For Sale by Owner
This helpful Q&A offers great guidance for navigating the successful sale of a business.
When business owners get ready to sell, they sometimes underestimate the amount of time and energy the process can require. Putting a business on the market can be unfamiliar territory to even the most savvy business owners. This article is not only a good primer for preparing a business for the market, but it also offers personal accounts and tips that can speed the process along and help it go off without a hitch.
A Personal Story
As president and vice president of Prime Investments, the authors of this article have a great deal of firsthand experience with selling businesses. The following real-world scenario is a good example of a typical selling situation.
One of the first business sales we ever worked on was a $30-million-a-year lighting distributor. The lead came in from a cold call. The seller was very secretive—he wouldn’t give us any information over the phone because he wanted to meet us first. This was before the age of websites and instant online reports. As we drove to meet him, we thought it was probably a waste of our time, that the gentleman was probably selling light bulbs out of his trunk. But when we arrived at our destination, we were pleasantly surprised by the large, modern building with the gentleman’s name in 2-foot block letters over the front entrance.
The owner turned out to be a very sophisticated and savvy businessman. He was a hands-on owner, completely knowledgeable about his industry, international trade mechanisms, finance, and management. He wanted to sell his business and retire, but he had no clue as to how to proceed. He needed a business sales professional to educate him about the process, package his business for sale, locate the right buyer, put the deal together, and see the deal through to closing.
Almost 20 years later, the owner in this example is typical of most business owners today. No matter how sophisticated and successful, business owners often have little or no knowledge of how to go about selling their businesses. The following Q&A on the basic issues and process is a good starting place for business owners who want to sell.
Q: Why do people sell their businesses?
A: Retirement is the first answer that comes to mind when most people are asked this question. However, only a small percentage of business sellers are of traditional retirement age. Many successful owners sell while in their 40s or 50s. They want to turn the value of their business into cash while they are still young enough to enjoy their lives, spend more time with their families, travel, or even begin a new business venture.
Q: How long does it take to sell a business?
A: It typically takes 6 to 12 months to sell a business. Even if there is a buyer in hand today, the process—including letter of intent, due diligence, purchase contract negotiations, financing, and settlement—takes a minimum of 4 months (and that is if no problems arise).
Q: Is there a market for businesses?
A: Absolutely. Just as there is a market for the goods or services a company provides, there is a market for businesses for sale. Prices are defined by a competitive market.
Q: Do most buyers target a specific type of business?
A: No. Most buyers are interested in broad categories—such as service trades, construction trades, or distribution—and then limit the search by geographic and size considerations.
Q: What kinds of businesses do buyers avoid?
A: Buyers avoid businesses where there is a substantial risk that the company’s goodwill will not transfer. Goodwill might not transfer for one or more of the following reasons:
- unstable customer concentration (one or two big customers whose loss would cripple the business);
- the business is really a personal service business (where the knowledge and relationships necessary to conduct the business reside exclusively with the owner); or
- external risk factors, such as increased competition, impending loss of a valuable location, or technological obsolescence.
Q: Why do people buy businesses?
A: People buy businesses: 1) to make money, 2) to make money, and 3) to make money. Whether buyers are individuals, equity funds, or other businesses, they buy businesses to make money. Of course, many also want the freedom to succeed or fail on their own merits, and business ownership offers that opportunity. In the end, however, buyers are paying for the right to step into the previous owner’s shoes and make even more profits.
Q: How are businesses valued?
A: Buyers buy businesses to make money, so it is not surprising to learn that businesses are valued based largely on how much money they make. Other factors that influence the valuation include the type of business, recent trends in the individual business and its industry, assets and/or liabilities included in or excluded from the transaction, geographic desirability, and the existence of risk factors like those that might affect goodwill transferability (listed in the answer to a previous question).
Q: Is the valuation based on taxable income?
A: Valuations typically use formulas that include the corporate taxable income and other benefits that the owner takes from the business, such as the owner’s salary; interest on debt that will not transfer; non-economic depreciation and amortization; one-time, non-recurring expenses; and pension contributions. These formulas also include the owner’s discretionary expenses paid for by the business that are not related to the actual operation of the company. This bundle of owner’s compensation items is called the owner’s discretionary cash flow or adjusted EBIDTA (earnings before interest, depreciation, taxes, and amortization).
Q: Should you use a broker to sell your business?
A: Yes. It is in the owner’s interest to use an intermediary. Intermediaries package the business and present it in the best light to obtain the highest possible price. They maintain confidentiality and field all inquiries away from the business premises. They also find the best possible buyer for a particular business and minimize the amount of time the owner spends on the sale. They resolve differences between the buyer and seller before they become personal. In addition, they help secure financing and keep the deal on track, moving forward to settlement.
Q: How does a business owner choose a broker?
A: Selling a business is a delicate and complicated matter that needs to be guided by a hands-on, experienced professional. The first rule is to choose a broker who is local. The broker needs to be there—in person—to guide the process, attend meetings, assess personalities, anticipate and solve problems, walk those involved through the process, negotiate, and sometimes cajole. Basically, the broker’s job is to do whatever is necessary to make the deal. A broker’s work simply cannot be phoned in.
Before deciding on a broker, it is best to meet the candidates in person. Business owners should determine if they comfortable with this person. They should ask themselves, Will this person represent the business in a professional manner? In this situation, one cannot ask too many questions of prospective brokers. Some important ones to start with include the following:
- Does the broker understand what the owner is trying to accomplish by selling the business?
- What is the broker’s plan for selling the business?
