A comprehensive explanation of the process of how to sell your business from a New Zealand perspective
You’ve spent years building your business, you enjoy working with your customers and employees, but you’re getting older and its time to nurture your health and sell your business. Here’s how to do it.
Business Value and Price
Business value and price are two different figures. The price of a business is what you state at the start, perhaps think of it as a reserve in an auction or a listed price with negotiation wriggle room. It can go up or down and may be different from the theoretical value.
The theoretical appraised value is an opinion of “fair market value” by an expert. That is the price a willing, prudent and knowledgeable buyer and willing seller reaches in an open market. Note it’s not a fact and can be wide in range.
There are three approaches to valuing a business: 1) Asset 2) Income and 3) Market.
We tend to use Asset valuation primarily where there are expensive assets such as planes or heavy machinery, and so is not applicable most cases.
We use the Market approach to find similar businesses—similar in terms of revenue, earnings, margins and geography—and calculate the value based on what similar businesses sold for.
We use the Income approach to calculate the value of future maintainable earnings discounted for risk.
The first step for both the income and market approaches is to estimate Future Maintainable Earnings.
Earnings are key. We usually start by making the following adjustments to Net Profit to arrive at Adjusted EBITDA:
- interest expense and interest income is excluded to remove any debt structure assumptions
- taxes are removed to avoid including seller specific tax strategy and history
- non-cash items are adjusted including gain/loss on disposal of fixed assets, depreciation and amortization; depreciation is an artificial calculation for tax purposes than real-life wear and tear of assets (sometimes we may replace depreciation with an actual maintenance capex forecast)
- one-off unusual items that are unlikely to regularly occur (e.g. car crash results in insurance claim income)
if there are any family members being paid above or below market rates then these wages need to be adjusted to market rates
other owner benefits that are really personal (e.g. non-working wife’s salary, a car not needed for work purposes) are added to earnings
For the purposes of valuing a small business (less than $2million of turnover), we use Earnings Before Proprietors wages Interest Tax Depreciation and Amortization or “EBPITDA” by also making the following adjustments:
- include all owner’s benefits regardless of how the owner takes the money out of the business (wages, dividends, drawings)
- only one owner’s “total benefit” is taken into account, if there is more than one owner then the other owners’ salaries are adjusted to market rates for their position and kept as/added to expenses
American’s call EBPITDA “Seller’s Discretionary Earnings” and it essentially calculates what the owner can spend on a salary, taxes, interest and capex. It provides an accurate picture of the true cash producing ability of the business and removes the vagaries of bookkeeping from earnings.
A mid-market company uses EBITDA to show an investor—not a working owner—how much a company is earning. The investor does not actively run the company so must pay a professional manager to do this, and so this salary (at market rates) is included in expenses.
Note that we are interested in future income streams, the Future in “Future Maintainable Earnings”, and use historical data as the best proxy (and is a fact rather than an opinion).
However, if there are strong reasons to believe that the business will have significantly different future earnings, then earnings can be adjusted. These strong reasons really need to be supported by facts, e.g. a large contract won or lost, rather than a simple forecast or guess.
Prospective buyers are interested in how risky those future income streams will be. The formal way to measure that risk is through the income method. You look at each risk factor and assess whether it increases, decreases or is neutral/irrelevant to the risk of the future income streams. The higher the risk the greater that income will be discounted.
That discount is expressed in different ways including as a capitalisation rate (higher rate means more risk and lower value) and earnings multiplier (higher multiplier means less risk and more value).
We will cover risk factors below from the perspective of whether your business is ready for sale, just note the same factors are used in valuation.
This article is about the overall process of selling a business. For more about the valuation methods see my article Business Valuation in New Zealand.
Is the Business Sale-Ready?
Hopefully, you have time to make a considered exit when that suits the business, not a hurried exit based on a heart attack or some other health event.
In order to get your business sale-ready, consider the following risk factors (note these factors are also used to value a business). If you can easily improve a factor (lower business risk) over the next year or two then certainly do it.
