, or employees. Finally, if your business has grown quite large and/or you're in an industry that's red-hot at the moment, you may be able to sell out to the general public via an Initial Public Offering (IPO), although an IPO is generally considered a tool to raise capital for on-going business development.
Financial Buyers Are Interested in Cash Flow
Financial buyers are interested primarily in your company's cash flow. They are typically individuals or companies with money to invest, and are willing to look at many different types of businesses or industries. In some cases they are corporate refugees—former executives of larger corporations who want to buy themselves a job by finding a company to actively manage. In other cases, they may be holding companies that are simply looking for good returns on their investments, and who would like your current management to stay in place.
Financial buyers will scrutinize your financial statements and your assets very closely. Most are looking for a solid, well-managed company that won't need a great deal of immediate change, but there are some investors who specialize in turnaround situations and will be willing to look at companies that are not currently profitable.
Strategic Buyers Look for Fit with Long-Term Plans
Strategic buyers are those who are interested in your company's fit into their own long-range business plans. A strategic buyer may be one of your competitors, or a similar company from another region that wants to expand into your local area. The classic strategic buyer would be a larger company who does what you do in a nearby region. However, another possibility is a company in a related business, whose management can see that your company has strengths from which they can benefit — for example, you may already produce a product that they want to sell, or you may have distribution channels that they want to exploit. Sometimes these types of buyers — who are in related, but not completely parallel businesses — are referred to as "synergistic buyers."
Whether synergistic or competitive, strategic buyers are generally the ones who will pay you the most for your company. The better the fit, the more they will want your business and the greater the premium they will pay.
You must be careful in speaking with competitors or people your business currently deals with directly as suppliers, vendors, or customers. Although they may be legitimately interested in buying your business, if the deal falls through, you don't want them to have gained enough information to ruin you.
It's best to let your agent deal with all potential buyers initially, revealing only enough to whet their appetite. If negotiations progress, you'll want to have them sign confidentiality agreements to protect your legal rights, but don't rely solely on the paper — you need to keep your sensitive information under lock and key until the final sales contract is signed.
Company Insiders Have a Stake in the Business
A third group of potential buyers for your company is your family, friends, and key employees. These people know your business from the inside, and may already have a personal stake in seeing that it survives and prospers. They may be willing to pay more for your company than an outside financial buyer would, because their inside knowledge lowers their risk.
However, the main problem with company insiders is that they frequently lack cash. You may have to finance a large part of the transaction yourself, or arrange third-party financing through a leveraged buy-out. The flip-side of this is that if you know the parties well, you may be more willing to be flexible as to terms; for example, you may be more willing to recover part of the sales price via an earn out provision, a consulting arrangement, or even a non-qualified pension plan.
How Can You Reach Buyers?
Now that you have a sense who your potential buyers might be, how do you go about reaching them? (Assuming, of course, that you're not going to be selling to company insiders, like your children or your key employees.)
You could start by advertising your company yourself, in the "Business Opportunities" section of your local paper, strong regional papers, and/or the Wall Street Journal or New York Times. You could also start sending out feelers to your friends, associates, and network of business contacts to see whether they or anyone they know might be interested in buying your business.
However, we don't recommend these tactics. If your employees, customers, and suppliers find out that the business is up for sale, you could have big trouble on your hands. Key employees might start jumping ship, and other employees might stop putting forth much effort if they see you as a lame-duck boss. Customers might search for other sources, and suppliers might search for other customers. Many people assume that when a company goes on the block, the primary reason is that it's on shaky financial ground, so you may find that credit is not being extended to you or people don't want to sign long-term contracts with you. Avoid all these problems. Keep your divestiture plans to yourself and your team of advisers as long as possible.
A better course of action is to let your business broker or mergers and acquisitions intermediary look for potential buyers for you. They should have a long list of contacts, including brokers in other areas of the country, to sift through in search of the perfect match. They may also advertise your business in local and national publications, trade journals, etc. under their name, not yours.
Your broker should be able to approach potential buyers confidentially, keeping your name out of the discussion, until some positive interest is shown. The broker should also screen the potential buyers to weed out those who are merely nosy, and those with no visible means of coming up with the purchase price.
Prepare a Selling Memorandum
One of the best tools to promote the sale of your business is a selling memorandum. If you are using a broker, this information will them understand your goals even more clearly.
A selling memorandum is essentially a business plan in reverse. It should present all the important information about your company, products, industry, and market in an easy-to-grasp format that presents your company in a very positive light. The elements of a selling memorandum are very similar to what you'd find in a business plan that was prepared for a venture capitalist or a banker.
