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Selling Your Business: How the Process Works

by Don Naideck and Bill Blumberg

One of the first business sales we ever worked on was a $30 million a year lighting distributor. The lead came in from a cold call. The seller was very secretive-he wouldn't give us any information over the phone-because he wanted to meet us first. This was almost 20 years ago, before the age of Web sites and instant online reports. As we drove to meet him, I kept thinking that we were wasting our time, that the gentleman was probably selling light bulbs out of his trunk. When we arrived at our destination, we were pleasantly surprised to have pulled up to a large, modern building with the gentleman's name in two-foot block letters over the front entrance.

The owner turned out to be a very sophisticated and savvy businessman. He was a hands-on owner, completely knowledgeable about his industry, international trade mechanisms, finance, and management. He wanted to sell his business and retire. But he had no clue as to how to proceed. He needed a business sales professional to educate him about the process, package his business for sale, locate the right buyer, put the deal together, and see the deal through to closing.

Almost 20 years later, this owner is still typical of most business owners. No matter how sophisticated and successful they are, today's owners often have little or no knowledge of how to go about selling their businesses. If you are thinking of selling, the following primer on the basic issues and process might get you started on the right foot.

Why do people sell their businesses?
"Retirement" is the first answer that comes to mind when most people are asked this question. We find, however, that only a small percentage of business sellers are of traditional retirement age. Many successful owners sell while in their 40s or 50s. They want to turn the value of their business into cash while they are still young enough to enjoy their lives, spend more time with their families, travel, or, perhaps, begin a new business venture.

How long does it take to sell a business?
It typically takes six to 12 months to sell a business. Even if you had a buyer in hand today, the process, including Letter of Intent, due diligence, purchase contract negotiations, financing, and settlement, takes a minimum of four months. And that's if there are no problems-if the deal doesn't fall apart so you have to start at the beginning with a new buyer.

Is there a market for businesses?
Absolutely. Just as there is a market for the goods or services your company provides, there is a market for businesses for sale. And, just as in the market you compete in, prices are defined by a competitive market.

Do most buyers target a specific type of business?
No, most buyers are interested in broad categories, like service or construction trades or distribution, and then limit their search by geographic and size considerations.

What kind of businesses do buyers avoid?
Buyers avoid businesses where there is a substantial risk that the business's goodwill will not transfer. The goodwill might not transfer for one or more of the following reasons: unstable customer concentration (one or two big customers whose loss would cripple the business); the business is really a personal service business (where the knowledge and relationships necessary to conduct the business reside exclusively with the owner); or external risk factors, such as increased competition, impending loss of a valuable location, technological obsolescence, etc.

Why do people buy businesses?
1) To make money. 2) To make money. 3) To make money. Whether buyers are individuals, equity funds, or other businesses, they buy businesses to make money. Of course, many also want the freedom to succeed or fail on their own merits that business ownership offers. In the end, however, buyers are paying for the right to step into your shoes and make as much (and, hopefully, more) money as you do.

How are businesses valued?
Buyers buy businesses to make money. It is not surprising to learn then that businesses are valued based largely on how much money they make. Other factors that influence the valuation include the type of business, recent trends in the individual business and its industry, assets, and/or liabilities included or excluded from the transaction, geographic desirability, and the existence of risk factors such as those listed above.

Is the valuation based upon taxable income?
Valuations typically use formulas that include the corporate taxable income and also include other benefits that the owner takes from the business, including the owner's salary, interest on debt that won't transfer, non-economic depreciation and amortization, one-time non-recurring expenses, pension contributions, and other benefits accruing to the owner, and the owner's discretionary expenses paid for by the business that are not related to the actual operation of the company. This bundle of owner's compensation items is called the "owner's discretionary cash flow" or "Adjusted EBIDTA" — Earnings Before Interest, Depreciation, Taxes and Amortization.

Should you use a broker to sell your business?
Yes. Although we may be prejudiced, we believe very strongly that it is in the owner's interest to use an intermediary. An intermediary packages your business and presents it in the best light to obtain the highest possible price. He maintains confidentiality and fields all inquiries away from the business premises. He finds the best possible buyer for your particular business. He minimizes the amount of time you need to spend on the sale so you can concentrate on running your business. He resolves differences between the buyer and seller before they become personal. He helps secure financing. He keeps the deal on track and moving forward to settlement.

How do you choose a broker?
Selling a business is a delicate and complicated matter that needs to be guided by a hands-on, experienced professional. The first rule in choosing the right broker is to choose a broker who is local. The broker needs to be there, in person, to guide the process, attend meetings, assess personalities, anticipate and solve problems, hold hands, negotiate, cajole, etc.-to do whatever is necessary to get the deal done. A broker's work simply cannot be "phoned in."

The second rule is to meet the broker in person before you make your decision. Are you comfortable with this person? Do you believe that is this person will represent your business in a professional manner? Does he understand what you are trying to accomplish by selling your business? What is his plan for selling your business? Can you see a sample prospectus? How does he find potential buyers? Does he charge a fee up -front or does he get paid only when the sale is completed? You can't ask too many questions.

The third and final rule is to ask for and check three to five references. They should be from recent sales of businesses that are of similar in size and type toas yours. You don't want your broker to be learning on the job with your transaction.