However, if it’s going to take a few years, and you can’t be sure that your effort will result in improved performance, then it may not be worth the time and effort. By holding the company you also face the risk of deteriorating health in the business, the economy and yourself.
Earnings and Revenue
Has your business had three years of stable or growing earnings and preferably revenue? If not three years then at least the last 12 months of strong earnings.
In order to get the business ready for a sale that maximises the price, your aim is to: reduce expenses, improve gross margins and boost earnings. Perhaps increase prices, cancel any long-term projects, take a hard look at employee levels and supplier costs, remove family and personal costs out of the business, put those cash jobs into the business, and stop taking “free” product home ;).
What are the opportunities to immediately grow earnings? All those things you’ve wanted to try out but didn’t have the time or inclination. You won’t get paid for any value from future opportunities, buyers will say that is their effort, not yours.
Your aim: target those opportunities to increase earnings over the next 12 months. Even if they don’t make as much as you hoped and mean you work long hours for the next year, at least you keep that value not leave it for the buyer.
How exposed is a business to a significant drop in earnings due to a large customer leaving the business? Specifically, what percentage of revenue is reliant on customers that make up more than 10% of revenue. When you leave, will your large customers? It comes back to the security of income streams.
If you’re in a B2B industry, do you have long-term legal contracts with clients or at least preferred supplier status? How easy is it to assign the contract or status to the buyer? If you don’t have contracts, how strong are the client relationships with the business vs yourself?
If you’re in a B2C industry, how many of your customers are repeat customers, and can you show that loyalty to buyers? Do you have any customer satisfaction information that shows they are likely to return to purchase?
Your aim is:
- to see if you can reduce any one customer’s revenue to being less than 10% of total revenue by growing the customer base and total revenue
- secure income streams with contracts or preferred supplier status
- secure client relationships with the business, not you the person
- measure (and improve) customer satisfaction and loyalty
Does the business rely on only one geographical market and one product or service, or does it have nationwide sales and even exports for many different products?
- sell into other regions, perhaps Auckland, Christchurch or Palmerston North if you’re based in Wellington
- sell other product lines
- sell into other customer segments
Management Depth and Systems
If the main owner was “hit by a bus” would the business be able to continue operating? How many layers of management are there to take over operations while the owner recovers in a hospital for 6 months? Or less morbidly, can you go for a holiday for two months and know your business is in good hands?
Does the main owner have specific skills, licenses or knowledge that are critical to the business operating? Do you have all businesses processes written into manuals such that the buyer can pick them up and run the business including administration, financial reporting, IT, operations and HR, from your sales lead process to alarm codes, from machinery operation to debt collection?
Your aim: ensure there’s a good manager(s) who can assist the buyer, that other staff hold required licenses, that processes are documented not in your or their heads, that IT systems are used that are cloud-based not on your PC.
Do employees have specific skills, licenses or knowledge that are critical to the business operating? How long would it take to replace them if they left? Do they have clear job descriptions and up to date employment contracts? Are they able to leave with your IP or with a group of customers to set up their own business?
Your aim: not be reliant on one employee, have up to date employment contracts with clear job descriptions, keep IP in the company rather than personal to employees, ensure the business, not the employee owns the customer relationship.
Is it a highly competitive market with many competitors who compete on price, deep-pocketed competitors who engage in price wars, or are there few competitors who compete on non-price factors? What are the barriers to entry e.g. high tangible asset costs, patents, well-known brands, high switching costs, regulation, and licenses?
Your aim: not much you can do about external forces, so simply explain competition, price aggressiveness, and barriers to entry.
How profitable is the industry? Is the industry growing, flat or declining (in your region)? Is it a highly regarded industry with significant assets that will attract buyers?
Your aim: show that you are growing faster than the industry and are more profitable. If the industry is growing fast and is profitable make this one of the key headline factors when selling the business.
How much of future growth can be met by self-funding versus being raised from the bank or introduced funds?
