An Overview: The Basics of Selling a Company

Most every business owner will eventually need an exit plan. The reasons will vary.

• The owner is tired of doing what he or she is doing and, consequently, not maximizing the potential of the company. Some practitioners in the sale of businesses consider this the most often cited reason for selling.

• The owner has insufficient sources of capital to maintain a healthy cash flow or grow the company, a very common reason for selling.

• The owner lacks capital, expertise, adequate facilities, or technology. These are unfortunate but frequent.

• An industry is declining due to new technology, unpopularity, or obsolescence.

• The owner wishes to pursue other opportunities, an often-cited reason for selling.

• The owner has a physical or mental condition that prevents or deters required involvement in the company.

• The owner wants to retire from business, the reason for selling that typical buyers prefer most.

Every business either changes hands or ceases to exist at some point. The company could be liquidated, sold, merged, turned over to heirs, reorganized as a public company, or just shut down and ceased to exist. All of these are common methods of an owner exiting a privately held company.

It may be easier to attract a rewarding disposition of your business venture if your business has proven to have viability, growth potential, and a sustainable profitability. Businesses that fit this description attract more attention and more capable buyers. But businesses without these favorable achievements are not necessarily worthless and may also have value to a buyer for reasons other than a continuing stream of income. There may be an opportunity available to the owner to reap some reward for founding, nurturing, and operating the business for a period of years even if the profitability has not been the greatest achievement.

The most commonly desired exit strategy is a sale of the company. If executed favorably, this provides a home for the company and a reward for the owner. Successful transfers of ownership obviously do occur quite often in the small business world and work out well for the seller and the buyer. Unfortunately, that is not always the case. Sometimes, they don't work out so well. Sometimes, the new owner cannot retain the customer base. Sometimes, the new owner is not adequately capitalized due to the impact of purchasing the company and providing working capital and servicing purchase financing used to acquire the company. Buyers and sellers both have a tendency to overlook eventualities and overestimate outcomes. In other words, both are sometimes overly optimistic.

The most important fact that exiting business owners should be aware of is that sometimes a company offered for sale sells and sometimes it doesn't. This next sentence may seem surprising. Usually, it doesn't sell. If you get the true statistics from an agent, broker, or industry expert, you will find that only about 20 percent of businesses listed for sale actually sell. Why is this? The reasons for a company not selling are many.

• Overpricing can make it impossible for a typical buyer to obtain adequate financing or may prevent the buyer from realizing a reasonable return of the investment required to acquire the company.

• Most buyers are not willing to accept unprofitability. Generally, if the current owner is unable to make a profit, it is too big a risk to assume that a new owner could do so.

• Too much of the revenue of the company is concentrated in one or a few customers. The loss of one or more could cause failure.

• The owner's relationship with the customers is such that it may be difficult to maintain the level of revenue after the owner leaves.

• The company may require expanded facilities or a new location to succeed.

• New technology or obsolescence may be causing declines that cannot be resolved.

• The area where the company is located may have deteriorated and be unable to support a sustainable level of revenue.

• Potential buyers may lack adequate equity capital to obtain additional financing of the transaction.

• There may be no source of financing for a particular industry or area.

• Potential buyers may be unable to assure themselves of a continuation of the income stream due to contracts expiring or limited demand.

The most prudent approach to entering the process of selling your company is to get a good understanding of the important elements of a successful transaction and to follow the steps essential in providing an offer of the opportunity that will be successful for the buyer and meets the goals of the seller.

That is what most business buyers want and need. That is what most successful business sellers provide. That is what is essential for a successful sale of a business—one that turns out well for all parties and survives the pitfalls and unconsidered circumstances of the many changes that take place for the seller, buyer, employees, customers, and others directly affected in the outcome.

There are many essential steps to a successful sale of a company. The priorities should be:

1. Determining the objectives of the seller. The seller should determine his or her objectives in exiting the company, whether he or she is cashing out, entering into another business, retiring, establishing an income stream for retirement, making tax considerations, or a long list of other considerations.

