A Complete Guide on How to Sell a Business

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Selling a business is a life-changing experience. If unprepared, the process can quickly become overwhelming with the required quantity of work to maximize the value of the business. Preparation is crucial, which involves understanding the entire process that occurs before successfully exiting a business. We have put together a complete guide below on how to sell a business from start to finish. 

Preparation  

Waking up one morning and deciding to sell a business out of the blue is not recommended. Putting a business up for sale without the necessary preparation will diminish its value and limit the ability to find a suitable buyer. 

However, given time to prepare, the end result is most likely a better business, and maximized transaction value. Here are some of the things to prepare before putting a business up for sale:

1. Exit Strategy - One of the first things to understand is why the business should be sold. A clear exit strategy will help define the type of buyer to look for. 

A strategic buyer is the best fit to acquire a business if the end goal is retirement. A strategic buyer will absorb the company and have people ready to run the business. If looking for help in growing a business while sitting at the helm, sell to a financial buyer.

2. Financial Statements - If a business has been operated without the intention to sell, then preparation will take longer. Why?

Because the primary goal of most entrepreneurs, if not all, is to appropriately avoid paying huge taxes. Therefore, profits may be minimized due to business expenses that will reduce the margins and taxes. Which is neither appealing nor acceptable to potential buyers when they look at the financials. 

Usually, buyers ask for three years of financials during diligence. As soon as an owner decides they want to begin the journey of selling their business, it's time to start fixing the financial statements, especially if using a cash method instead of an accrual method.

3. Tax Implications - Some states offer lower taxes than others. When seeking to save taxes on the future sale of acompany, start thinking about relocating years ahead. Hire a good tax lawyer that will help navigate the intricacies of taxation. 

4. Real Property Structure - Typical entrepreneurs own the property where their business lies, while typical acquirers don't want to buy the real estate. Owners can set up a legal entity that owns the property and make the company pay rent. This process will make selling the business a lot easier.

5. Business Operation - Some founders do everything themselves inside the business. Business operations rely heavily on their presence, which makes selling it even harder. As soon as an owner decides they want to sell their business, then they should start letting go and automating processes. Especially if looking to retire post-sale, they need to train a successor. 

Sale Process

After all the necessary preparations, it's time to start the sale. We highly recommend hiring a banker to help with transaction, especially for first time sellers. Investment bankers are well versed in finding buyers and executing an auction process that will help increase prices. Below is a detailed view of the entire sales process during an auction:

Step 1: Screen Investment Banks

Select the right investment bank for the process. While all bankers do the same job description, there are nuances to consider when hiring the right partner for a transaction. 

The first consideration is the fee structure. Not all bankers charge the same rate. Smaller banks tend to be less expensive, but biggers banks may have a larger network of buyers. But either way, a typical success fee is 5%. There are also creative fee structures such as "X amount of money or 5%, whichever is higher", or "5% capped at X amount of money". 

Another consideration is the investment banks field of expertise. For example, if selling a software company, use a bank who knows the software industry and other players in the area. The best buyer for a company will almost always be close or adjacent to the industry. Remember, the more interested buyers, the higher the potential price.

Step 2: Investment teaser

One significant role a banker plays in a transaction is to create an investment teaser, a one-page teaser for a company. A teaser is a marketing document with the primary purpose of enticing potential buyers to come to the deal-making table. 

This document is entirely anonymous to protect the identity of the seller. An effective investment teaser typically includes investment highlights, company overview, customer overview, deal information, product or sales mix, and financial summary. The teaser doesn't have to be a one-pager, but it should not exceed more than three pages.

The investment teaser is arguably the most important document because it is the first thing potential buyers will see. 

Step 3: Finding Interested Parties

Once the investment teaser is finished, banks will send it out to their universe of buyers. These are companies they already have a working relationship with, who are proactive acquirers, or companies that are potentially the perfect buyer for the company. 

As mentioned before, this is why it is necessary to screen and choose the right bank for the specific industry. Investment banks should not only be hired for their efforts and fee, but for the ecosystem of companies they have access to.  

Step 4: Non-Disclosure Agreement

An NDA is a legal document that binds both parties to secrecy. The good news is that if an NDA is being brought up, there is an interested party. Signing an NDA is in both parties' best interest, because anonymity is now over. The buyer will now get preliminary information regarding the company and an overview of the business. 

Step 5: Confidential Information Memorandum

Like the investment teaser, the CIM is also a marketing document to make a company more attractive. This document is more comprehensive than the teaser and should also be prepared by the chosen investment bank. Here are the things often included in a CIM:

1. Executive Summary
2. Investment Thesis
3. Overview of the Market
4. Overview of the Target Company
5. Products and Services
6. Revenue Profile
7. Employee Profile
8. Customer Profile
9. Financials – Historical and Projections
10. Management Structure

After buyers review the CIM, there are typically meetings or calls connecting the potential buyer with the seller.

Step 6: Indication of Interest (IOI)

This phase is where the buyers will submit an indication of interest letter, including a price range of their offer. The buyer's price will be vague and dependent on the industry and the information they received in the CIM. A typical IOI includes due diligence plans, a high-level proposal for deal structure, and expectations for seller transition.

The next step includes

• management presentations
• dinners with CEOs
• tours of the vicinity
• answering many questions regarding the business for sale

The buyer performs initial diligence to have enough information to build their models and gain a more accurate picture of the price they are willing to pay. 