Your aim: if possible, show that growth can be self-funded and not require extra investment or bank finance.
Do you have any assets that are not needed or are used mostly for personal reasons? Do you have hire purchase HP?
Your aim: remove assets from the business now rather than awkwardly at the time of sale (awkward because you have to explain why the asset is personal). Given most business sales are for assets, not shares you will be obliged to pay off any HP or loans secured against business assets, this is best done without early payment penalties so should be planned to avoid such charges.
Do you own your premises through the business?
Your aim: if you own the building, you want to get it valued and sold into your new property company. Then ensure you are paying a lease at market rates to the property company, that way the P&L has an accurate lease expense. You can then choose whether to sell the building to the business buyer, sell it to a property investor or keep it (never sell it to an investor first or you could find they will not agree on terms with the buyer resulting in you being unable to sell the business at its current site).
Is there obvious maintenance capex that needs to be spent?
Your aim: accurately describe what maintenance capex needs to be spent in the next year or two. We remove depreciation because its a tax minimisation calculation not because its a poor business expense. Instead, we need to make a calculation of what is required to be spent (if anything) on maintaining assets or replacing them and subtract from earnings.
Are there any legal issues, disputes, or contingent liabilities? Do you need to formally seek IP protection such as trademarks and design registrations?
Your aim: settle any legal issues and ensure that any liabilities are disclosed by yourself rather than found by the buyer (or they will wonder what else they don’t know), register IP.
Is the industry facing technology disruption including overseas outsourcing?
Your aim: external issues, just put industry disruption into context by showing how small it is or how far in the future it will be.
Are you facing environmental legislation or effects that will ruin or benefit your industry?
Your aim: show buyers how you will mitigate the risk, or take advantage of the opportunity.
Do you depend on one key supplier or can you purchase goods and services from any number of suppliers? If its one supplier, how likely are they to remove supply?
Your aim: to ensure that you can continue to operate without relying on one supplier. For example, if you rely on one software platform, show you can use open source or other platforms. If you are an exclusive importer then find other suppliers to reduce your exposure.
Lease & Tenure
If location is a key driver of revenue e.g. hospitality and retail do you have a long-term lease including rights of renewal? If you have a business that is difficult to move e.g. a factory, do you have a long-term lease? Do you have a demolition clause or significant rent increases in the next rent review?
Your aim: increase the lease length including renewal rights to perhaps 15-25 years, you may even need to move locations to get a more secure lease agreement. See the Assets section above if you own the building.
Reason for Selling
Why are you selling? Retirement is perfect. Health issues are a legitimate reason but suggest there will be less vendor assistance post-sale so is not ideal. Lack of earnings, negative cash flow, poor market conditions are reasons that are sure to reduce offer prices. Other poor reasons are burnout (buyer wonders what will happen to their health) or buying another business (what is wrong with this one?).
Your aim: the best time to sell is while the business and yourself are in good shape, you’re retiring not fleeing the business.
When the buyers walk through your manufacturing site, visit your salesroom or come and see you at the office what will be their first impression?
Your aim: clean, tidy, paint, repair your operation, mow the grass, clean the windows, replace the 1970s blinds with the latest design, upgrade the website, social media accounts…as you know first impressions are an unavoidable emotional judgement people make—rational or not.
The Business Plan and Opportunities
Do you have a way to describe the future potential and opportunities of the business? Can you provide a financial forecast?
Your aim: buyers will want to understand the future income stream, so describe the business opportunities perhaps through a simple business plan with a forecast for the next year or two. It helps buyers to understand the possibilities of increasing earnings. Note you don’t want to legally warrant that performance, it’s just indicative of the opportunities.
You’ve prepared or are preparing your company for sale, let’s look at how to sell it.
The Method of Sale
There are a number of decisions you need to make on what method to use to sell your business:
- buyer type
- sales method
We’ll go through each of these in turn.
I strongly believe a business sale should be confidential.
