Few transactions are as potentially complex as the sale of a business. However, by being aware of several key considerations and working closely with a carefully chosen accountant and knowledgeable business lawyer, you improve your opportunity for achieving a highly satisfying outcome.
#1: Understand the four methods you can use to assess the value of your business.
These four methods are:
- Asset method: Total up all your assets including both tangible ones like furniture and intangible ones like copyrights you may hold and determine the
- Compare to Similar Businesses: Look at recent sales of businesses similar in size to yours in your area. How are you alike? What is different?
- Income value: Evaluate the revenue the business generates.
- Industry-specific formulas: Does your industry have a specific rule of thumb that investors use in establishing a business’s value? Check with your financial advisor.
#2: Make sure your business is in order.
Before you put your business on the market make sure your company financial records are up-to-date. Check to make sure all your arrangements with suppliers, renters, etc. are all in writing and legal. Sell off obsolete inventory and clear up old receivables to bring your balance sheet into good condition. Also be sure you avoid acquiring any new expensive office equipment that will take money off the bottom line.
#3: Before you disclose your business workings to a potential buyer, make sure he or she signs a noncompete agreement.
The last thing you want is for a potential buyer to learn your trade secrets, see your customer base, and view your top employees up close unless you are protected with a noncompete agreement. Without this agreement, your prospective buyer can become your competitor who is using inside knowledge to replicate your operations.
#4: Make sure you understand the earn-out option before you agree to let a buyer use it.
As a seller, you can be paid with equity of the buyer or cash. Buyers may pay you in cash at closing, over a period of time in a note (seller financing), or as contingent consideration based on performance of your company in the future (also known as an earn-out).
Typical concerns of a seller with an earn out include the inability to control the company’s direction post-closing, as well as potential concerns over the buyer’s financial resources.
In an earn-out purchase, the buyer pays part of the purchase price to the seller at closing and part over time, based on the future performance of the company. There are multiple ways this arrangement can turn sour including disputes about whether the buyer has met the earn-out goals or whether the seller has incorrectly stated the earning potential of the business.
Enter these agreements only with great caution and expert legal advice.
#5: Know what is going to happen with your employees.
If the purchaser is buying shares of the business, he or she will keep your employees once the sale is finalized. Just the ownership of the business will change hands. However, if your sale is an asset sale, and the new owner does not want to continue employing all your staff, it can fall on you to handle their termination and any severance due. However, through a carefully worded purchase agreement, you can make the buyer liable for severance and other such costs. Work closely with your lawyer.
#6: Enter escrow arrangements with your eyes wide-open.
Usually a part of the purchase price of your business will be held in escrow for one year up to 18 months. This money is there to protect the buyer against any false representations you, the seller may have made. The amount of escrow typically ranges from 10 to 20 percent of the purchase price. Obviously, as the seller it is to your advantage to keep the amount of escrow and the length of time it is held to a minimum.
As mentioned above, selling a business is a complex process. Straightforward sales take from six to eight weeks. However, some more involved business sales can take three to four months or even up to a year in the occasional instance.
#8: Watch Your Liability.
It is very common to focus on the total purchase price, which is the starting point for any deal. However, as a seller it is imperative that you understand the extent of your liability.
If you are selling your company, you must carefully review the representation and warranties section. Breaches can quickly add to damage claims from the seller. Further, the disclosure schedules that are attached must be extraordinary detailed – consider it the seller’s insurance policy.
Likewise, it is imperative that you limit your liability as well as know “when” you will no longer be liable. After the completion of the sale, you cannot renegotiate the terms.
Sellers should also ensure that there is a “basket” that exempts claims under a threshold amount, as well as claims over a certain amount. For claims that cross over a threshold amount, the seller will request that certain claims are not excluded, including fraud on the part of the seller and certain fundamental representations.
Finally, sellers must be careful of the definitions of both knowledge and materiality. Both definitions play a critical role in establishing and defining the seller’s liability.
#9: How You Sell Matters.
A successful future for a business owner selling a business comes down to more than just the money.
As a business, you can (1) sell your stock, (2) sell your assets, or (3) merge. A sale of stock is often referred to as an entity purchase agreement (also known as a stock purchase agreement) and a sale of your assets is an asset purchase agreement.
Generally an asset purchase agreement is better for buyers and an entity purchase agreement is better for sellers.
Under an entity purchase agreement, the buyer assumes all debts and assets of the seller. The buyer literally steps into the shoes of the seller and the business continues to operate as usual.
If you sell your stock, you likely will receive long-term capital gains on the sale. The highest marginal long-term capital rate is 23.8 percent versus 39.6 percent ordinary income rate. If you are C Corporation, you should be especially concerned of an asset sale. A sale of assets can trigger a double taxation issue.
Under an asset purchase agreement, the buyer purchases the tangible and intangible assets of the selling business. This includes everything from equipment, trademarks, trade secrets, office equipment, inventory, real estate and more.
Further, the buyer generally only assumes liabilities that it chooses, so it is far less risky for buyers. If there is an unknown liability, such as tax debt, the buyer will likely avoid having to pay the tax and then chasing the seller for reimbursement.
Most small businesses are asset purchase, but it is possible to creatively structure the sale in a tax advantage manner for the seller.
At the closing, there is typically a working capital adjustment. This is to ensure that the seller has adequate capital to continue to operate your business. Other common elements include escrows, which holdbacks of part of the purchase price.
#10: Choose the right financial advisor and lawyer.
The results of your sale are directly correlated to the strength and experience of your team of advisors. Make sure you hire a lawyer and accountant who is well experienced in handling the finer points of a business sale, and who has a track record of satisfied business clients.
If you are ready to begin the process of selling your business in Colorado, call the highly skilled business attorneys at Robinson & Henry in Castle Rock, Colorado. We will help you negotiate a sale that brings the return you are hoping to achieve. Call 303-688-0944 for a no obligation, free consultation.