Are You Thinking About Selling Your Business?
The COVID-19 pandemic has put unprecedented stress on private business owners. Some are now considering selling their businesses before Congress has a chance to increase the rates on long-term capital gains. Before putting your business on the market, it's important to prepare it for sale. Here are six steps to consider.
1. Clean Up the Financials
Buyers are most interested in an acquisition target's core competencies, and they usually prefer a clean, simple transaction. Consider buying out minority investors who could object to a deal and removing nonessential items from your balance sheet items. Examples of items that could complicate a sale include:
- Underperforming segments,
- Nonoperating assets, and
- Shareholder loans.
Sales are often based on multiples of earnings or earnings before interest, taxes, depreciation, and amortization (EBITDA). Do what you can to maximize your bottom line. That includes cutting extraneous expenses and operating as lean as possible.
Buyers also want an income statement that requires minimal adjustments. For example, they tend to be leery of businesses that count as expenses personal items (such as country club dues or vacations) or engage in above-or below-market related party transactions (such as leases with family members and relatives on the payroll).
2. Highlight Strengths and Opportunities
Private business owners nearing retirement may lose the drive to grow the business and, instead, operate the company like a “cash cow.” But buyers are interested in a company's future potential.
Achieving top dollar requires a tack-sharp sales team, a pipeline of research and development projects, and well-maintained equipment. It's also helpful to have a marketing department that's strategically positioning the company to take advantage of market changes and opportunities, particularly in today's volatile market conditions.
3. Downplay (or Eliminate) Risks
It's no surprise that businesses with higher risks tend to sell for lower prices. No company is perfect, but industry leaders identify internal weaknesses (such as gaps in managerial expertise and internal control deficiencies) and external threats (such as increased government regulation and pending lawsuits).
Honestly disclose shortcomings to potential buyers and then discuss steps you have taken to mitigate risks. Proactive businesses are worth more than reactive ones.
4. Prepare a Comprehensive Offer Package
Potential buyers will want more than just financial statements and tax returns to conduct their due diligence. Depending on the industry and level of sophistication, they may ask for such items as:
- Marketing collateral,
- Business plans and financial projections,
- Fixed asset registers and inventory listings,
- Lease documents,
- Insurance policies,
- Franchise contracts,
- Employee noncompete agreements, and
- Loan documents.
Before you give out any information or allow potential buyers to tour your facilities, enter into a confidentiality agreement to protect your proprietary information from being leaked to a competitor.
5. Review Deal Terms
Evaluate different ways to structure your sale to minimize taxes and maximize selling price. For example, one popular element is an earnout, where part of the selling price is contingent on the business achieving agreed-upon financial benchmarks over a specified time. Earnouts allow buyers to mitigate performance risks and give sellers an incentive to provide post-sale assistance.
Some buyers also may ask owners to stay on the payroll for three to five years to help smooth the transition to new management. Seller financing and installment sales also are common in management buyouts and purchases by joint venture partners.
6. Hire a Valuator
A fundamental question buyers and sellers both ask is what the company is worth in the current market. To find the answer, business valuation professionals look beyond net book value and industry rules of thumb.
For instance, a business valuation professional can access private transaction databases that provide details on thousands of comparable business sales. These “comparables” can be filtered and analyzed to develop pricing multiples to value your business.
Alternatively, a valuation expert might project the company's future earnings and then calculate their net present value using discounted cash flow analyses. These calculations help buyers set asking prices that are based on real market data, rather than gut instinct. However, final sale prices are influenced by many factors and can be lower than a company's appraised value.
They can also estimate the value of buyer-specific synergies that result from cost-saving or revenue-boosting opportunities created by a deal. Synergistic expectations entice buyers to pay a premium above fair market value.
Consider Selling Business Assets, Not Stock
In general, owners who sell their businesses prefer to sell stock, rather than assets. Here's why.
Stock sales. These transactions are comparatively simple. Plus, the tax obligations are usually lower for the seller under a stock sale than under an asset sale.
However, buyers may be reluctant to structure a deal as a stock sale, because they must assume more risk. That is, the business continues to operate, uninterrupted, and the buyer takes on all debts and legal obligations. In a stock sale, the buyer also inherits the seller's existing depreciation schedules and tax basis in the company's assets.
Asset sales. Sellers who are open to asset sales may attract more buyers than those who are focused only on selling stock. Assets sales allow buyers to cherry-pick the most desirable assets in a deal. In addition, asset sales offer a fresh start: The buyer receives a step-up in basis on the acquired assets, which lowers future tax obligations. And the buyer negotiates new contracts, licenses, titles, and permits.
The seller's tax bill in an asset sale can vary significantly depending on the circumstances surrounding the proposed deal and the type of entity (C corporation, S corporation, LLC, etc.). In many cases, the tax hit can be substantially reduced with proper advance planning. Seek advice before a transaction is complete or you may find yourself locked into an unfavorable tax outcome that could have been avoided.
Planning for a Sale
Operating in a sale-ready condition is prudent, even if you're not planning on selling your business anytime soon. Our experiences in 2020 have taught us to expect the unexpected: You never know when you'll receive a purchase offer, and some transfers are involuntary. Contact John to help you prepare for a sale whether in 2021 or beyond.