Your employees, customers and suppliers will find it unsettling that you are going to leave the company and that some stranger who “doesn’t have your abilities” is going to to take over.
Your managers may decide to leave, your customers will start to look for other options especially when competitors come knocking on their door to let them know the “news”, your suppliers may tighten credit or look for new distribution options.
This may result in an earnings collapse which ruins business value just when you needed it earnings to be at its strongest.
The argument for a business-identified sale is that you can increase the number of buyer enquiries by revealing the business name and showing photos and videos. That any drop in earnings and operational disruption is outweighed by the increased buyer pool.
My reply is that you should be able to show how good the business is without revealing its name. Active buyers are actively screening the business-for-sale websites and industry buyers can be contacted directly, so the extra buyers are likely to be tyre-kickers who are curious, not real purchasers. You’re not selling a property, a business is full of people whose opinions and actions matter.
There are exceptions to the confidentiality rule. The first is equity raising for a growing company, where raising funds is seen as a positive action to provide capital to grow faster. Another is for a famous company, where announcing the sale will lead to intense media interest that generates such a high level of buyer interest that the benefit outweighs the cost. Lastly, you may have a deadline by which the company needs to be sold, the extra buyers found by the deadline may outweigh the costs.
If your business is going to be purchased by people who cannot be directly identified then you need to list it on business-for-sale websites. For example, cafes may be purchased by mothers returning to the workforce, corporate workers who want to run their own business, immigrants who want to share their home country cooking etc. There is no easy way to identify who these people are.
You may also choose to do some advertising, usually in digital channels given prints cost and lack of performance targeted at such people.
If your business is going to be purchased by someone in your industry (so can be identified) then you need to make a buyers list. You’ll directly contact them. Often this is an industry which requires technical ability and know-how. It’s also the normal process for mid-market sales.
And it’s often both. You list—and contact directly. A construction trades business may have some obvious large buyers but also many smaller buyers which are difficult to identify.
Most often a business is listed for sale on an open-ended basis.
Potential buyers are directly approached over a few weeks and the website listings start to attract buyers over many months. The idea is that there are a limited number of buyers who will sporadically enter the market to buy a business over the next year. You don’t know who they are or when they’ll become interested so you leave your business listed for sale for many months to capture different buyers’ attention. A business can take 12 months to sell (or possibly not sell at all).
Sometimes an owner needs the business to sell by a certain date. They may need the money (e.g. Eric Watson dispute with Sir Owen Glenn allegedly meant he sold Soul restaurant), be sick, or the business may be burning cash and they need to exit. In which case, either a deadline sale or the more formal tender process can be used.
The problem with a tender is it is restrictive in what you can change, especially the tender date, so you set the rules and see if you get any good tenders. A more flexible approach is the deadline sale with the option to accept prior offers. You have much flexibility in moving the deadline or straight out accepting a good pre-deadline offer.
Most often you disclose your price.
You could say price on application (POA) or negotiation, expressions of interest (EOI), non-binding indicative offer (NBIO), but buyers will then have to spend significant time calculating a price with no idea of whether they are wasting their time. Buyers have a limited budget or have certain valuation parameters in mind. If they don’t know what you want then they may not bother spending the time to evaluate the business.
So set a price, arguably its also good negotiation practice as its anchors the negotiation at your favoured price point.
Price is expressed as $XX plus SAV, plus GST (if any). SAV means “Stock at Valuation”, in short, any stock should be valued at cost and is a simple fact assessed through a joint stock take near the settlement date.
Most companies are sold by a registered GST entity to another registered GST entity so no GST is paid or claimed under the IRD going concern ruling. If one party is not GST registered, and will not be at settlement, then you need to seek accounting or legal advice as you may need to pay GST.
How long does it take?
There is no sensible average, some businesses sell in 3 months, others take more than 12 months—think 3-9 months. It will take about a month from an engagement letter being signed to putting the business on the market as a business appraisal, Information Memorandum and a number of other things need to be done.
