Most business owners have one business that they will sell in their lifetime, so it is worthwhile to know what to expect from this process. This paper addresses issues that create challenges and reduce business value for the owner when selling their business. It offers solutions to maximize value for the owner while still making the deals equitable. While this paper details many practical aspects gained from experience, note that to cover all aspects of your individual situation, detailed analysis is always required.
Pitfall #1: Not Giving It Enough Time
Nobody wants to hear this, but the fact is that selling a business is a process that takes time. There are a variety of ways the deal can be done, but they all involve time. If we stop to consider the stages of selling a business, this time requirement becomes clearer.
The stages involved in selling are as follows:
• Initial buyer evaluation
• Negotiation and contract signing
• Due diligence
• Post-closing responsibilities
If we assign an average of three weeks for each stage, then the best case timelines are four to five months. Averages in today’s environment are often 9 months at a minimum. After closing the seller often provides a training and transition period to guarantee success for the new owner. While the duration depends on what was negotiated, as an owner it is important to think of the future of your business even after you sell.
This provides goodwill, positive results for new owners and finance partners, and maintains the reputation of what you have built. In short, sellers should plan for a minimum six month process to sell their business, with twelve months being a likely scenario.
Pitfall #2: Lack of Preparation
From the buyer’s perspective, by the time they look at a specific company, it is likely they have already done research. They would have done detailed analysis of the industry. They would have received from other sellers readily available information packages, and have reviewed operations and financials of other companies similar to the one you are selling. In other words, you are competing with sellers who have prepared their financial statements, and possibly documented personal succession plans.
When an owner prepares the financials, they should consist of the last three years of statements, and they should be reviewed by a reputable independent CPA firm. The owner’s management team should also be able to operate the business independently. This allows the owner time to show the business, and focus on matters like educating potential buyers on scalability and growth opportunities within the business.
To prepare the information package for the buyer, the business seller should do the following:
- Make financial records current.
- Prepare reports for the last three years.
- Eg: P&L, B/S, Cash Flow, and MRR (monthly recurring revenue)
- Collect together the tax returns for the last three years.
- Compile and update the lists of customers and vendors.
- Have a CPA independently review the above financial reports.
- Review and make copies of contracts.
- Write up a full summary about the business, including its recent history, its target customer market and how it operates generally.
- Create an EBITA summary spreadsheet that shows 5 years of history and growth, with bottom line and top line numbers. Show any add backs that exist as one time charges or excess compensation.
In short, a full package about the business needs to be prepared so that the prospective buyers can evaluate the purchase.
Another point of preparation is more mental. Business owners understand that companies can be bought and sold. Employees on the other hand will tend to worry. They may start looking for other work if they discover the company is being sold. So it is best to keep the news of the pending sale quiet until the new owner has taken possession. Here is what can be done to alleviate this problem:
- Use non-disclosure agreements (“NDAs”). NDAs could be used to discourage people from discussing the potential upcoming sale of the business. Anyone who needs to be told about the sale should be required to sign an NDA beforehand.
- When the prospective buyers tour the facility, the owner should be prepared to answer questions from employees, such as “Who was that visitor?” In the early part of the process, schedule buyer tours after-hours.
- Always consider that the sale of the business is not guaranteed. Continued operations without workforce distractions are important to the business.
- Oftentimes investment in the business is part of a sale or merger & acquisition activity. Setting up a small team within your business that supports investment objectives is often a good way to work through the process of a sale without divulging information that may distract the company.
Pitfall #3: Staying on After the Sale
Sellers should be ready to remain involved in the business for a few weeks to a few months after the sale. One cannot expect the new owner to learn everything about the business in a few days when it had taken the seller years to figure out. Thus in many cases, new owners naturally expect a training and handover period to make this transition as smooth as possible.
From the seller’s perspective, business owners have different reasons for selling their business. Some want to sell and retire, while others want a partial sale so they can raise cash to expand. So in regards to staying on after the sale, sellers should work out their post-sale retention period with the buyer early on in the deal.
We have established that sellers staying on for a while would have been negotiated as part of the deal, so this responsibility should come as no surprise to the seller. The other issue to be considered is that the buyer may require a portion of the sales proceeds be withheld in escrow until the training, handover, performance and other duties have been fulfilled satisfactorily. The seller should be certain that the requirements for release of this escrow (or any earn-out payments) are defined simply, and are quantifiable in terms that are already being reported on by the business.