2. Determining the value of the company. Valuation helps determine a realistic range of values that a transaction might bring for the seller. The potential value that can be realized from a sale of the company will help the seller determine if the sale will meet his or her objectives, whatever they may be.

3. Preparing the company for sale. Preparing the business for sale can enhance or lessen the perceived value of the company. The value may be there, but the first impression or a more thorough examination may fail to demonstrate the quality of the operation, the diligent management, or the potential of future growth of the company.

4. Preparing an offering of sale. Determining the method of offering the business for sale is important. You can offer your company either through representation by someone in the business of selling businesses or as a for-sale-by-owner offering. Both methods have advantages and disadvantages that should be fully understood in the decision-making process.

5. Preparing a marketing plan. Preparation of a marketing plan and offering information to attract potential buyers is another important phase of an offering for selling your company. Important in this phase is selection of methods of attracting potential buyers, such as Internet ads, e-mail campaigns, direct mail to potential buyers, newspaper ads, and a listing on businesses-for-sale websites.

6. Implementing the marketing plan. Meeting and conferring with respondents, providing facility tours for qualified potential buyers, and providing face-to-face meetings with accounting and legal advisors are all functions of this phase of the process.

7. Providing necessary information for the sale. Preparation of comprehensive information about the company is important for presentation to qualified parties who have expressed an interest in an acquisition. Information includes a description of the business operations, financial statements, current and historical sales records, employee staffing, management staffing, and projection of growth potential.

8. Negotiating the terms and conditions. This phase of the sale process includes receiving offers, proposals, or letters of intent to purchase and negotiate an agreement of price and terms. Terms should include assets included or excluded, financing terms, training and transition assistance for buyer, employment agreements, due diligence period, contingencies, closing procedures, and an integration period for acclimation of the buyer with the customers, employees, vendors, and the general operation of the business.

9. Completing due diligence and documentation. Documents—including a purchase and sale agreement, a bill of sale, a promissory note, a schedule of assets, an inventory list, a noncompetition agreement, and other documents necessary for opening escrow and closing the transaction—become the important issue.

10. Integrating the buyer. Integration of the new owner with employees, customers, vendors, and others involved in the business provides a period of training and transition assistance to fulfill acclimation of the buyer with all aspects of the business and to achieve cooperation of those essential in the successful operation of the company.

I learned about these critical steps during years of business ownership and participating in training sessions, seminars, and professional courses of study required for certification as a Certified Business Intermediary and from the experience provided by participation in many engagements with companies and transactions of business sales. Much of my education has been provided through an affiliation with the International Business Brokers Association, M&A Source, the Association for Strategic Planning, and the Association for Corporate Growth. These organizations and the ongoing training they inspire has provided the basis for many successful years of practice in the business of selling businesses and a thorough understanding of the steps to success and the avoidance of failure in the transfer of ownership of privately owned companies.

First Things First—The Objectives

Watching a business sale transaction progress through the various steps, from the initial decision of going to market to documentation, and then watching it all fall apart at the last minute, will emphasize the importance of following a thoughtful plan throughout the arduous process. The best way to avoid an unhappy ending of a sale transaction is to take first things first.

What Should Come First?

What should come first? Finding a buyer? Preparing the necessary documents? Discussing it with your employees, lenders, customers, and vendors? None of these should probably come first. The following should be considered the most important first steps:

Get a good idea of the fair market value of your company, one that you can support to a buyer's satisfaction by demonstrating your previous performance and supporting the likelihood of a continuation of success.

Identify, with certainty, the objectives you wish to achieve if you should realize a successful disposition of your company and determine the cost of or ongoing cost requirement of those objectives.

Determine if the value of your company, if received in a successful transfer of the company, will be sufficient to finance the achievement of your personal objectives.

And the answer is: 1 + 2 = 3.

