If you’re a homeowner, then you understand how complex and time-consuming the sale of a home can be. You have to renovate everything in the home that’s substandard, fix anything that’s broken, gather together a seeming library of legal and financial documentation — the list goes on. Selling a small business is just as, if not more, complex with many moving parts involved, including staff, customers and clients, real estate leases, equipment leases, among many others. Just as in starting a business or buying a business, selling a business should not be taken lightly.
Selling a small business requires careful planning, patience, and flexibility. All three requirements will result in a better selling process and likely a higher price. Read on to find out exactly how to sell a business and get the most out of the sale of your business.
Selling your business requires assembling a team of experts, including your accountant, attorney, and business broker. They bring their expertise to the sale, plus free up more of your time, which is huge because you’ll still be running your company during the entire sale process. Once your team has been assembled, it’s time to actually get into the selling process.
Explain Why You are Selling Your Business
You’ve decided to sell your business and need to find potential buyers. The first question they’ll likely ask is, “Why are you selling your business?” The last thing you want to do is not have an answer to this essential, preliminary question. You’ll want to have your reasons clearly and concisely prepared early on so you can answer this question and not raise issues. Similar to used cars, if your business is for sale for the wrong reason, buyers won’t be interested.
A good way to go about this step is to determine your motivation for wanting to sell your business, as well as how urgent your need to sell is. Some motivations for wanting to sell a business can be flexible with timing, such as the current owner simply being bored with his business or work. There are plenty of other situations, however, where your need to sell is more urgent.
Here are some of the most common reasons why business owners want to sell their businesses:
- Business owner is retiring
- Business owner is relocating
- Business owner is burnt out
- Business owner is dealing with health problems
- Business owner is pursuing other opportunities
- Company has reached a high point for the business owner
- Business owner is facing divorce, family or personal change
- Business owner has overwhelming financial problems
- Business owner is looking for a change
- Company isn’t making enough money for owner
- Business owner has a problem with partners or current investors
- Business needs a buyer with more capital to reach its maximum potential
Note which ones relate to your motivation and situation. If they do, then also note whether the urgency of your situation to sell is immediate or flexible. For example, if your motivation to sell is due to being fed up with your partners, figure out if this is of immediate urgency or if you can be flexible and put up with your partners for a bit longer. Flexibility is almost always better when selling a business.
Prepare the Timing of the Sale
You either put a lot of time into starting your business or buying it, so you need to put as much time as possible into preparing to sell it. Ideally, you should start your sale preparations a year or two ahead of your target sale date. You’ll want to give yourself as much time as possible because, as you prepare to sell your company, you’ll likely uncover areas of your business that need to be improved before you can close the deal.
Before you get into any hard numbers, which will come with the business valuation step, you’ll need to assess the attractiveness of your business to a buyer. What makes your business a good sell?
At this stage, you don’t need to calculate anything complicated. Ask yourself general questions about your company’s performance, such as:
- Has revenue consistently increased over the last two to three years?
- Have profits consistently increased?
- Have costs and operating expenses increased at a pace consistent with revenue?
- Does your business revenue consistently cover costs and operating expenses?
- Do your assets exceed your liabilities?
Your answers can be a simple yes and no, but more questions answered in the affirmative mean your company is more attractive to potential buyers. Other areas of self-assessment include how appealing the location of your business is, the quality and uniqueness of your product or services, the state of company equipment and facilities, the status of current leases, and the size and loyalty of your customer or client base.
As you assess the attractiveness of your business, highlight the areas that you find need improvement. List all the areas in need of improvement and put an action plan together. Taking the time and putting in the resources to make improvements is worth it even though you’re ultimately selling the business. If you don’t, a qualified buyer will easily be able to identify areas of your business that are subpar and knock down the price or walk away.
Consider the Type of Buyer You Want
While you carry out your improvement plan, you should also start figuring out what type of business buyer to target. There are all different types of individuals and businesses who are shopping for a company to buy. Each type of buyer has a different approach and various advantages for you as a seller. The type of buyer you target depends on the condition of your business, how you want to exit, and the goals you’re trying to achieve in selling your company.
Selling Your Business to Another Business
Businesses or private equity groups will often acquire companies more for strategic reasons than solely financial reasons. These types of potential buyers usually want to integrate the products or services your company provides in order for them to expand their capabilities, market reach, competitiveness, and profitability. Typically, these businesses or private equity groups are bigger and more robust than the business being purchased.
What’s great about a business-to-business sale is that it opens up the possibility of a high selling price and the potential for a quick payoff. When selling your company to another business or private equity group, it is common for them to require your continued involvement for a period of time before you completely exit your business and relinquish responsibilities. Some small business owners want to sell their company and be done with it, so this route — like all others — depends on your circumstances and goals.