What should the business offering package or "prospectus" contain?
A good prospectus should contain a history of the company for sale, an overview of the industry, an explanation of the company's particular niche (including sources of revenues, types of customers, etc.), an overview of the business's organization, a review of the operations (the nuts and bolts of how the company actually functions), information about the competition the company faces, a summary of the historical financial results of the company, information about the assets that will transfer to the buyer, and a section devoted to the growth potential of the company. A good prospectus should not be a fill-in-the-blank "boilerplate," but should be written specifically for the business it describes.

Who should receive the prospectus?
Only qualified (financially and by ability) prospective buyers who have signed strict Non-Disclosure Agreements prohibiting them from disclosing information to anyone except their lawyers and accountants.

Should you pay money for the prospectus?
No. While some brokerage firms charge $30,000, $40,000, or even $50,000 to package a business for sale, other firms work exclusively on a "success fee" basis, earning their fee only when the business is actually sold. The firms that charge large up-front fees often secure their clients by making extravagant claims about the prices they can achieve. One of these companies was recently the defendant in a large class action lawsuit. The company was required by the court to return much of the up-front money it had collected from businesses it never sold. Instead of being taken in by wild promises, it is smarter to choose a broker that has the confidence to work on a "success fee" basis and that has a track record and local references that can be verified.

What happens after the prospectus has been prepared?
After the prospectus has been prepared and reviewed by prospective buyers, interested buyers may want to meet with the owner, view the business site, and obtain more detailed information. In order to maintain confidentiality, meetings should occur away from the business premises. Any on-site tours should occur after all employees have gone home.

Should the fact that you are trying to sell your business be kept confidential?
Absolutely. While some owners understandably feel an obligation to their employees to let them know what is going on, we have found that no good can come of telling employees that their company is for sale before the sale is actually consummated. If an employee finds out his company is for sale, he might start looking for another job, fearing the new owners will replace him. If vendors find out you are for sale, they might put you on COD. If competitors find out you are for sale, they might use that information against you in the competitive marketplace. Employees should be told of the sale in a post-closing company meeting, where the new owners are introduced. At that meeting, the new owners typically assure everyone that their jobs are safe (their jobs really are safe- buyers typically are very concerned about retaining existing employees, without whom the business would have little, if any value) and that they intend to grow the company, creating opportunities for everyone.

What does an offer look like?
Offers typically come in the form of a Letter of Intent. A Letter of Intent is a short, non-binding document that spells out the basic terms of the proposed transaction. It usually proposes that closing be contingent upon executing a formal Purchase Agreement, upon the buyer obtaining the necessary financing, and upon the buyer's successful completion of its due diligence study.

What is due diligence?
Due diligence is a short period of time in which a buyer who has a Letter of Intent that has been accepted by the seller and who has placed a deposit with the broker can examine the books and records of the seller to determine whether he wants to proceed to a final, binding Purchase Agreement. During this time, the business is typically off the market for other buyers. Although buyers sometimes ask for as long as 90 days to complete their due diligence, we strongly recommend that due diligence last no longer than 30 days. There simply is no reason to allow the business to be kept off the market for longer than that.

What is a Purchase Agreement?
The Purchase Agreement is the binding, legal document that describes and controls the transaction. It usually has exhibits appended to it, such as the business's financial statements and other documents, which become part of the contract and settlement package.

Do I need a lawyer and accountant?
A lawyer should be retained to review the Purchase Agreement. An accountant should be consulted to ensure that the sale is structured in the manner most beneficial to your tax situation.

When do I get my money?
At closing. The current lending environment is very favorable to business transactions. As long as your company is stable, profitable and has good financial records, you should be able to be "cashed out" at closing.

What happens after closing?
That depends on the needs of the parties involved. At a minimum, the seller stays with the company for a month or two after closing to train the buyer and familiarize him with the clients and business practices and procedures. Sometimes, if both parties desire, arrangements are made wherein the seller stays with the company on a longer-term basis. For example, we have seen several sellers who were happy to stay on in a sales or operational capacity so long as they had no administrative responsibilities.

Is this a good time to sell?
The decision to sell a business is a very personal one, often relating to quality-of-life issues for the owner and his family. That being said, it is an extraordinarily good time to sell a business. The economy is strong. Interest rates are still low. The lending climate is favorable. And, of course, capital gains tax rates (which most business sellers can take advantage of) are at a historical all-time low of 15 percent.

Selling a business is the end of one journey and often the beginning of a new adventure. The business being sold often represents the bulk of the seller's estate and the monetary value of the seller's life's work. The sale shouldn't be rushed, but should be handled in a deliberate manner with proper professional help. The business should be prepared and packaged in a manner calculated to achieve the highest attainable price. The selling process should be managed in a way that maintains confidentiality and doesn't interfere with day-to-day operations of the business. The transition to new ownership should be structured in a manner that ensures the continued health and viability of the business for both the employees and the new owners.

When handled correctly, the sale of a business can give the seller the money needed to start the next phase of his life, whether it leads to retirement, more time with family, the pursuit of other interests, or a new business venture. Although, at the closing, many sellers have mixed emotions about giving up their cherished "baby," after the sale most sellers are soon exhilarated by their new-found freedom and prospects for life's next adventure.

Don Naideck is president and Bill Blumberg is vice president of Prime Investments in Radnor, Pa., a leading seller of privately held businesses. For more information, go to its Web site at www.primeinvestments.us.