Preparing your business for a sale: Five tips to get it right
You’ve worked hard to build a successful business and you’re proud of where it’s at today, but you’re thinking about moving on. Here are five tips to sell at the best price and terms.
Planning the sale of a business involves two parts: personal readiness and business readiness. Personal readiness is about finding your “financial independence number” — the amount you need from the sale of your business to meet your future financial needs. Business readiness is the process of improving the business and optimizing the sale to ensure you make or exceed that number.
Maximize your value drivers
Ideally, business readiness planning should start before you start looking for a buyer or even mention the possibility of a sale to your staff. We recommend meeting with your advisors to review the business, how it’s positioned in the current market, and what’s needed to prepare it for sale. A business that’s ready to “go to market” will have these characteristics:
- Strong financial performance with a recent track record of success and a strong outlook
- A strong, sustainable competitive advantage
- Well-entrenched customer relationships
- A well-defined, credible, and supported growth story
- An attractive end market and geographic focus
- Demonstrated operational expertise
- A strong, sustainable management team and a plan for backfilling management gaps that may arise once the deal closes.
These value drivers can have more impact on your business’s valuation than a single metric such as EBITDA — a common valuation metric based on earnings — which is why they deserve attention prior to hanging out the “for sale” sign.
Reduce your risk
The other side of the valuation equation is risk. In general buyers will pay more for a business with less risk because there’s more certainty they’ll get their cashflow out.
Indicators pointing to high levels of risk include:
- A perception of commodity products
- Low margins and/or margin risk
- High revenue concentration (customer, geography, product line)
- High capital investment needs
- Limited capacity for growth
- Management transition or involvement of shareholders
- Lack of customer entrenchment and/or brand awareness
- Raw material commodity and/or foreign exchange exposure
- Unclear intellectual property ownership
It’s critical to understand what the value drivers and risk factors look like as a whole and whether a transaction at this time would support your financial independence number. In some cases, you may determine it’s better to delay a sale to fix red flags and address deficiencies. That’s why it’s important to plan early and keep your thoughts about selling confidential.
It’s critical to understand what the value drivers and risk factors look like as a whole and whether a transaction at this time would support your financial independence number.
Structure the deal to maximize after-tax proceeds
An early planning consideration that can have a big impact on your financial independence number is what entity type and tax structure will maximize your post-sale proceeds. In many cases, this will overlap with the financial independence number from your personal readiness planning. In many transactions, the sale price or “headline number” gets the most attention during sale negotiations. It’s an important number because it drives what ultimately goes into your pocket, but entity and tax structure can move the needle significantly enough to make or break your post-sale financial independence number.
When structuring a deal, it’s critical to understand how entity choice influences the other pieces of the transaction. Is the company currently structured as a C Corp or a flow-through entity? Which structure will be best for you? Will it accommodate the needs of a likely buyer? If not, is there anything we can do to improve the outcome for both parties?
Whether or not you can make an entity change to benefit the deal often depends on the time horizon available for the sale. Sellers typically can’t make a choice immediately before a transaction so planning has to start early. In a perfect world, you’d start five years out, but even a couple of years can be enough to change to an S corporation and sell stock via an Internal Revenue Code section 338(h)(10) election. That would provide the simplicity of selling stock from a legal perspective while giving the buyer tax benefits associated with an asset purchase.
You might also qualify for a small business stock gains exclusion. If so, you’d exclude capital gains from federal tax, providing a significant impact on your after-tax
Close the deal
The deal’s not done until you’re over the finish line, and that often entails fixing potential deal breakers along the way. Poor planning for transitioning your management role can scuttle the deal. Likewise, with key staff in the organization — those with lots of expertise and industry knowledge that the buyer needs to successfully maintain the business. Unfortunately, many sellers don’t know how to bring up the subject of a sale and find key staff heading for the exit once they find out about the intention to sell.
The deal’s not done until you’re over the finish line, and that often entails fixing potential deal breakers along the way.
In this situation, we recommend putting in place a “stay bonus” agreement with each key manager that incentivizes them to stay through closing and support the deal. When the deal closes, the owner takes a part of his or her proceeds and pays it to the management team member as a thank you for staying through the deal and getting it closed. This provides a meaningful check to the manager and for the business owner it takes the risk of them leaving off the table. There can be tax benefits to that as well.
A seller’s severance package can provide similar security to key staff. This is a contingent promise to a key team member that if his or her position is made redundant within a certain period of time after closing — say 18 months — you’ll make a payment to ensure a soft landing and ensure he or she isn’t unemployed without a paycheck.
These types of transaction risks should be off the table before the business hits the market.
Avoid these common mistakes
Here are three common mistakes your advisors can help you avoid:
- Failing to keep your cards close to your chest: Occasionally an owner is approached by someone preemptively or unsolicited about selling their business. The owner sends along information such as financial statements or customer presentations without thinking about how to position or package the information in a way that optimizes value. The buyer now has information that isn’t positioned properly and can lead to a poor outcome. Always connect with your advisors before engaging with potential buyers.
- Failure to shop the market: Limiting discussions to a single buyer loses the ability to be competitive in the market. To find the best-fit buyer, it’s important to get non-disclosure agreements in place and engage in one-on-one discussions with multiple suitors. They’ll presume and expect there’s other groups in the mix. They won’t know who or how many buyers are in the running, but it forces them to accommodate your timeline and put their best foot forward at each phase.
- Waiting too long to sell: Waiting too long to sell can put your personal financial goals at risk. There’s a saying in the business, “You can sell a day early, but not a day late.” If your business is optimized to sell and you’re able to hit your financial independence number, that’s considerable incentive to move toward a sale sooner rather than later. If you wait longer than necessary, a market event could happen that impacts your transaction negatively.
Get started now
You’ve decided it’s time for a change. Retirement may be around the corner, or perhaps your business has reached its potential and a sale to a strategic or financial buyer is necessary to take it to the next level. You’ve got one shot at getting the best outcome. It’s never too soon to start planning for a sale, but it can certainly be too late — hindsight is always 20-20. To evaluate your business for a sale, give us a call.