You’ll contact your buyers who drop everything to negotiate a sale…which almost never happens. More likely they are on holiday, are in the middle of a big project, need to mull over their finances…and things go at the speed they set. Until you get an offer in which case, you let other buyers know, and the serious ones will speed up their decision making.
When you list on business-for-sale websites the time it takes to sell will depend on how many buyers enter and exit the market every few months.
You’ve made your decision about confidentiality, buyer type, sales method and price. Time to decide how to describe your business.
Describing your Business
You need to write a teaser and an Information Memorandum (IM). You need an NDA.
A teaser is sufficient information to attract a buyer without identifying the company. It should cover what type of industry, where it is (or perhaps lower North or South Island to keep it non-identifiable), when it was founded, why your business is so good, and how much you’re asking. All in 300 words.
Its what you say on the phone, write in an email or write as a description on a business-for-sale website listing. It usually gives revenue as well as positive descriptors e.g. growing, established, profitable, loyal customer base, opportunities.
You are simply providing enough information for a buyer to screen opportunities e.g. the buyer may only want to buy businesses in their industry, in Wellington, with at least $3 million of turnover.
You don’t want to hype the business but nor do you want to hide key selling features.
In New Zealand, we call the company information document that is sent to buyers an Information Memorandum (IM). It is sometimes also called an offering memorandum, confidential information memorandum, marketing book, company profile, or prospectus.
In essence, it’s a brochure that sells the company. It tells a positive story that makes buyers interested in looking more into the company.
The contents might look like this for a mid-market company, either in Word or PowerPoint format:
- Business Overview (history, products, differentiation, sales channels, growth opportunities)
- Management (senior, organisation chart, capability, reason for selling)
- Industry (market, competition)
- Financials (P&L, Balance Sheet, Cash Flow Statement)
- Investment (valuation, desired transaction)
- Appendix (risks, financial details, DCF, operational detail)
For a mid-market company, we usually create a financial model to forecast the financials and calculate business value.
For a small business its much shorter, in a Word Document, likely only a few pages with key information, something like:
- Business products and market
- Sales channels
- Three years of Revenue and Gross Margin (or possibly a summary P&L with adjustments to EBPITDA)
- Reason for selling
Before we start contacting buyers, we need to prepare a Non Disclosure Agreement (NDA), also known as a Confidentiality Agreement (CA). This means that if a receiving party discloses your confidential information you can sue them in the courts. A business broker will have their own NDA, otherwise you should ask your lawyer for an NDA—though I acknowledge you’re probably going to search the interest and use a free one…see this “Non-disclosure agreements – getting it right“.
You also need to think through how you’ll execute the NDA. If you use your name then a quick search of the Companies Register will probably show you as a shareholder of your company. Best ask your lawyer for advice on how to do this. If you’re not using an intermediary then they’ll use their generic one that doesn’t identify you.
As you know, the first thing a marketer will tell you is to understand your customer—or buyer in our case. We want to know their motivations, their risks, and where they get information about buying companies. That way we can write good ads or letters, know how much info to release, and how to get on their radar screens.
The two most likely types are Corporate employees and Industry buyers. Less likely are Investment Firms and Multinationals. There are other types such as mothers returning to the workforce through their own business, older immigrants, highly skilled young New Zealanders returning from overseas etc which are covered in ex-corporate.
Most small businesses (say a value of $1 million or less) are purchased by corporate employees. NZ research has found 48% of Kiwis hoped for a better lifestyle and more freedom, 33% wanted to earn more money, and 6% had problems finding full-time work.
They are worried about the risk of being self-employed so are easily scared off, especially by undivulged risks they find themselves. So you need to identify risks and show how you handle them.
Amongst this group will be those who dream of owning a business but don’t have the funds, and the merely curious, both known as “tyre kickers”.
You can most efficiently reach corporate employees and related buyers by listing on business-for-sale websites.
