How to Sell a Business
Selling a business is an exciting and daunting prospect for many entrepreneurs, especially those doing it for the first time. It is a lengthy process involving intense scrutiny of financial documents, regulatory approval, negotiations, and deal execution. Once it is over, owners often doubt their decision to sell the business and if they got the best deal.
When you sell your business, it is essential to set your personal feelings aside to objectively evaluate your company, its vision, and what it stands for. This approach enables you to give an accurate valuation.
Many entrepreneurs over- or under-value their businesses. Others don’t capture the real earning potential. Therefore, you will need to analyze your firm objectively, study the current market, and consider employing the expertise of professional advisors.
Several factors can impact the sale process. These are:
- Your reasons for selling
- The legal considerations and implications of selling
- Whether you can afford to lose the income
- Whether you can live on the proceeds from the sale
- How to spend your time after you sell your enterprise
- How to handle the proceeds of the sale
This guide will explain how to sell a business and all the considerations you have to make to leave you happy with your decision.
Reasons to Sell Your Business
Many business owners sell their businesses for various reasons. We detail the most common in this section.
Because of burnout or fatigue
You may be at the point where you feel drained or burnt out. Once you get this far, you can no longer give the business the attention it deserves. Therefore, selling is a good exit strategy.
For personal reasons
Personal reasons may also be driving the sale. These may include health, family emergencies, retirement, or concentrating on other obligations.
To raise working capital
Selling a stake in the business is a potent way to raise working capital to continue or expand operations. Extra money provides you with additional cash flow for machinery, equipment, and new hires.
To cover liabilities
Business liabilities can accrue unsustainably. Thus, selling the firm (or a part of it) to cover them can be a sensible strategy.
Cashing out of the business also boosts your income. The money you raise can diversify your portfolio and help you buy the things you’ve always wanted.
To do something different
Going to the office and doing the same thing every day eventually gets boring, no matter how successful you are. Therefore, selling your business gives you the change you want. It’s a great way to start afresh and do something different with your time.
You can’t provide adequate leadership
Firms often grow to the point where you can’t manage them effectively anymore. Therefore, you might take the opportunity to sell to someone who can. You may also require a new team with the resources, approaches, or skills to take it to the next level.
If your company’s value has grown significantly
Your firm’s value may have grown to the point where you believe you should exit immediately. Valuations could be sky-high and unsustainable, giving you a chance to cash out before the crash.
If you have received an offer too good to refuse
Related to this last point, a buyer might offer you a deal that seems too good to be true. They may rate your company’s potential more highly than you do.
(If you find yourself in this situation, try to find out more about the buyer’s profitability projections. You might not want to sell at all if they are correct.)
If you have achieved your business goals
You might have set up your firm to solve a particular problem. Now that you’ve done it, you might need a new mission to keep you occupied. In situations like these, selling to a run-of-the-mill operator makes sense, freeing you up for new and purposeful projects.
If you want a fresh start
Lastly, you might sell your business because you want a fresh start. You’d like to do something different with your time, perhaps to travel, start a family, indulge in a hobby, or try a new career.
How Long is a Business Sale Transaction?
While every process is unique, a business sale may take between six months and two years, according to SCORE, a non-profit association for entrepreneurs and partners of the U.S. Small Business Administration.
It is, therefore, crucial to begin sale preparations as early as possible. It also helps to involve a team of professionals to guide and support the process. Not only will their knowledge help make the process quicker and smoother, but they can also ensure you get the maximum value from your business.
It is advisable to analyze and address any bottlenecks that impede the process ahead of time. You must be as 'buyer ready' as possible.
Steps to take when Selling a Business
Selling a business and getting your desired outcome requires going through several steps. Any strategy you adopt should ensure proper valuation of the firm and secure a high payout.
Step 1: Define the owner’s exit strategy
Before beginning the selling process, you’ll need to ask yourself the following questions:
- Do you want to move away from the business entirely, or do you want to retain some shareholding?
- What is your exit strategy?
- What role will you play after a sale?
All these should be clearly defined even before looking for a buyer. Clearly define the goal of selling the business from the outset, and involve employees, suppliers, and creditors to maintain business continuity.