Components of selling memorandum. It starts with an Executive Summary that briefly states out your key selling points, and tells the buyer why you want to sell. The buyer will always want to know why you are selling, so have some plausible explanation ready that casts your business in a good light!
You'll also need sections that describe
- the facts about your company's history, structure, and operations;
- the asking price and basic terms you're looking for;
- your industry, market, and products;
- your employees and physical assets;
- historical and projected financial statements; and
- any other information that will explain who you are and why your business is such a strong opportunity.
Keep in mind who your audience is! Don't divulge any information that you wouldn't want your competitors to see. On the other hand, remember that much of your financial information is publicly available anyway, so there's no need to be paranoid.
Your selling memorandum is essentially a marketing piece, and it's likely that your business broker will want to have a hand in creating it. In addition, you should run it past your lawyer and accountant (in fact, it's likely that your accountant will provide the financial information you include.)
In most cases, this memorandum is not considered a prospectus that would need to comply with SEC or state securities regulations. Nevertheless, it's important to make sure that your statements are accurate and not misleading or incomplete, and that your projections and written expectations for the business are reasonable.
In particular, if problems exist, don't try to cover them up. The buyer will find out eventually, and will probably distrust everything you say after that. In the worst-case scenario, you could be sued for fraud. Instead, where problems exist, briefly state the problem and then present one or more possible solutions. For example, if your revenues have been falling off, but you think a new advertising campaign will drive up sales, make sure that the two ideas are linked in your memorandum.
Do not show your selling memorandum to anyone who hasn't signed a confidentiality agreement, often referred to as a "nondisclosure agreement," or "NDA" for short. That includes your accountant, business broker, and other professionals (your lawyer will already be bound by professional responsibility requirements so a formal confidentiality agreement isn't necessary).
Defining Terms of the Sale
Terms drive price, and you should arrive at a general agreement with the buyer about the major terms before you start talking dollars. You may even include a short list of your absolute requirements as part of your selling memorandum, so that buyers who can't meet your minimum terms won't waste your time.
Among the terms you should be considering are
- What, exactly, are you selling? Which assets will go with the company, and which (if any) are you going to keep? Are your key contracts transferable to a buyer? If your business is incorporated, will you sell stock or assets?
- How much of the purchase price do you need to receive at closing? Will you consider an installment sale? Will you entertain an earn-out or stock as payment?
Once you've got a feel for what terms the buyer will accept and what you can live with, you can begin to negotiate the price.
General Ground Rules for Negotiating Terms
Some business advisers say that you should let your broker or intermediary do all your negotiating for you — that you should not talk directly with the buyer until almost everything has been settled. A broker may be better able to remain objective without giving too much away. Other business advisers say you are the best representative of your company and of your own expectations from the sale, and buyers will respond better to direct contact with you.
We think that you'll have to use your judgment about how you want to handle this. Some business owners are superb salespeople, and could probably close the deal better than their business broker.
On the other hand, some are not good "people persons" and are better off leaving the negotiations to a pro. The size and price range of your business may also play a part in your decision, since a broker will be more willing to spend a lot of time doing shuttle diplomacy if he knows he'll be making $50,000 or more on the sale. On smaller deals, the broker may do little more than to locate potential buyers and introduce them to you.
Be sure that a prospective buyer signs a confidentiality agreement before getting into any sort of serious discussion about terms with you or your broker.
We do advise you to arrive at some general agreement with the buyer — either directly, or though your broker — before getting your lawyer and tax adviser involved. Getting lawyers involved in a deal too soon is usually a mistake, since they tend to get caught up in the tiniest details rather quickly. And since you're paying these professionals by the hour, it's often best to make sure you can reach a basic agreement with the buyer before the legal fees clock starts ticking. You can save money by getting some of the initial dancing around out of the way before calling in the professionals.
However, we do recommend that you hold some preliminary, general conversations with your attorney, accountant, and/or tax expert even before any buyers turn up, just to be sure that you understand your options. We're just suggesting that in the usual case of a fairly straightforward sale of stock or assets, you may not have to involve the professionals in negotiations with a particular buyer until you're fairly sure that the deal will fly.
Make sure the buyer understands that anything you agree on is subject to your attorney's later review and approval. After the letter of intent is signed, there will be plenty of time for your respective attorneys to hash out the details.
Decide Exactly What You Are Selling
Although it may seem obvious, you know exactly which of your assets will be sold with the company. You may have already removed unproductive or nonessential assets from the business in the course of getting it ready for sale. If not, consider doing so now. If you have assets that aren't needed to run the business, the buyer isn't likely to pay extra for them — you may be better off retaining these assets and selling them yourself.
