4 Pitfalls to avoid when timing the sale of your business
- Underestimating your own commitment
- Tardy initiation of the sale process
- Delaying the sale in an attempt to grow the business for another year
- Not staying in control of the process when receiving an unsolicited offer
The definitive guide to deal structuring when selling a business
The legal transaction structure will be determined when structuring the deal, i.e. whether the company will be sold as an entity (share deal) or as separate assets (asset deal). In addition, the payment method and certain intangible aspects of value that are important to the seller must be clarified as well, such as the time you have to remain actively involved after the sale. Furthermore, the way a deal is structured dictates when the sale proceeds are received and the income tax implications.
Three basic elements of deal structuring are:
• Whether the assets or shares of the business are being sold
• The terms of payment
• Other contractual terms
Apart from securing a reasonable price, a good deal structure is key for a successful sale.
Which is best: an assets or shares sale
The asset deal and the share deal mainly differ from each other in terms of the legal contract design, taxation of the amount realized and the risks and chances of the takeover in question. Sellers basically prefer a share deal, whereas buyers usually prefer an asset deal. From a tax perspective, the share deal has the advantage of obtaining tax free private capital gains. The sale of assets, however, leads to the taxation of hidden reserves from a seller's perspective. In the event of a share deal, all the risks pass to the buyer (known as "universal succession"). The type of transaction which suits best depends on the specific characteristics of the company and the preferences of the part ies involved. We r ecommend you take advice fr om legal and tax experts when making this decision.
How to attract the best buyers for your business
Ideally, preparations for selling the business should get underway at least two to three years before going to market. This is because many of the initiatives involved will take time to implement. Even if the owner is not planning to sell their business in the near future, adequate planning and preparation are essential in case they receive an unsolicited offer or face a sudden change in circumstances (such as health problems).
Unique sale arguments should be developed during preparation. These usually have more to do with the competitive advantage and intangible value the business offers than its physical assets. The assets on the balance sheet are of secondary importance, particularly for service companies. Buyers are typically interested in the unique attributes of the seller’s product and service offerings, customer base and the strength of its management team. The seller should therefore focus on the following points to make the business more attractive when putting it on the market.
- Promote the business name and its brands. In many cases, awareness of your business can be raised by advertising in trade magazines, newspapers and other public information channels
- Foster customer loyalty and diversification. Demonstrating a loyal and diversified customer base increases the chance of a high value sale
- Ensure a strong and committed management team is in place. Ideally, the owner should endeavor to become redundant so that the business can run well without them. It is also important to demonstrate that the business is not dependent on a handful of key employees, and that a strong successor has been identified for each key management position
Buyers will assess the “transition risk” associated with the business, i.e. the risk that the company will lose major customers, key employees or other elements of value shortly after the transaction. It is important to demonstrate that things like customer retention plans and management succession plans actually exist. Ideally, buyers should be able to see that the business has a sustainable competitive advantage which can be readily transitioned following the sale transaction. Finally, it is important to investigate why the buyers wish to purchase the company so that buyer-specific arguments can be prepared.
The owner should ideally strive to hand over an efficient, well-run operation that enables a buyer to readily integrate the business into their existing operations. There are some initiatives that may be worth undertaking.
Top 8 Mistakes owners make when selling a business
- Underestimating the effort needed for the preparation of the sale
- Over-investing in capital assets in the years prior to a sale rather than paying down debt
- Underestimating the importance of a clean and lean balance sheet
- Not splitting operating and non-operating assets in the accounts
- Posting private spending on business accounts
- Poor communication and missing incentives for key employees
- Lack of tax and estate planning
- Not recognizing potential MBO aspirations
How to create attractive financial statements
Buyers like to see revenue and profit growth in the years leading up to the sale. Revenue growth might be accomplished by accelerating the sale of products and services to customers and by putting short-term sales initiatives into place. However, accounting standards governing revenue recognition must be considered.
If expenses in the years leading up to the sale are carefully controlled, this can impact positively on profitability. However, it is important to be aware that most buyers will be on the lookout for reductions in operating expenditures that are required to support the long-term viability and growth of the business. For example, in the years leading up to the sale, business owners sometimes reduce costs that may not offer an immediate payback, such as advertising, R&D and equipment maintenance. When a buyer discovers that expenses such as these have been artificially reduced, they usually reduce the purchase price accordingly. This impairs their own negotiation position, especially in cases where a high correlation with the long-term operational performance can be shown.
However, owners of privately held companies sometimes incur costs that are not essential to the operation of their business, and these can be reduced or eliminated with little or no unfavorable impact on the business’ long-term operating results. This might include personal cars, trips or other discretionary expenses that are charged through the business.
In the years prior to the sale, owners might want to consider capitalizing certain expenditures rather than expensing them. Most privately held companies are operated with the aim of minimizing tax. This explains why purchases of capital assets with relatively low monetary values are often expensed. However, by capitalizing and depreciating some of these items (where justified) it may be possible to increase the purchase price for the company, particularly where a buyer relies on a “multiple of EBITDA” as one of its primary valuation methodologies.
Buyers also like to see a clean balance sheet. This starts with removing any redundant assets. Redundant assets are those not required in the ongoing operations of the business, such as marketable securities and vacant land. Potential buyers are not usually willing to acquire non-operational activities and assets or to pay a reasonable price for them.
Careful attention should be paid to working capital management. The lower the business’ working capital requirements are, the more cash will be generated to provide the buyer with a return on their investment, which in turn can lead to a higher purchase price. Furthermore, the owner will probably have to negotiate a target working capital amount at the closing date of the transaction. The purchase price will be adjusted upward or downward for working capital that exceeds or falls short of the target. To improve their ability to negotiate a lower working capital target (and enjoy more upside potential), the owner will need to demonstrate that their business has operated with modest working capital levels in the years leading up to the sale. As a result, the owner needs to actively manage the working capital several years before they sell as the results take time to materialize.
Finally, the owner should be conscious of under-accrued liabilities in their business, such as employee vacation pay, pension obligations, post-retirement benefits and product warranties. Buyers will closely scrutinize liabilities that will be assumed at the closing date. Any such previously unidentified liabilities can have a negative impact on the purchase price.
Things to Consider in a MBO
A difficult situation can occur if management itself shows interest in buying the business. This has the following two drawbacks for the seller.
When and how to tell employees
This depends greatly on the culture of the business. In most cases it is necessary to tell a select group of employees, such as the Chief Financial Officer, about the possibility of a sale before going to market. This is because such individuals will need to be involved in gathering information for prospective buyers.
Once a potential buyer has expressed interest, it is usually necessary to tell other key employees within the business (i.e. people in the management team) about the process. As previously stated, a strong management team is crucial to the sale process and in reaching the highest possible purchase price. It is particularly helpful when key employees attend management presentations with potential buyers to show that the business has a strong management team. If key employees are not advised of the pending sale of the business until a potential buyer begins their due diligence investigation, the owner runs the risk of jeopardizing their negotiating position if their employees react with concern or leave the business prior to the transaction.
It is only natural for employees to feel nervous when they find out that the business is for sale as they may be concerned about the possible changes under a new buyer or worse, losing their job. So it is important to keep key employees informed of what is happening and to address any concerns they may have.
Some owners implement an employee share ownership plan (ESOP) to help align employee interests with their own. While ESOPs can be a powerful mechanism, they should be used with caution. It is much easier to implement an ESOP than to make changes once it is in place.
A special bonus for a successful sale is an easier way to align employee interests with the owner’s interests. This also serves to reward them for all the additional work that is involved in the sale process.