Step 2: Set out the timing of the sale
Timing is an art many entrepreneurs can’t get right. But those who do reap handsome rewards.
When to sell your business is something you should prepare for actively well in advance of a potential sale. Adequate preparations help you optimize the operations and put the business’s financial affairs straight to sell for the highest price.
Ideally, you want to be ready to sell when the price spikes. This approach lets you maximize investment returns and get the largest cash payout.
Step 3: Conduct a thorough business valuation
Next, you'll want to determine how much your business is worth. Getting this step right is a critical part of the sales process.
You should conduct a realistic valuation to minimize value expectation disparities between yourself and buyers. M&A advisors, as well as valuation experts, can help derive an attractive valuation.
Hiring professionals eliminates your sentiment from the sales process and aligns the business value with current market conditions. It also provides objectivity that may be lacking when assessing your business personally.
You should do the valuation before listing the business for sale.
Valuation methods/steps before selling a business
There are several methods/steps you should use to value a business. We list them below:
Prepare the financial statements and determine the SDE.
You can value a business by preparing the company's financial statements. The owner should gather financial records for the past three years, including:
- Income statement – a financial statement showing your firm’s performance over a specific accounting period
- Cash flow statement – a summary of the cash entering or leaving the company over the accounting period
- Balance sheet – a summary of your assets and liabilities during an accounting period
Accountants can then use this information to project profitability (and, therefore, value). The price of the business should be similar to the present value of all future profits.
Consider using a projection model if the business hasn't been operating for three years. These calculate future cash flow based on economic analysis, industry and business dynamics, and historical data.
Next, ask your bookkeeper or accountant to transform the income statement into a seller's discretionary earnings (SDE). These documents take non-recurring purchases and discretionary expenses into account to accurately reflect the value of the business.
Work out the value of the business’s assets
You can calculate a business’s asset value by estimating the value of tangible and intangible assets. Pricing physical assets are straightforward, while intangible assets, such as goodwill, intellectual property, contracts, etc., are much more difficult.
Moreover, asset valuation will only help determine the value of a business in a vague sense. That’s why investors prefer to focus on the firm’s earning potential.
Use price multiples to value an enterprise
Lastly, you can use price multiple to value a business.
Multiples are ratios estimating the value of a business by multiplying a specific item on the financial statement by a certain number. Investors perform tricks like these on the assumption that ratios can characterize enterprises in similar industries, letting them compare your firm to a benchmark.
As the owner, you can do the same. You can look at the profit-earning potential of your firm and compare it to the returns any would-be investor might expect. A high ROI might mean you can afford to raise the price.
Compare your business’s valuation to similar enterprises for sale right now or recently sold
Comparing your business to similar enterprises sold recently is another powerful valuation technique. Companies in the tech space often are prone to this type of estimation method because most of their profitability lies in the future.
Step 4: Improve the value of the business
Buyers are interested in businesses that offer the highest potential for future profit. So, the sooner a business owner begins working on increasing the business's selling price, the better.
Some of the ways to enhance the value of an enterprise before a sale are the following:
You can do this by examining your current processes by listing each step and analyzing them in turn. One approach is to break tasks into smaller steps and look for opportunities to modify them.
You can also try:
- Establishing a work priority to deliver maximum value to clients upfront
- Maintaining proper documentation of your workflows and which strategies work best
- Sharing best-practice workflows with your employees
- Automating workflows using robotics or AI-powered software
- Testing your new workflows regularly and collect data to ensure they perform
You can also boost the value of your firm by reducing expenses. Slashing your expense ratio from 0.95 to 0.9 doubles your profitability, making your enterprise considerably more lucrative.
Some good ways to reduce expenses at your business include:
- Sell leftover waste products, such as cardboard, metal off-cuts, and paper
- Evaluate your insurance policies to ensure you don’t have duplicate cover
- Avoid the temptation to take out unnecessary debt to finance expenditure
- Modernize your marketing efforts by increasing automation of your social media outreach, email marketing, and SEO
- Use virtual and remote-working technology to reduce the need for employees to travel to the office
- Develop your employees’ skills to help them get more done in a week
- Hire experts consultants in cost-cutting
- Set expectations for how long it should take to complete a particular piece of work
- Encourage employees to write and stick to a weekly schedule
- Leverage your network more and pay for advertising less
- Implement a referral program to reward customers and contacts who generate new leads
Focusing on core competencies
Limit the types of services and products you offer to a specific niche. Only focus on delivering your core competencies. Trying to broaden the net too much could result in lackluster profitability, time-wasting, and frustration for staff and clients.