Most likely your competitors, though could also be suppliers (or even customers). In essence, they want your customers. They may be from another region (Australia or further abroad) and want to establish themselves in the marketso will probably keep your employees but put their systems and manager in charge.
The big risk here is a competitor could feign interest in order to access confidential information including customer lists. You will need to carefully assess their intentions and slowly release information based on that assessment—perhaps not even show customer lists until the final day of due diligence.
The other risk is sharks, those who look for businesses in distress and pay bottom dollar. If they keep asking about business distress then watch out (unless you need a fast sale).
You directly approach these companies.
There are two types. Firstly, Venture Capitalists. They only invest in high growth companies and expect an ROI in the range of 50%. They also are keen for capable management to remain in place. It is unlikely your mature business will attract their attention. To find out more about startup investment see the New Zealand Venture Investment Fund for more, or look out for a future article I plan to write about on this.
Secondly, there are private equity (PE) groups, who prefer to buy mature companies. Unfortunately, they tend to only buy companies with EBITDA over $5 million. However, your company may have something in particular that interest them so they may be an option. See my mid-market specific article The Mid-Market Business Sale Process where I talk more about PE firms in NZ.
The advisor and you will brainstorm a list of possible buyers.
Who are the local, regional and national competitors? How about Australia, are there any competitors there large enough to move into NZ, are there any buyers aggressively expanding (perhaps with PE firm backing)? Are there any other international competitors that have invested in Australia? What about companies in a related industry, e.g. building industry, not just joinery or timber? How about large customers or suppliers?
Does each possible buyer have the financial resources to buy your company? Do you want to risk approaching local competitors when you know they may not buy, just seek to find out confidential information through abusing the process? Take these out of the list or contact them at the end of the process.
Then rank them by attractiveness and by the speed of decision. The speed of decision because large corporates are slow to make decisions so talk to them first, then speak to smaller more agile firms, and lastly local competitors. Attractiveness in that they have the funds and you fill a gap in their business. Your list is hopefully 20-50 contacts long, you need their email address and phone number.
Businesses for Sale – the Competition
In effect, other businesses for sale are your competition. All the buyer types above have other options when it comes to buying a business. In the case of the ex-corporate buyers, they can choose different industries. In the case of industry buyers, they can choose to buy outside of Wellington or whatever your region is. There is one big macro event that is happening though, Baby Boomers are retiring.
ASB conducted research that found that 190,000 businesses are going to be sold in the next five years. It’s simply a function of the Baby Boomer demographic bubble. Over the next 10 years, the number of people reaching retirement age will increase by 35%.
Against that trend, we have solid immigration and the millennial generation seems more open to owning their own business.
The market for businesses is the same as other markets, the price that will clear the market depends on the number of buyers and sellers, and their respective value expectations and risk profile. Too many sellers will result in a reduction of price and vice versa.
You’re ready! Your business is ready for sale, the price has been determined, information memorandum is finalised, and a buyer’s list is prepared.
If its part of your strategy, list the business for sale on various websites using your teaser. New Zealanders use the following:
The last two are mainly used by business brokers but, fear not, trademe and nzbizbuysell are where most enquiries come from. You could also choose to use international business-for-sale websites but they don’t prove to be terribly effective.
Then send your teaser by email, or use it as the basis of a phone call, and contact the people on the buyer list.
You’ll get periodic enquiries care of the websites which simply give a username, an email address and a message asking for more information. They may have actual names and phone numbers, but often they’re annoyingly anonymous.
If the buyer is interested send the NDA. Part of your NDA may ask for background information because, as per the buyer profiles above, we saw that many of these prospects won’t have the money, are not serious about buying, or may have bad intentions. Before we give any more information we want to screen them to ensure we’re releasing information only to likely buyers. This is particularly the case with enquiries from the business-for-sale websites where we also haven’t established identity.
Once you have their signed NDA perhaps give them a call, and politely ask for background information and experience based off the NDA. Why they’re interested in your business, how long they’ve been seriously searching for a business opportunity and what annual earnings they seek. If possible, find out what cash they can pay at closing and whether they have access to financing.