Selling Your Business to an Individual
Many individuals are entrepreneurial but want to avoid the risks of a startup. These individuals are the kinds of people who could be potential buyers of your business. This type of buyer wants to buy your company to gain the immediate benefits of sales and cash flow, plus the added advantage of acquiring established operating systems, customer base, and reputation. Trying to find funding to launch a startup is very difficult, whereas an individual can utilize seller financing to purchase a business more conveniently.
Selling Your Business to an Existing Partner
This approach to selling your business can be very convenient — if it’s possible. Most business partnerships are founded with legal documents that include a buy-sell agreement that outlines how one partner will sell to the other partner or partners. A buy-sell agreement makes the selling process smoother because it specifies the price and procedure for selling your part of company ownership. This is an area that, unlike working with other potential buyers, won’t lead to as much back-and-forth negotiations, which consume time, energy, and money. By selling to an existing partner, your exit route is well laid out and there tends to be less disruption to your customers and staff.
Selling Your Business to an Employee
Identifying a top employee, be it a vice president, C-level, or director-level person, to sell your company to can be a convenient way to exit your business. Selling your business in this manner usually doesn’t produce a high selling price. However, it does produce less disruption than selling your company to outside buyers. Having a key employee takeover ownership provides a good transitional period for your staff and customers, helping maintain continuity. This type of sale also can allow you some flexibility if you want continued involvement on some level with your former business.
Prepare Key Documents Needed for Selling Your Business
Throughout the selling process, you should have at least an accountant and an attorney as part of your team. When preparing all the critical documents you’ll need for a sale, your accountant and attorney will come in handy. For this step, you need to gather your financial statements and tax returns dating back three to four years and have your accountant review them.
Prepare the following forms:
- Income statement: This shows your gross revenue, costs, profits and losses each year of business.
- Cash flow statement: This shows how money was received and paid out of your company and its resulting impact on business assets.
- Balance sheet: This shows the value of all tangible assets owned by your business minus the liabilities your company owes.
- Seller’s discretionary earnings statement: This shows how much your business makes after adjusting for extraordinary, non-recurring and discretionary expenses. This means it presents more accurately how much money your business really generates for you as the owner, which is of major importance to potential buyers.
But there are many more documents beyond financials that are integral to the selling process. Your buyer is going to want documents like a list of equipment, staff, company procedures, contracts, and more. Here are some of the key documents involved in a small business sale process:
- Key Documents
- Corporate or Schedule C tax returns
- Returns for the last 2-3 years, enabling the buyer to verify revenues shown in financial statements
- Business financial statements
- Statements for the current and past 2-3 years, including income statements, balance sheets and current cash flow statement
- Seller’s discretionary earnings (SDE)
- Your most recent annual income statement adjusted to reflect revenues and essential operating costs without extraordinary, one-time or discretionary expenditures
- Current building lease
- Including information on lease duration and whether it can be transferred
- Copies of contracts and agreements
- Such as with vendors, suppliers, distributors, independent contractors, government and more
- Intellectual property documentation
- Patent and trademark information
- Management and operational documentation
- Including procedural manuals, product and pricing lists, other reports and agreements.
- Staffing records
- Including a list of employees with hire dates, salaries, contracts and benefits
- Business formation documents
- Documents like articles of incorporation, organization or partnership agreement
- Additional documents
- Inventory, accounts receivable and accounts payable, suppliers and distributors, major equipment, fixtures and furnishings
It’s best to put all these key documents in a packet, including an executive summary describing how your business is conducted, along with its purpose and goals. While you’re doing all this housekeeping, make sure your company is presentable, especially if you have physical property. Your business should be clean and any equipment that’s broken should be repaired well before you get too deep into the sale process.
Consider Hiring a Business Broker
A business broker is a professional who specializes in helping people buy and sell businesses. They’re also called transfer agents or intermediaries, and they can be a huge asset when you’re trying to sell your business.
Business brokers can offer great insights on valuation, marketing, prospecting, negotiations, and more. Business brokers deal with buying and selling companies all the time. This enables them to understand the financial, operational, and legal aspects of your company that your accountant and attorney may see. Business brokers are also helpful because you’ll be busy running your company so they handle the sale process. You can also search online for business brokers near you.
Perform a Business Valuation
Just as you would do when buying a business, when you sell yours, you need to figure out how much your company is worth. With all your financial statements prepared in the previous step, you’re now set up to move into the business valuation step of the selling process.
Find a Business Appraiser
Having an accountant as part of your team is important for tracking all your finances and all the documents needed for a sale. However, an accountant’s skill is in accounting and not in buying or appraising businesses, unless that’s their specialty. Seeking a third-party valuation of your company can give you the best estimate of what it’s worth when you’re trying to sell your business. For help valuing your entire business, it’s a good idea to seek out a business appraiser with a professional certification from a recognized trade association.