Reducing customer concentration
Lastly, you can increase your business’s value by reducing customer concentration, or the number of customers who buy from you, to eliminate your reliance on just one or two. You can do this by:
- Broadening your marketing appeal
- Acquiring a new firm with a diverse client base
- Entering new markets
Working with accountants and bookkeepers who understand how buyers value companies can provide tremendous benefits. You can implement quick strategies to boost the value of your enterprise in the days and weeks before a sale.
Step 5: Gather financial information
A business's financial history and future projections are essential elements of the sales process. Unfortunately, firms usually prepare their financial statements for tax purposes and not for business sale purposes. Therefore, you will need to recast them (with the help of a professional) so that prospective buyers have a good view of the company's earning capabilities. Expect to pay around $350 for this service.
Step 6: Compile due diligence information
All potential buyers will thoroughly scrutinize a business through the due diligence process. It is a standard part of the process and, therefore, something you should facilitate.
A well-organized company with all documents readily available and organized reflects well on the owner and may even give them an upper hand in the negotiations. To enable quick access, you should designate a room as a data room where potential buyers can find all the relevant documents and data.
Offering a “Business Summary” or Confidential Information Memorandum is also helpful. It contains all the necessary company information at a glance.
Step 7: Filter buyers
A business, especially a medium-sized firm, often has several potential suitors. Engaging each of these can be draining and even impossible.
Therefore, it is vital to filter potential buyers to target those better suited to buy the business. Management or M&A advisors can do this for you.
Step 8: Qualify potential buyers
The next step is qualifying the potential buyers to screen their suitability, bearing business continuity in mind. Not all investors are suitable. Their long-term vision, values, and what they stand for may be incompatible with your legacy.
Step 9: Negotiate the deal
Once you have keen buyers lined up, the next step is negotiation. The general goal here is to inform buyers and convince them of the actual value of your enterprise.
Unfortunately, you can derail deals at this stage. Buyers need clear guidance to make informed decisions on the following matters:
- Terms – the legal conditions under which they will take over the running of the business
- Liabilities assumed by the acquirer – any debts, employees, or obligations they will inherit if they go through with the sale
- Current assets retained by the seller – any assets you want to hold onto after making the sale
- Equity ownership – what their stake will be in percentage terms (compared to you and other buyers)
- Stock sale versus an asset sale – stock sales refer to the owner’s purchases of shares in a corporation, while asset sales involve the buying of both assets and liabilities
- Seller financing and security to support that financing – whether you’ll enable prospective buyers to take out credit to support the sale
- Employment contracts – existing labor contract terms and when they expire
- Non-compete agreements – clauses in employment contracts preventing workers from going to another firm
Step 10: Indications of Interest, Letter of Intent, and Transaction Documents
When buyers are happy with a deal, they then take formal steps to complete the transaction, similar to a regular property purchase.
The three stages buyers express interest in buying a company are:
Indication of Interest (IOI)
The “indication of interest” or “IOI” is a nonbinding document containing the transaction’s proposed terms, valuation, and structure.
Letter of Intent (LOI)
The letter of intent, or LOI, is more in-depth than the Indication of Interest. It includes the terms of the deal and a period where the buyer deeply evaluates the company.
The purchase agreement is the binding document that outlines the terms of the sale. It goes along with other signed documents, such as non-disclosure agreements (NDAs), non-compete agreements, etc.
Step 11: Complete the transition period
After a sale, you may need to help buyers complete a transition period where you help them settle into their new business, showing them the ropes. This item is negotiated on and doesn’t take place in all transactions.
The practice is more common in mergers and part acquisitions. There is usually a transition period where the processes are optimized to reflect the new entity.
The business sale process is complete following the transition period and the signing of all documents. You can finally relax!