Once you’re happy with the enquirer, send the Information Memorandum (or an edited down one if you’re still uncertain).
Three things may then happen: 1) they’ll say its not for them and withdraw their interest, 2) deathly silence, or 3) they start asking lots of questions.
A “quick no” helps everyone—a bit of a shame but there is no need to waste time following up! You should try to find out why so you can establish if they have a reasonable issue with your business that you need to address in the IM.
Most likely you’ll get silence and you’ll have to follow up. They’ll say they’re still thinking about it, you’ll follow up again…now they’re too busy but are interested…crickets…at some stage, they’ll say they have some questions or they’re not interested. This is the time wasting part of the selling your business. Essentially you’re waiting for your business sale to get to the top of their to-do list, they need to discuss it with their wider team, or some other excuse. Weeks can pass.
Interested buyers will ask numerous questions, make site visits to view the location and discuss the business. Many of the questions you’ll choose to answer and the rest you’ll politely defer to due diligence (DD). Its a solid idea to start to compile a frequently asked questions and their answers document to share with buyers.
DD happens after you agree on the sale and purchase terms including price. But even then you may choose to give a competitor very limited information until right at the end. The customer list and employee details are some of the most confidential bits of information, along with pricing for some industries.
Most of the buyers will fade away without making any site visit. For those who are truly interested they’ll keep asking questions until you say that you really need a formal offer.
People have different theories about negotiation tactics. I tend to think the best approach is to be polite but frank and open with your objectives and issues. If the parties are sufficiently willing to make a deal then they will come to an agreement that often requires compromise on both sides.
I prefer any offer to be in writing and to contain all the important terms. For example, you may get fixated on the price but if the terms of payment mean a large part of that price is deferred and contingent then the headline price is artificially high, see the section Terms of Sale: The Price below.
Terms should include: tangible vs intangible assets, deposit, settlement and possession dates, stock adjustments, turnover warranties, vendor assistance period, vendor restraint of trade, lease details, and length of time to seek landlord consent for assignment, finance conditions (amount, lender, amount of time), due diligence date, any deferred and contingent payments, employee liabilities, exact asset list, and more depending on your industry.
Terms of Sale: The Price
You want complete payment in cash on settlement date right? The issue is that this may result in a lower price than if you agreed to deferred and/or contingent payments.
Your aim: decide whether you really need to take a lower price in cash, rather than a higher price in cash and future payments.
The simplest situation is where additional payments are made every 3,6 or 12 months. This allows the purchaser to use the business cash flow to help pay the next instalment.
Another option is vendor finance, where the owner loans money secured by the business (and sometimes the buyer assets), at an appropriate interest rate.
A more complex situation is an earn-out. The purchaser is looking at the financial accounts and wondering just how many customers will leave when you leave, how many employees will stick around, whether they can keep costs to the same level as yourself. Chances are they are nervous about all of these things as well as the unknown issues they think they will uncover. This means they assess the risk of future income streams much higher than you do and offer a price accordingly discounted.
On the other hand, the owner may feel all those scenarios are unlikely and, regardless, think that it’s up to the new owner to operate the business capably. They don’t want to leave any money in the business at risk of the other owner’s mistakes.
It’s a classic negotiation scenario and needs to be bridged with a fair compromise to both parties. Perhaps most of the payment is at settlement and the rest is paid on the basis of revenue or volume forecasts being met.
Vendor Assistance and Restraint of Trade
How long are you going to provide vendor assistance? Also, will you continue to work in the same industry at some stage?
Your aim: decide on how long you’re willing to provide assistance post-sale. Some larger corporate buyers want a year or two of vendor (owner) assistance (and pay you a salary), it gives them time to replace you with someone who can learn the business. Other buyers may not want the vendor to be around the business for more than a couple of weeks because they are worried employees will defer to the vendor rather than themselves.