- Can the owner see a sample prospectus?
- How does the broker find potential buyers?
- Does the broker charge a fee up front or get paid only when the sale is completed?
Owners also should ask for and check three to five references. These should be from recent sales of businesses that are similar in size and type to the one being sold. An owner does not want the broker to be learning on the job with this important transaction.
Q: What should the business prospectus (the offering package) contain?
A: A good prospectus should contain the following:
- A history of the company for sale
- An overview of the industry
- An explanation of the company’s particular niche (including sources of revenue and types of customers)
- An overview of how the business is organized
- A review of operations (the nuts and bolts of how the company actually functions)
- Information about the company’s competition
- A summary of the historical financial results of the company
- Information about the assets that will transfer to the buyer
- A section devoted to the company’s growth potential
A good prospectus should not be a fill-in-the-blank “boilerplate,” but should be written specifically for the business it describes.
Q: Who should receive the prospectus?
A: Only prospective buyers qualified (financially and by ability) who have signed strict non-disclosure agreements prohibiting them from disclosing information to anyone except their lawyers and accountants should receive the prospectus.
Q: Should a business owner pay for the prospectus?
A: No. While some brokerage firms charge $30,000 to $50,000 to package a business for sale, other firms work exclusively on a “success fee” basis, earning their fee only when the business is actually sold. Firms that charge large up-front fees often secure their clients by making extravagant claims about the prices they can achieve. One of these companies was recently the defendant in a large class-action lawsuit. It was required by the court to return much of the up-front money it had collected from businesses it never sold. Instead of being taken in by wild promises, one should choose a broker that has the confidence to work on a success-fee basis, as well as a solid track record and local references that can be verified.
Q: What happens after the prospectus is prepared?
A: After the prospectus has been prepared and reviewed by prospective buyers, interested buyers may want to meet the owner, view the site, and get more information. To maintain confidentiality, meetings should occur away from the business premises. On-site tours should occur after employees have gone home.
Q: Should the fact that the owner is trying to sell be kept confidential?
A: Absolutely. While some owners understandably feel an obligation to their employees to let them know what is going on, no good can come of telling employees that the company is for sale before the sale is actually consummated. If employees find out the company is for sale, they might start looking for other jobs, fearing the new owners will replace them. If vendors find out a company is for sale, they might put it on cash on delivery (COD). If competitors find out, they might use that information against it in the competitive marketplace.
Employees should be told of the sale in a post-closing company meeting, where the new owners are introduced. At that meeting, the new owners typically reassure employees that their jobs are safe (buyers typically want to retain existing employees, without whom the business would have little value) and that they intend to grow the company, creating opportunities for everyone.
Q: What does an offer look like?
A: Offers typically come in the form of a letter of intent. A letter of intent is a short, non-binding document that spells out the basic terms of the proposed transaction. It usually proposes that closing be contingent on executing a formal purchase agreement, on the buyer obtaining the necessary financing, and on the buyer successfully completing its due diligence study.
Q: What is due diligence?
A: Due diligence is a short period of time in which a buyer who has a letter of intent that has been accepted by the seller, and who has placed a deposit with the broker, can examine the books and records of the seller to determine whether to proceed to a final, binding purchase agreement. During this time, the business is typically “off the market” for other buyers. Buyers sometimes ask for as long as 90 days to complete due diligence, but it is strongly recommended that it last no longer than 30 days. There simply is no reason to allow the business to be kept off the market for longer than that.
Q: What is a purchase agreement?
A: The purchase agreement is the binding, legal document that describes and controls the transaction. It usually has exhibits appended to it, such as the company’s financial statements and other documents, which become part of the contract and settlement package.
Q: Does a business owner who is selling need a lawyer and accountant?
A: A lawyer should be retained to review the purchase agreement. An accountant should be consulted to ensure that the sale is structured in the manner most beneficial to the company’s tax situation.
Q: When does the seller get the money?
A: At closing. The current lending environment is very favorable to business transactions. As long as a company is stable, profitable, and has good financial records, it should be able to be “cashed out” at closing.
Q: What happens after closing?
A: That depends on the needs of the parties involved. At a minimum, the seller stays with the company for a month or two after closing to familiarize the new owner with the company’s clients, business practices, and procedures. Sometimes, if both parties desire, arrangements are made whereby the seller stays with the company on a longer-term basis. For example, some sellers are happy to stay on in a sales or operational capacity so long as they have no administrative responsibilities.
Q: Is this a good time to sell?
A: The decision to sell a business is a personal one, often relating to quality of life issues for owners and their families. That said, it is an extraordinarily good time to sell a business. The economy is strong, interest rates are still low, and the lending climate is favorable. Also, capital gains tax rates (which most business sellers can take advantage of) are at an all-time low of 15 percent.
Selling a business is the end of one journey and often the beginning of a new one. The business being sold often represents the bulk of the seller’s estate and the monetary value of the seller’s life’s work. The sale should not be rushed, but should be handled in a deliberate manner with proper professional help. The business should be prepared and packaged to achieve the highest attainable price. The selling process should be managed in a way that maintains confidentiality and does not interfere with day-to-day business operations. The transition to new ownership should be structured to ensure the continued health and viability of the business for both the employees and the new owners.
When handled correctly, the sale of a business can give the seller the money needed to start the next phase of life, whether it leads to retirement, more time with family, the pursuit of other interests, or a new business venture. At closing, many sellers have mixed emotions about giving up their cherished “baby,” but after the sale, most sellers are soon exhilarated by their newfound freedom and prospects for life’s next adventure.