6 Essential Steps to a Successful Business Sale
As originally published in ColoradoBIZ.
By Dave Thayer
Business owners setting out to sell their business face numerous transaction risks.
Several years ago, a buyer reached out to business owners in Colorado with an interest in buying their business. The buyer put money down, enough to demonstrate they had funds, and secured seller financing for the balance of the purchase price.
After the sale closed, the buyer made several monthly payments while, unbeknownst to the seller, steadily ransacked the business. The buyer sold off assets, collected on receivables, failed to pay employees and suppliers and stripped the business bare before abandoning it.
The buyer had swindled other business owners using the same hustle before. By buying the business using the business itself as collateral for seller financing, the buyer was positioned to strip the business bare and walk away. By the time seller financing provisions for default kicked in, the business was a shell worth a fraction of its pre-sale value.
Business owners setting out to sell their business face numerous transaction risks that could undermine the value of the business and their life’s work. Each party to a transaction must be a good fit for the business sale to be successful. Sellers can avoid the more common pitfalls while gauging buyer-fit by following six steps to a smooth sale.
1. Confidentiality First
Successful transactions start with protecting the business up for sale. Every potential buyer should sign confidentiality and non-disclosure agreements before business-critical information is shared.
These agreements protect a company’s proprietary and confidential information if the deal does not go forward and prohibits a potential buyer from:
- • Disclosing discovery information to third parties, such as competitors
- • Using that information to start or enhance their own similar business
- • Soliciting or hiring existing employees
Be wary of potential buyers that tie up the sales process in this initial step. If negotiating a confidentiality agreement is a long and tedious process, with the buyer or the buyer’s attorney requesting needless and unrealistic revisions, this may signal trouble ahead and steer the seller toward an alternative buyer with more a reasonable negotiation approach.
2. Vet Buyers
Business owners may be subject to numerous scams and fraud from buyers who are intent on misrepresenting and defrauding unsuspecting sellers. Vetting the buyer can uncover misrepresentations, and in the case of the Colorado business, would likely have uncovered prior litigation against the same buyer by other defrauded business sellers.
Vetting each potential buyer includes performing background checks on the buyer and its owners and principals, such as Uniform Commercial Code searches, credit reports and criminal record searches. Prequalify the financial capacity of potential buyers to avoid wasting time with “tire-kickers” or people who clearly cannot afford the business.
3. Avoid Seller Financing
Not all buyers come to the bargaining table with financing in hand. They may simply not have the cash or ability to finance the purchase price through traditional lending sources, such as a bank. These buyers may be looking to the seller to accept a portion of the purchase price, such as 10%, in cash and seller financing for the balance via a promissory note with a market interest rate, using the business as collateral. Buyers may even throw in a personal guaranty. Seemingly, the worst that can happen is that the buyer defaults and the seller gets the business back.
Think long and hard about financing a potential buyer under any terms. If the buyer defaults, by the time a seller gets the business back, the buyer may have run the business into the ground through poor management and decision making or, like the Colorado business, may have purposely ransacked it. The seller could end up with a bankrupt business and a bankrupt buyer whose personal guaranty is worthless.
While it can be difficult finding buyers with the financial wherewithal to pay the entire purchase price in cash or through bank financing, a buyer who is unable to obtain third party financing for the purchase of your business may not be the right buyer.
Consider reducing the sales price for buyers who can pay all cash or obtain third party financing. If forced to provide seller financing, a seller should consider locking in liquid collateral to be forfeited in the event of a default. This could include investment securities and similar assets that can quickly become available to the seller if the buyer is unable to repay the debt. This avenue potentially bypasses personal guarantees that otherwise might require a time-consuming and costly court judgment to activate.
4. Assess Legal, Tax and Accounting Impact
Most private businesses are owned and operated through some type of entity, such as a corporation or limited liability company. Private business sales are typically structured as either asset sales or stock sales.
In an asset sale, the buyer of the business purchases substantially all assets used in the business along with any goodwill associated with the business but does not purchase the entity itself. Buyers typically favor asset purchases to avoid assuming liabilities of the entity that may or may not have been known to the seller.
In a stock or other equity sale, the buyer purchases the outstanding stock or equity interests in the entity and assumes ownership of the entity. In most cases, sellers generally prefer a stock or equity sale because they can treat the transaction as the sale of a capital asset and pay the long-term capital gains rate on any profit associated with the sale.
Asset sales agreements should allocate the purchase price among the assets being purchased, whether its equipment and fixtures, inventory, customer lists, business goodwill and, in some cases, post-closing consulting services. Purchase price allocations can have significant income tax consequences to both the seller and buyer.
5. Provide for Transition
Don’t get so focused on the business sale that the transition process that will occur after closing the sale is neglected. Generally, it is the buyer’s decision whether to make a clean break or require a seller to remain “on staff” assisting with transition and training.
If, however, a seller is not completely cashing out and is providing seller financing, it may behoove the seller to keep a hand in the transition to increase the likelihood of the business’ success and receipt of full payment on the deferred portion of the purchase price. Prior to closing, the seller and buyer should agree to the scope and terms of any transition services the seller is expected to provide, including hours and whether the cost of the services are rolled into the purchase price or will be an added buyer expense during transition.
6. Don’t Go It Alone
Business owners who have worked hard to build a successful business and want to net as much of the purchase price for as little expense as possible. But there are no mulligans when selling a business; owners only get one shot at doing it right.
While business owners may be successful in business, sale of business transactions are not part of the daily grind. Few owners have the time or experience to adequately address the legal, tax and accounting complexities of selling a business.
This is where a good sales team—a transaction attorney, CPA, business broker and other professionals–in your corner earns its keep. These professionals can help owners avoid these and other common pitfalls with an effective sales process and marketing effort to bring in the best price for the business while protecting owner interests.
This is part one of a two-part series on mitigating the risks associated with business transactions. For part two, click here.
David A. Thayer, Esq., is a corporate and transaction attorney, and former CPA, that focuses on being a deal maker, not a deal breaker, as he helps clients achieve their business dreams. He can be reached at firstname.lastname@example.org.
THIS INFORMATION IS NOT INTENDED AS LEGAL ADVICE. SEEK SPECIFIC LEGAL ADVICE BEFORE ACTING.