DETERMINE YOUR IDEAL SALE DATE
Often, entrepreneurs don’t want to sell until they are ready to retire. Ideally the decision to sell should be made two to five years prior to your desired retirement date. This is because most buyers will require you and your key employees to remain with the business for several years in order to facilitate the transition of the business’ key employees, suppliers, and customers. If you feel that you want to retire or move on to other things within the next several years, explore selling your business sooner rather than later. We recommend that you think about your exit plan from the start for tax-planning purposes.
It is always best to try to sell your business when it is not a necessity. If a potential buyer senses your immediate need to sell, you will lose significant leverage during the negotiation process.
Alternatively, if your business is attractive to several potential buyers, you could generate a substantial premium by creating a bidding war.
MENTALLY COMMIT TO SELLING
Before you sell, fully understand the impact of the potential sale. Carefully consider:
- Why you want to sell your business
- What you will do once you have sold your business
- Whether you have a price in mind at which you would be willing to sell
- How your key suppliers and customers will react to the sale of your business
- How you feel about someone else running your business
- What impact new ownership will have on your employees
- Whether you are willing to offer a loan or receive deferred or contingent consideration
- Whether you are willing to continue in the employ of a new owner and/or continue to own a piece of the business
You must mentally commit to a sale process, which will take time and patience, but it’s worth it at the end.
ASSEMBLE YOUR TEAM OF EXPERTS
It is extremely important to bring in a team of specialists to guide you through the sales process. The typical participants include an accountant, an attorney, and often an investment banker. Be sure to engage attorneys and accountants who specialize in mergers and acquisitions. Investment banker engagement letters are typically highly negotiated agreements, so it is prudent not to engage an investment banker without the help of an attorney. Those negotiations can result in savings ranging from several hundred thousand dollars to more than a million dollars.
Your team of experts will not only provide extremely valuable advice on how to maximize your company’s value, but will also help you and your management team with the significant workload necessary to get your company through the sale process.
Note that it is also important to consult with an estate-planning attorney and wealth advisor to make sure that your estate is protected after the transaction closes.
PUT IN PLACE A CORPORATE AND TAX STRUCTURE TO MAXIMIZE AFTER-TAX NET PROCEEDS
Planning ahead with an efficient structure will help you maximize your after-tax net proceeds by (1) providing extra value to potential bidders, which may increase their bids, and (ii) potentially reducing your taxable income arising from the sale.
For example, potential buyers will often increase their bid if they are able to structure a transaction as an asset purchase for tax purposes. This can result in a “step up” in basis for the buyer, which is a valuable tax asset because it creates a large amount of depreciation of assets. You may be able to structure your company to enable a sale that provides a “step up” in basis for the buyer while maintaining a tax efficient structure for you. In addition, you may be able to take advantage of certain tax-efficient structures such as the benefit of having your equity treated as a qualified small business stock and potentially obtain at least $10 million of the sale price free from federal income taxes.
It is important to work with sophisticated counsel and accountants early on to put in place a structure that will maximize after-tax net proceeds. Often, it is too late to make any changes if this occurs during the sales process. Start thinking about this as early as possible, even if a sale process is years away.
UNDERSTAND THE VALUE OF YOUR BUSINESS
Before formally committing to selling your business, it is important to obtain a realistic understanding of its value. There are several approaches to business valuation. The most common method is to determine some type of multiple of adjusted earnings. This can be done by either averaging your adjusted earnings over the course of several years or for your most recent year, if that particular year is indicative of what you expect in the future.
Adjusted earnings often add back pretax earnings in addition to owner salary, interest expenses, depreciation, and any personal expenses run through the business. The multiplier of this number varies widely by industry, market conditions, and size of the business. For example, a business in a high-growth industry will likely get a higher multiple of earnings than a business in a low-growth industry. Further, larger companies typically get higher multiples of earnings due to the fact that they often have more potential buyers interested in them.
Valuation of a private business is a difficult task, but lawyers, accountants, and investment bankers can assist you with this process.
RECONSTRUCT YOUR FINANCIALS TO SHOW YOUR TRUE EARNINGS
Many privately held businesses are operated in a manner that minimizes the owner’s tax liability. Unfortunately, these same operating techniques can cause a reduction in earnings and a decrease in the value of a business. For example, your financial statements should not include any personal expenses that you may run through the business because they reduce earnings and would not reoccur after a transaction closes.
PREPARE FOR DISRUPTIONS TO YOUR BUSINESS
Be aware that selling your company can cause significant disruptions in your business. Management will be required to spend considerable time assisting with the due-diligence process and educating the potential buyer about its business operations.
Also, you may not want to discuss the sale process with employees, suppliers, and customers until it becomes absolutely necessary. Employees may become nervous about the uncertainty of the sale of a business or the possibility of working for a new owner, and may consider leaving. Should you choose to discuss the sale of the business with your employees, you may consider offering them “stay” bonuses, accelerated vesting of options, or other benefits and retention programs.
Finally, suppliers and customers often fear that their relationship with the business could adversely change after the sale. It is important not to risk any disruption to your key relationships until you are certain that a transaction is likely to close.
IDENTIFY AND ELIMINATE POTENTIAL OBSTACLES
Bringing in an attorney and an accountant who specialize in company sales will help you identify any potential deal obstacles. To the extent feasible, it is wise to correct any weaknesses in the business, such as those existing due to a pending lawsuit, contractual disputes, or other outstanding legal, tax, banking, or financial issues that could slow down or complicate completing a deal. Other possible obstacles include obtaining requisite permits or licenses, fixing any employment practice violations, updating corporate board and shareholder minutes, and registering the ownership of intellectual property such as patents, copyrights, and trademarks.
PREPARE FOR THE BUYER’S DUE-DILIGENCE EXAMINATION
Once the sale process begins, a buyer will thoroughly review every contract, agreement, and record pertaining to your company and business. Prior to disclosing information to the buyer, it is important to have your attorney and accountant undertake a thorough review of your corporate records and agreements to ensure that all are complete and up to date. Take any necessary corrective measures recommended by your experts. By having your advisors conduct due diligence prior to the buyer’s review, you will help reassure the buyer that your business has been conducted in a competent, professional manner.
Additionally, you will be assisting your advisors in minimizing your liability by enabling them to provide complete and accurate disclosures to the buyer in the purchase agreement. If a buyer finds any issues in the due-diligence process, it can lead to increased post-closing liability for you. Start getting organized ahead of the sale process and make sure you have complete copies of all of your contracts.
PROTECT YOUR PROPRIETARY INFORMATION
Prior to commencing the buyer’s due-diligence process and any negotiation on the sale of your business, you must execute a nondisclosure agreement with the buyer in order to protect your confidential information. This agreement should also include a provision prohibiting the potential buyer from soliciting any of your employees, consultants, suppliers, or customers.
Jeremy Weitz is Chair of the Buchalter’s Corporate Practice Group and Co-Chair of the Firm’s Mergers & Acquisitions Practice. Mr. Weitz’s expertise covers mergers and acquisitions, private equity, publicly and privately traded securities, venture capital, corporate maintenance and formation, corporate finance, and licensing.
Tanya Viner, Esq. is Co-Chair of the Buchalter’s Mergers & Acquisitions Practice and Los Angeles Chair of the Corporate Practice group. Ms. Viner’s practice focuses on mergers and acquisitions, representing both the buyer and seller in large complex transactions ranging from the sale of closely-held family businesses to transactions in excess of a billion dollars.