If the fair market value of your company does not seem likely to fulfill your objectives, then you should either reevaluate your objectives or wait until number one will support number two. If you are unlikely to make this equation work, then you should do nothing until it can. The numbers in the equation can always change, and they often do over time, but they still need to add up, or the deal will probably either fail or turn out badly.

A Case Study about Verifying Your Objectives

Two partners with significant backgrounds in the industry founded and operated a food distribution company on the West Coast. This enabled them to build a good client base for their new enterprise over a period of six or seven years. They had a trained staff and good rapport with suppliers, enabling them to acquire exclusive distributorships for some seafood and deli products. They developed a private label line of their own that was adding additional business and enhancing customer loyalty and retention. One of the partners wanted to sell the company in order to take advantage of an opportunity in another country. The other and his wife wanted to go into the deli retail business, a less stressful life with good expansion potential. They expressed these objectives as their decision to offer their company to market. I was engaged to find them a buyer. The process began: evaluation, preparation, advertising, inquiries, correspondence, meetings, visits to the facilities, disclosures, offers, and letters of intent. And eventually, about twelve months from the time the initial engagement began, a purchase and sale agreement with a foreign buyer was prepared. The buyer was well experienced in the industry with adequate funding, and he was intent upon finding an opportunity in this country. The partners seemed pleased with the agreed price. The sale process moved forward. Due diligence was completed, and closing of the transaction was in sight. So what happened next? You guessed it. One of the partners sat down with his wife and had a heart-to-heart discussion about the value they would receive from the proceeds, the cost to fund their planned new enterprise, and their future financial obligations. They got cold feet. They backed out, and the deal failed. Both the other partner and the buyer were furious, and the broker was seriously disappointed, but none of that mattered. It takes two to tango, and one wasn't dancing.

This case study exemplifies the importance of determining value, identifying objectives, and making sure in advance that the sale proceeds will fulfill the objectives. If not, what is the point of going forward? As the seller, you have exposed confidentiality of your business operations. You have made your employees aware that you intended to leave the business. You have wasted the time of the professionals who worked the transaction, and you have squandered your own time and focus.

Questions for You, the Seller, to Consider

Why do you think you want to sell your company? Do you want to open a new business? If so, what are the capital requirements? Will the potential sale proceeds provide the necessary capital? How long will it require for you to become profitable in the new enterprise? Will you have sufficient funds to sustain your lifestyle until such time as your new enterprise is profitable? Do you want to acquire another company? What will the acquisition cost be? What will the other capital requirements be, such as working capital or improvement costs?

Do you plan to retire? That is certainly a good reason and the one most desirable for the typical buyer. The buyer will usually be more at ease and have less anxiety about hidden failures and undisclosed negative aspects of the business. The buyer will usually be less concerned about the seller starting another company later and competing for the customer base.

If you are going to retire, what will your financial requirements be after you do so? Will they be less than they are now? How much income going forward will you require to sustain your lifestyle? Most retirees' financial obligations don't change much after retirement unless they downsize or change their lifestyle.

In order to sustain your lifestyle, how much income must you maintain? Will your retirement benefits cover your financial obligations? Do you have savings or other investments that you can rely on to cover your financial obligations? Or will you need to sell your company for enough to cover the nut?

If you sell your company for $500,000, how long will that money last? If you invest the proceeds, how much will they earn? If you are required to pay income tax on the capital gain from the sale, how much will you have left?

All these questions deserve answers and actually require answers if you are going about the process prudently and proving out the numbers before you get to the closing of the sale. Otherwise, not only could you be guilty of causing everyone lots of wasted time and money, you could be subjecting yourself to legal liability for monetary losses of the parties involved, a forcing of the closing under a demand for specific performance of the contract and fees for legal representation of you and the buyer, and fees for any brokers or advisors who may have been involved. So make sure the deal will work for you before you sign your name to the contract.

In order to make sure the deal will work for you, you must first have decided what your objectives are and determined both the funding required to fulfill your objectives and your company's fair market value. Then you will be ready to do the old 1 + 2 = 3.