Here are some typical business valuation credentials:
- CBA/Certified Business Appraiser
- ASA Accredited Senior Appraiser
- CVA Certified Valuation Analyst
- CBV Chartered Business Valuator
- CPA/ABV Certified Public Accountant Accredited in Business Valuation
To find a business appraiser, you can turn to your accountant, attorney, or business broker for referrals. You can also search online to find business appraisers in your area on the American Society of Appraisers website.
Calculating the Value of Your Business
Small businesses are often sold based on valuing them in terms of multiples of earnings. This involves multiplying a company’s profits or income by a certain number to end up with a value. When selling your business, you would use your seller’s discretionary earnings — annual income statement adjusted to reflect revenues and essential operating costs without extraordinary, one-time, or discretionary expenditures — as the basis. The number you multiply it by is determined based on the performance and condition of your business. In general, most small businesses sell based on an earnings multiple of one to four.
Find Potential Buyers
Finding the right buyer can be a challenge. That’s part of the reason why business sales can take anywhere from six months to two years. And it’s also the main reason to consider hiring a business broker. It is their job to find the right buyer for your business. They will handle the marketing and advertising of your small business while at the same time maintain confidentiality, so staff or clients don’t get jolted. Business brokers can tap their network to find potential buyers and field offers.
Pre-Qualify Potential Buyers
Pre-qualifying the potential buyers who respond to your for-sale ads is a smart strategy. This is because usually nine out of ten respondents to your ads are not qualified to make the purchase. One good method of pre-qualifying potential buyers is to describe your business and response requirements in a manner that forces unqualified buyers to opt themselves out. For example, you should describe the size of your business and asking price, followed by asking interested parties to respond with a description of their purchase capabilities. When done this way, unqualified buyers will likely not put in the effort to respond, leaving you with qualified, serious potential buyers of your business.
Once you’ve lined up some potential buyers, here’s what you can do to keep the selling process going:
- Find out if the potential buyer pre-qualifies for financing before divulging information about your business. If you plan to use seller financing, work with your accountant and attorney to reach an agreement with the buyer.
- Allow some room to negotiate while standing firm on a price that makes sense and incorporates your company’s future value.
- Put down any agreements in writing, including a nondisclosure/confidentiality agreement for the potential buyers to sign.
Conduct Due Diligence
Conducting due diligence is the research and investigation step that proceeds the actual purchase. When selling a small business, due diligence has two sides:
The buyer will conduct research on you and your company.
You, the seller, will investigate the buyer.
During due diligence, the buyer will want to fully understand the condition of your business by reviewing all financial statements and obligations. The main things the buyer looks for in this area are debts, pending or potential legal issues, ongoing leases, long-term customer agreements, employment contracts, supplier and distributor agreements, and much more. Meanwhile, as the seller, you should conduct due diligence on your buyer’s ability to purchase and manage your business.
The buyer will likely want to research and examine, in great detail, the financial condition of your company, business operations, and legal issues. You’ll want to allow plenty of time to help with the buyer’s due diligence. Lean on the talents and services of your accountant and attorney to help you determine what information to disclose and what to protect if the buyer wants to bring in a third party to review some of your financial or other important information.
Close the Deal
After the marathon of the selling process and all its intricacies, you’re finally at the home stretch of closing the deal. You will have reached this step when the buyer submits a letter of intent to purchase. The letter of intent to purchase puts your buyer’s proposal in writing.
Though this is a non-binding, non-legal document, it sets up the final phase of the sale and how it will work out. The letter will present the price, purchase structure, as well as the terms and purchase conditions proposed by your potential buyer. This is another area in which having a business broker is a great move. In this case, your business broker will receive and discuss the buyer’s purchase intentions.
Once you and the buyer have negotiated a final price, it’s time to put the deal in writing. Have your attorney prepare the asset purchase agreement for you and the buyer to both signs. The asset purchase agreement is a definitive agreement that finalizes all the terms and conditions of the purchase and sale of your company’s assets. The sale of your business is completed when you and the buyer both sign this document.
A common request by the buyer is for you to sign a non-compete agreement, in which you would agree to not start a new, competing business that could draw away customers and thus hurt the buyer commercially.
The Bottom Line
Selling a business is a grueling process, which is why working with a team of professionals is so important. Your accountant and attorney are indispensable during this process. And though you may be able to handle the marketing, advertising, and communication with the potential buyers yourself, hiring a business broker allows you to focus on running your business. The last thing you want to do is get distracted and hurt your company’s performance right when you’re trying to sell it.
The steps to sell your business can feel ironic at times. For example, before you can sell your business, you may have to make large improvements, such as increasing how much revenue you generate and upgrading equipment. The irony being, if you improve your business in these ways, you might start to reconsider selling altogether. This is why it’s important you thoroughly figure out your motivations for selling, what your objectives and goals are so you can know that you’re fully committed to selling your business.