Documents Required to Complete a Sale Process
You must prepare various documents and review them for accuracy before listing your business for sale. These help you value your business correctly and negotiate a reasonable price. Potential buyers will be interested in documents revealing the strengths and weaknesses of your firm.
Fortunately, you don’t have to prepare all of these yourself. Accountants, bookkeepers, and professional business brokers can help you prepare these documents in advance.
Getting the jump on these documents can advantage you when selling. Reviewing data may reveal areas of your business you need to fix before approaching qualified leads. This way, you can get the highest price possible.
The following are the most common documents buyers will want to see. You should have an understanding of each of them and the role they play in the business sales process.
- Confidential Information Memorandum (CIM). An M&A document that contains critical information about your business, valuing its assets, liabilities, revenue profile, customer profile, and management structure.
- Three years of historical financials with tax returns. A set of documents your bookkeeper can prepare, showing the profitability of your enterprise.
- Five years of projected financials. A set of documents your accountant can prepare showing how much profit your enterprise is likely to generate over a near-term time horizon, given commonly-accepted assumptions.
- A strengths, weaknesses, opportunities, and threats (SWOT) analysis. A document showing potential buyers what you’re good at, what you can’t do, how your business could expand, and the risks it faces.
- The projected growth of your industry. A research document detailing the context of your business and whether it is likely to grow in the future because of broad economic patterns and demand trends.
- Key end markets and their projected growth. More details about the markets you sell into and whether they are growing overall, supporting your enterprise’s long-term profitability.
- Critical employees. A list of “key people” your firm depends on to deliver products and services to customers.
- Any contracts with suppliers and customers. A list of existing contractual relationships with vendors and clients, including when they started, when they will end, and their renewal value.
- All loans and their payment schedule. A list of outstanding debts, to whom you owe them, and how much.
- Tangible and intangible assets. A document similar to a balance sheet listing everything your company owns, including non-physical assets such as “goodwill” and “brand value.”
- Certificates. Documents confirming your company formation.
- Copies of leases. Documents detailing relationships you have as a lessee or lessor with individuals, contractors, customers, employees, and third-party organizations.
- Confidentiality agreement. A contract that protects confidential or sensitive information from entering the public domain.
- Letter of Intent. A document or non-binding agreement setting out the terms of a proposed deal to buy your business. (You should codify this document for the buyer’s benefit, letting them see what they are purchasing.)
- Purchase agreement. The document that transfers the business entity from you (the seller) to the new buyer or owner.
Some of these documents may be confidential. Therefore, business owners may be uncomfortable sharing them with every potential buyer.
Unfortunately, inventors need these documents for their internal due diligence requirements.
The solution is to get both parties to sign a non-disclosure agreement (NDA). This compromise assures you while enabling the buyer to follow their preferred processes.
What Happens to Debt?
What happens to debt when selling a business? Does it disappear, or is it absorbed in the transaction? The answer depends on how the transaction is structured.
Sale transactions are typically structured either as a stock sale or an asset sale.
A stock sale involves buying the entire company, including all disclosed and undisclosed assets and liabilities, including those unknown at the time of the purchase. Typically, large companies opt for this type of transaction, usually those that:
- Want to merge with other big companies
- Acquire the entire operations of a medium-sized business completely
An asset sale involves the transfer of stated assets and liabilities. Here, you and the buyer choose which items to include in the transaction and which to omit. (You can transfer some assets to a different firm if you don’t want to sell them).
Many small businesses are acquired through an asset sale to mitigate the risk of unknown or “contingent” liabilities. Buyers don’t want to take on undisclosed debts or issues unintentionally.
Consequently, asset sales are more complex to finalize. Negotiations and agreements are often more complicated than a stock sale, where assets and all liabilities automatically transfer.
There are some instances where you do not include debt in any business sale.
1. Leased Equipment
Leases on equipment are separate if they apply to an individual. For buyers to take over the lease, you will need to transfer it independently of any sale arrangement.
2. Successor Liability
There is significant successor liability in the sale of a business, which means that the buyer could be liable for certain things, even though that wasn't agreed to contractually. Examples could be unpaid utilities, sales tax, property tax, payroll taxes, social security taxes, and so forth. Successor liability occurs by operation of law, not by contract.