Pitfall #4: Personal Guarantees
Personal guarantees (aka “PG”s) are great assurances for lenders when borrowers obtain loans. Lines of credit with a bank, loans on assets, and real estate leases can be secured by PGs. Business owners may forget the PGs are even there, especially when they have been making their loans or lease payments on time.
When a business owner wants to sell their business, they should ensure that the PGs are removed from the loans and leases. For the lender, this means that they must accept an alternate person to be the guarantor, i.e. the buyer. For leases, landlords may require a new lease to be drawn up with the buyer, and the old lease would be voided, releasing the seller from the lease obligations. A UCC filing search should be performed prior to listing or marketing the business for sale. Any retired debts found in the UCC search that have not been updated should be removed.
In order to get released from a PG, sellers need to negotiate with the lender and landlord. And they need to complete this before the sale of the business is finalized. Otherwise, the new owner will have no motivation to help sellers get released from the PGs.
The probable worst case scenario in trying to get a PG on a loan removed is that the buyer would have to pay the loans in full as part of the purchase agreement. If this is done, then the seller’s proceeds from the sale of the business would be reduced by the amount of the loans.
In summary, sellers should be able to walk away free and clear of any potential liability. Otherwise, if the new owner defaults on the payments, then the original seller will be liable as guarantor of these loans or leases.
Pitfall #5: No Recourse with Seller Financing
It is common for the seller to finance the buyer’s purchase of the business by holding a note. But what is the seller’s recourse if the buyer starts missing payments? For this reason, the seller must be able to claim back either the business or the assets of the business if the buyer fails to make good on their promise to pay. If the business sale was an asset sale, the seller should have claim on any and all assets of the new business as collateral for the loan. If the business sale was a stock sale, then the seller should have claim on all the shares of the business. In case of buyer default, the original seller once again becomes the owner of the business. This is a good topic for buyers and sellers to discuss with their advisors and attorneys in order to get it done correctly.
Bonus Pitfall: Failure to Assign Contracts
Generally speaking, when a business is sold as an asset sale, the actual business entity changes. Contracts that the original business has in place may need to be assigned from the old business to the new business. Often this assignment requires the approval of other parties to the contract.
Businesses have contracts with a wide variety of entities they interface with. This includes customers, vendors and suppliers, and landlords. Any of these contracts could have stipulations on how (or even if) the contracts can be assigned in case the business is sold.
As an example, consider the case where a customer requires contract assignment on any change of control of the business. If the buyer and seller fail to notify the customer of the sale, and fail to secure the customer’s approval, then the buyer is at risk of losing that customer’s
revenue. The seller is also at risk of whatever legal action the buyer or the customers may take.
Sellers should take this prudent action prior to finalizing the sale of the business: review all the contracts (with attorneys), see which ones require approval for assignment, and secure this approval from the other parties. While many sellers may not have the luxury of time to plan this far ahead, part of the planning stage of selling a business should begin two or even three years prior to the sale. During this time, adjustments could be made to the terms of all contracts, making them more conducive for the sale of the business.
While there are many other aspects of the sale of a business that demand the seller’s attention (as well as the buyer’s), the above pitfalls are some of the more prominent. The key takeaways are as follows:
- Allow enough time to prepare and sell the business.
- Don’t leave the buyer stranded post-sale. Help them with the transition.
- Keep the buyer or business firmly on the hook if there is seller financing involved.
- Remove personal guarantees, and disentangle from the liability of the business.
- Review all existing contracts for any impact caused by the sale or change of ownership or control of the business.
The above reading is from the author’s knowledge and experience. The author is not a business broker or an attorney. It is not meant to be legal advice. There are many good business attorneys who will look out for their clients’ best interests. Sellers and buyers can find one who will do the deal for them at reasonable fees.
About the Author
Walid Costandi has a mission: To release entrepreneurs from the shackles of their business!
I am looking to partner with business owners. Together we can identify a transition plan that keeps both your legacy and your employees secure. I am also working on projects to merge companies in order to create larger enterprises that have a higher market value.
I would love to hear your comments and suggestions. Please feel free to reach out to me on LinkedIn (https://www.linkedin.com/in/walidc/) or via email at firstname.lastname@example.org.