The next round of bidding should be more accurate, and the prices are more specific than the first round. Now, it’s time to choose which buyers to take to the next round. 

Step 7: Letter of Intent (LOI) 

The last round of buyers will now submit a letter of intent, which is a formal document outlining the preliminary commitment of one party to do business with another. An LOI typically includes the duration of the diligence, stipulations, requirements, and specific price. The LOI is not a deal-binding contract. However, some stipulations are binding. Here are some of the most commonly negotiated terms in an LOI.

1. Exclusivity - In a proprietary deal, exclusivity is heavily negotiated because buyers want exclusivity for a while. However, if in an auction process, exclusivity is not on the table, and the diligence duration is next on the board. The faster a deal gets done, the better.   
2. Customer retention - There are instances where the buyer would want to secure specific customers from the transaction. A lack of customer information can be a deal-killer, so make sure it’s possible to deliver on any promises before agreeing to this. 

Step 8: Due Diligence 

Also known as the confirmatory due diligence process, this is where the buyer obtains access to all kinds of information regarding the business to justify their offered price and deal thesis. Be aware that the buyer will be as thorough as possible. At this stage, it’s important that the seller does not become too distracted and neglect the business’s day-to-day operations.

One option is to appoint a dedicated person to run the business while accommodating the buyers or vice versa. 

Step 9: Negotiations

Now it's time to finalize the terms and conditions of the transaction. The negotiations are typically driven by whatever is found in the diligence phase. Every red flag will drive the offered price down. There are also many things heavily negotiated other than price, and we have listed some of the most common ones.

1. Disclosure schedules

Disclosure schedules define what's included in the sale and what is not included. Do not pawn it off for the lawyers alone to review. The business sponsor and the financial people have to be the ones to review this because no one knows the business more than them. If the lawyers are the only ones reviewing this, they will only provide a legal view of the document. 

2. Limitations of liability

Limitation of liability clauses limits the amount one party has to pay the other party if they suffer a loss because of a contract between them. In short, if the buyer gets sued because they bought the company, they have the right to claim damages against the seller.

This is highly negotiated because buyers want unlimited liability as much as possible and sellers want the least amount of liability possible. 

3. Non-compete

A non-compete prohibits the seller from competing with the buyer for a certain period. This clause is a must for buyers to protect them from the seller who knows everything about the business they bought.

If the seller’s owner is retiring, then this clause shouldn't matter. Otherwise, it’s common for the owner to keep their options open and set a reasonable duration of two to three years, and anything more than five years is too much. 

Also, if the seller is divesting a business unit, they need to watch out for the buyer's definition of the business. There are instances where the buyer might define the business too broadly, hindering the parent company from operating. 

4. Golden handcuffs

If the buyer heavily relies on employee retention, they will ask for help. Some buyers like to have the seller pay for the stay bonuses, and the buyer will include them in the final price.                                                    

Step 10: Legal Contracts

After negotiations, it's time to put it in writing and wrap up everything. The primary legal document that supersedes every prior agreement is the purchase agreement. This document typically includes:

1. Parties involved 

Who are the buyers, and who are the sellers. There are instances where it's not just two parties involved, and in which case, other company owners should enter into the purchase agreement. 

2. The agreement to buy and sell

Probably the most important provision in this contract is the agreement to legally transfer full ownership of the company, free from any encumbrances, to the buyer. 

3. Payment considerations

This provision will state how the buyer will pay the seller for the company, which could be in cash, debit, promissory note, or a combination of these. 

4. Restrictive Covenants

Covenants are the agreed-upon rules, such as non-solicit, non-compete, and golden handcuffs, protecting the newly acquired business from the seller. 

5. Warranties and Indemnification 

This section lists statements or facts the seller provides regarding the company's condition. If they are untrue, warranties will cover all areas of the company.

6. Conditions precedent

Signing the contract does not mean that the deal is done. Certain conditions need to be met before ownership can be fully transferred, and this section lists everything that must happen before the deal closes. The most common conditions are tax clearances, anti-trust, and consent from third parties, such as landlords.  

7. Completion

The completion schedule is a list of all the documents that need to be signed, and other actions necessary to complete the deal after the legal owner's ship is already transferred to the buyer. 

8. Post completion

Even if the sale is complete, other important agreements will still need to be followed, such as earn-outs, restrictive covenants, confidentiality obligations, warranties, etc. 

Step 11: Payment

Now it’s time to wait payment to arrive. After payment, the buyer will take all the necessary actions to complete the conditions precedent. 

Step 12: Closing

The buyer is now the new owner of the company.  

Final Word

Selling a business can be long and tedious, and we did not even include the emotional turmoil that comes along with the experience. Choosing to sell can be one of the most challenging decisions an owner has to make, especially if they have been with the company for decades. However, if an owner musters up the courage and decides to exit the business, this guide provides what to expect and the items to prepare a business to maximize its value.

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Let’s embrace the crisp days of fall, take the time to turn over a new leaf, and hear what other M&A practitioners are doing every day to source the biggest and best “pumpkin” of a deal.

And while we know that not every pumpkin is the same; some are big, some are small, some are meant to be carved into pieces, and some are meant to become part of an even bigger pumpkin, we also know that there’s a perfect “pumpkin” of a deal out there for everyone, you just have to know what to look for.

Join us for the M&A Science Fall Summit on October 20.