Involving a Broker in the Deal
The team involved in a business sale largely depends on the size and nature of the business. An attorney and an accountant are the bare minimum.
Attorneys handle all legal issues regarding the transaction and advise on all necessary federal and state laws. Accountants deal with the tax and accounting side of things.
More complex transactions will often involve a bigger team. You should never view these professionals as an expense. Instead, see them as an asset. In most cases, they often optimize the process such that you get the maximum value from the deal. They almost always deliver more value than they consume.
Even a small business will need an attorney to review the transaction and ensure all documents are in place. If you draft contracts and agreements incorrectly, you may be short changed or exposed to huge claims and liabilities.
All sale transactions will be subject to federal and state taxes. An attorney and an accountant will advise you on the best way to structure the deal concerning tax liability.
The following are some of the necessary people to involve when selling a business (it's possible to have some of these positions filled by the same individual):
- An attorney to look over your sales contract as well as advise on legal matters
- An accountant or bookkeeper to prepare all your financial documents
- A tax expert for computing, advising, and minimizing tax liabilities
- A valuation expert to value assets and provide a realistic business valuation
- A business broker/M&A advisor to help groom the business, identify buyers, and widen the list of possible buyers
- A business broker to write the sales memorandum/purchase agreement, boost your business credibility, and negotiate on your behalf
- An investment banker or another financier if third-party funding is needed
This team will allow you as the business owner to continue running the business while they concentrate on selling it.
How an Accountant Can Help You Sell Your Business
Bookkeepers play a critical role in business sales. They want to meet your objectives by:
- Ensuring the deal goes through without hiccups or issues
- Saving you money
- Selling for as much as possible
- Selling as quickly as possible
Accountants’ jobs seem straightforward on paper. However, the process itself is exceptionally detailed.
Accountants can assist you with your primary valuation – an objective valuation telling you what your company is probably worth at current market rates. They can also provide a picture of your income over time, showing how your enterprise’s earnings will evolve.
Accountants can also help you structure and organize deals. For example, they can tell you which deal structures are best if you are selling intellectual property along with business processes, premises, and equipment.
For the financially illiterate, bookkeepers can act as translators between your team and the opposing parties. They can explain financial terms in detail and what buyers really mean.
Everyday business taxes are complicated, but they get even more complex during M&As. Tax implications vary by jurisdiction and depend on bilateral taxation agreements.
Accountants are essential for auditing this process, organizing documentation, and ensuring your business’s tax filing status is correct. They can also liaise on your behalf with multiple regulatory bodies, including the IRS, SEC, and state authorities.
Accountants can also assist you with due diligence, helping you vet buyers before selling to them. This way, you can prove to regulators you took steps to ensure a sound, legal sale.
Objective third-party accountants won’t put any spin on your business’s situation. They will be frank with you. You can gain insight into internal practices that could jeopardize the sale or conflict with regulatory authorities, eliminating personal emotions.
Pitfalls to Avoid when Selling a Business
The following section lists some of the most common pitfalls you’ll want to avoid when selling a business.
The temptation to overvalue the business is very high among many entrepreneurs. It is only natural to expect top dollar for what you have worked on for a long time. However, potential buyers will thoroughly scrutinize the business before committing their money. They may discover it isn’t worth as much as you think it is during their investigations.
Selling too quickly
Some business owners sell their businesses too quickly without analyzing all the available options. Therefore, always work with a financial advisor. They will help you decide which is the best option for your business.
Taking too long to sell
On the other hand, you may be guilty of waiting too long to exit your business. Selling at the right time is a skill most entrepreneurs don’t have.
Not making use of professional accountants
Many sellers are averse to hiring professional accountants to facilitate the sale of their business. Yet in most cases, these professionals deliver at least 10-12 percent to the sales price through their skills and experience.
Bookkeepers can also help you get your head around your figures and present them to buyers intuitively. This way, you can increase the likelihood of a sale considerably.
Lack of preparation
The selling of your business is a critical point in its life cycle. Therefore, you can ruin it by under-preparation.