Buyers may want you to have a restraint of trade for up to 3 years within the regions you do business. You need to make sure that you are able to do this and still make sufficient income.
Buying Assets vs Shares
Buyers acquire businesses by buying either the shares or the assets. Most of the time it is the assets they acquire to avoid historical and unknown liabilities such as legal action or tax issues. This can mean more complexity as various third-party contracts have to be transferred to the buyer as part of the sale. If there are large assets that are worth significantly more than their book value, then the buyer will want these revalued so they can get the full benefit of depreciation.
Sellers would prefer to sell shares. It’s generally a tax-free transaction and the buyer may be able to seek warranties that any future liabilities will be paid for by the seller. The buyers may want to buy shares if there is a benefit that can’t be transferred out of the company such as consents or contracts. If there are large assets that are worth significantly more than their book value, then the seller will want to sell shares and not revalue the assets otherwise the IRD will clawback the depreciation.
This is a complex area and one that requires legal advice from your lawyer. A good example of the complexity of tax consequences on the sale of a business is here.
Sale and Purchase Agreement
The parties will hand over the term sheet (or a full sale and purchase agreement if using an advisor) to their lawyers for review. This is an essential step and should ideally be done by commercial lawyers with experience in business sales. They’ll write up an agreement (or review the advisor’s agreement), and both parties will sign.
A number of things happen from here depending on the agreement. Due diligence commences, sometimes the buyer just wants to check the bank statement against the P&L, at other times their accounting firm will get involved and go through the accounts in detail, HR Manager will meet all the employees and the Operations Manager will go through the factory etc.
The landlord is contacted by the vendor and asked to assign the vendor’s lease to the buyer. The landlord has little incentive to do this quickly, they probably don’t even want to spend time reviewing the buyer. The landlord’s lawyer will be involved and the lawyer’s fees will be paid by the vendor. If the buyer is not financially secure then they can be turned down.
Staff, Supplier and Customer Contact
If you are dealing with a competitor you don’t really trust, you may wait for the agreement to become unconditional before allowing contact with customers, staff and suppliers. However, if the purchaser has been prequalified, has completed due diligence and is still interested then you may choose to introduce the purchaser before the contract becomes unconditional. You could perhaps do this by introducing them as a business advisor rather than a probable new owner.
Congratulations, this is a major milestone. Most sale and purchase agreements have many exits for a prospective purchaser but at some stage, their time will run out or they will state they are satisfied with the business, and you have an unconditional contract.
Like we said at the beginning of this article, your business is important to you, not just as an investment but also all the friends you’ve made over the years you’ve built the company. Your customers, suppliers and last, but not least, your employees. It’s important to you that you don’t leave them in the lurch with some incompetent buyer who damages your employees’ livelihoods, disrupts your customers and annoys your suppliers. It’s not just the money that’s important here.
You’ve got your money, now you need to make sure the buyer doesn’t destroy all your hard work.
You want to announce the sales of the business and then work with the new buyer to ensure a successful transition.
On closing day, hold off on the champagne until you’ve told all your employees and key customers and suppliers. This means meeting them or picking up the phone rather than just an email. The buyer may accompany you and get the transition off to a good start.
You’ll want a press release ready to give to the community newspapers and trade magazines should they call, or if the new buyer wants to let them know. You may also send something similar to your smaller customers and suppliers.
Or you may not, if you run a small business like a restaurant, you may make a quiet announcement many months after closing because you want to keep the cachet of the original owner as long as possible. It depends on your industry.
The security of your vendor financing or future earn-outs will depend on how well the new buyer gets up to speed. At the same time, you have to give them room to make the decisions. You may choose to spend time with key customers or ensure that key processes are well understood so that the transition can happen as smoothly as possible.
Is when the business continues to thrive years later under the new owner with the same employees, customers and suppliers. Your business may have left your capable hands but it continues to be a legacy of your lifetime of hard work. You’ve received final vendor financing payment or a full earn-out.