There may be some valuable assets in the business that you want to keep, such as real estate or equipment that you want to lease to the buyer (or someone else.) You may also be the owner of valuable patents, trademarks, or copyrights that you want to retain and license back to the buyer. This can become an important negotiation point. If you retain some of the assets, the purchase price will be lower, thus making the business more affordable to a larger group of buyers.
In particular, retaining real estate used in the business can provide you with a steady stream of rental payments for years to come. Particularly if you have a buyer who's tight on cash (such as your child or another young entrepreneur) you can keep the real estate for now, and perhaps sell it to your buyer at some point down the road.
Picking and choosing among the assets to be sold is easier if you aren't incorporated. In a sole proprietorship, you'll simply retain the assets you don't want to sell — you won't be taxed on any profits unless and until you eventually decide to sell them. Partnerships and LLCs can keep the unwanted assets and distribute them in kind to partners or members upon liquidation, although the individual partners may have to pay some tax upon what is technically a dissolution of their business.
In a corporation, it becomes even more complicated. You may have to purchase the asset at fair market value, with the corporation paying tax on any capital gains inherent on the asset, if you want to remove the asset from the business entity. Consult your tax adviser for more details.
During the due diligence phase of the negotiations, the buyer will want to see a detailed listing of all the assets, their book value, and their fair market value. You'll be held to whatever list you provide, so make sure it's accurate to the best of your ability.
Will Key Contracts Be Transferred?
One issue you should examine closely, as you make your plans to sell your business, is the transferability of your key contracts.
Ideally, your most important contracts, including leases and contracts with customers and suppliers, should be assumable by the buyer. That way, you can get out from under the contract, and the buyer will have the resources needed to conduct business. If important contracts are not assumable, it will affect the buyer's willingness to buy your business since the contracts will have to be replaced or renegotiated.
If your business is organized as a corporation, selling stock, rather than assets, can solve the assumption problem since most contracts were probably made with the corporation rather than you personally. This is one reason some buyers may agree to or even prefer a stock sale.
If you rent your facility, try to get your landlord to sign a new lease with the buyer, rather than having you sublet to the buyer. Generally, a sublessor (which would be you) remains liable for the rent if the sublessee doesn't pay, for the duration of the lease.
The assignment of existing loans on the business can be a problem, if you had made personal guarantees to the lender. You don't want to be personally liable for the buyer's success in the business. If you can't get the bank to release you from further liability on the loan, you'll need to make sure that the cash paid at the time of purchase is sufficient to pay off such loans.
Will You Sell Assets or Stock?
If your business is incorporated, you have a very important decision to make: will you sell the assets of the business, or the stock? This is one of the most important terms in a sale of an incorporated business.
In most cases, selling stock is better for you, but selling assets is better for the buyer. If you agree to the buyer's demands for an asset sale, you should insist on a higher price because of the significantly higher taxes and liability risks you'll face.
With a C corporation, tax aspects are the main reason for the seller's preference for selling stock. Simply put, if you sell the stock, you'll pay capital gains tax on the sale, based on your tax basis in the stock (i.e., what you paid into the corporation in exchange for the stock).
In contrast, if you sell the assets, you are essentially taxed twice: first, upon selling assets to the buyer, the corporation will pay capital gains tax on the value of the assets over their existing basis to the corporation. Second, when the corporation is liquidated, you'll personally pay capital gains tax on the excess of the net proceeds of the sale, over your existing basis in the stock. With an S corporation, you can usually avoid this double tax.
However, the other main reason that sellers prefer stock sales, while buyers prefer asset sales, does apply to both C corporations and S corporations. The reason is that with a stock sale, any unknown liabilities the company may have are transferred to the new owner. With an asset sale, the liabilities would remain with the seller. Some examples might be future product liability claims, contract claims, lawsuits by employees, pension or benefit plan liabilities, etc. stemming from seller's ownership of the company.
Now, with careful legal drafting, these general rules can be altered in the sales contract. For example, in an asset sale, the contract can state that the buyer will assume certain liabilities of the seller. Because third parties won't be bound by the terms of the contract, the contract can also include escrow arrangements or indemnification clauses that will remove some of the buyer's risks, by stating that the seller's money will be used to pay for claims. However, if the drafting is not perfect and anything is left out, the general rules will kick in.
There are some reasons why the buyer may prefer a stock sale in certain situations. If the corporation has a good credit rating, the buyer may want to buy stock. Certain contracts such as leases, supply contracts, or employment contracts may have been written between the corporation and the third party, and it will be easier for the buyer to maintain these contracts if the stock is transferred. Stock sales may also be simpler to carry out since there's no need to transfer and re-title every single asset.
In earlier years, stock sales used to be quite rare, particularly for smaller companies. However stock sales have increased in popularity. The bottom line is that if the buyer insists on an asset sale, make sure you get paid for it!
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