Our advice? Hire a professional to help you streamline all the processes and prepare all documents before listing for sale. Adequate preparation gives you an advantage during the transaction and boosts your confidence.
Misrepresenting your business can lead to severe consequences. Buyers will notice the inconsistencies and pull out of the deal. Or, they will go through with it and then pursue legal action against you if they discover something you didn’t disclose.
Always prequalify potential buyers
Prequalifying buyers saves time and helps eliminate unsuitable parties from the purchase process. Therefore, you should do it if you can.
Start by digging deeper to get more information. Get to know the buyer financially. Ask for evidence of net worth, previous transactions, and companies currently owned. Also, get a sense of how much credit they can access or where their funds are. Any story should be consistent and make sense.
Don’t spend too much time vetting each buyer, though. This process can waste time and irritate investors, putting them off.
Failure to oversee the process
Owners should oversee the business sales process personally. Having advisors working on the process isn’t usually sufficient. The owner must be involved to see it through.
However, you don’t need to insert yourself into every interaction. Just maintain a good grasp of the process. Accountants, bookkeepers, brokers, and attorneys should take care of the rest for you.
Fear of negotiations
You will be surprised by the number of people who fear negotiations. They do not want to be in a room where things may get heated.
However, negotiations in business will always be there. Therefore, it’s something you need to get over. Either bite the bullet or hire someone who can negotiate on your behalf, such as a broker.
Confidentiality throughout the business transaction process is important. Anybody involved in the sale should sign a confidentiality agreement detailing what they can say about the process. You can scuttle a sale if the word gets out prematurely.
Lastly, transition issues can derail a sale.
The transition process is as important as the sale process. It determines the future of the business as it changes ownership. The transition period should be part of the negotiations as you and the seller agree on how the business proceeds and their involvement during the transition phase. Don’t wait until after signing the purchase agreement to thrash out these additional details.
Tax considerations when selling your business
All sale transactions face significant tax liabilities that you should always keep in mind. Sometimes the federal and state taxes can add up to up to half the sale amount.
However, there are many options available where you can structure the deal to minimize the tax exposure on the potential deal. Bookkeepers will advise on what Federal and State law requires. Always try to minimize or defer your tax bill.
When selling a business, you should pay attention to income and capital gains tax. The following considerations can help in structuring the sale for tax purposes.
Nature of business/entity
Sole proprietorships, partnerships, S Corporations, and Limited Liability Partnerships have tax flexibility as owners can sell their assets with just a final tax. C corporations do not enjoy that since once they sell their assets, the proceeds must be distributed to the shareholders and incur double taxation.
While it is possible to convert from one type of entity to another, authorities structure the tax rules to prevent you from improving your after-tax position by converting your entity to a different form of entity immediately before a potential sale transaction.
Stock sale vs. asset sale
Authorities subject asset sales to double taxation at the corporate and shareholder level. Buyers must pay taxes on both.
By contrast, stock sales attract capital gains taxes. Therefore, this transaction type has some advantages over an asset sale, especially for big companies.
For an asset sale transaction, both the seller and the purchaser must allocate the purchase price to all the assets involved. The same allocation must be used and declared by both of them.
Stock exchanges are an example of a tax-free deal. Here, one corporation takes over the stock of another in exchange for its stock.
According to section 388 of the IRS code, three types of corporate acquisitions qualify as tax-free deals:
- Type A Reorganization Stocks for assets acquisition
- Type B- Reorganization Stock for stock acquisition
- Type C Reorganization Stocks for assets acquisition
Every year, entrepreneurs and owners sell thousands of small and medium-sized businesses. Top buyers include private equity firms, bigger corporations, or people flush with cash willing to enter a new market.
There are many reasons you’d want to sell your business. Both financial and personal motivations are valid.
The key thing is to get the timing right. Some entrepreneurs optimize their business over several years to make it ready for sale. Therefore, knowing how to structure transactions and what leads to a successful sale matters even if you do not wish to sell your business immediately.
Critically, selling is not just about going with the highest bidder. All buyers are not the same. You need to carry out some due diligence on the values and reputation of the potential buyer. Even if you are completely exiting the business, you’d still want it to succeed after you leave.