08 Dec 5 Steps to Prepare for Selling Your Business
You’re busy running your business and all of a sudden you get a phone call from a potential suitor that is interested in buying your business. You’re flattered, intrigued, you might even consider selling. But what’s the value of your business? How do you structure the sale? What’s going to be your tax liability? What’s the number you walk away with? Are you and the business ready to sell?
I’ve had 5-6 of my clients approached this year alone. One of these actually sold. So what do you need to do to get ready for a sale and answer these very important questions? Here’s how:
- Know the value of your business. Ultimately, value is determined by what a willing buyer and seller are willing to agree upon. Remember the buyer is usually an investment banker or CFO of a large company who is an expert at beating you down on your price. You want the highest value, he/she wants the lowest value. The two places they try to beat you down is financial statement quality. Do you regularly get audited or review financial statements? If not, because the financial statements are of lesser quality, they will try to discount the numbers. The second area is employment agreements (with stay pay) of key people who really drive the business and will stay after the sale to insure an orderly transition. Management retention is a key driver in the buyer’s mind. Someone once told me that the value of a business is a multiple of cash flow/divided by risk.
- It’s going to be either an asset purchase or a stock purchase. Buyers, generally, like an asset purchase because they get a step up in basis on the assets. The difference between book value and the purchase price is usually treated as goodwill which is amortized off the balance sheet by the buyer. The second reason buyers like an asset purchase is they like to be shielded from the seller’s liabilities. The buyer would prefer a stock purchase for the opposite reasons the seller wants an asset purchase: tax liability and it lays off their liabilities on the seller. Generally, most deals I’ve seen are structured as asset purchases.
- Your tax liability can be calculated with the assistance of your CPA. Generally, the asset purchase will be taxed at capital gains tax rate for the most part. However, there may be elements of the sale that could be taxed as ordinary income and subject to those rates.
- In an asset purchase, the number you walk away with is an after tax, after debt number. Let’s pretend you sell your company for $5 million, you have $1 million in debt (payables, loans etc) and your effective tax rate on the transaction is 25% (blended rate of capital gains and ordinary income). $5 million -$2.25 million (debt plus taxes), you walk away with $2.75 million. Many owners want to know an amount of income they would receive over their remaining life in retirement, so an annuity calculator is helpful to make income calculations.
- Generally, there is a due diligence checklist that is provided by the buyer with specific items. Any items that haven’t been addressed prior to the sale can be areas of risk which the buyer will use to try and reduce the price. We try and reduce the risk prior to any discussions with a potential buyer to maximize the price. There are about 11 areas of financial due diligence and about 20 items of operational due diligence you can expect a buyer to inspect. (Yes, it’s a lot!) Both the business and the business owner have to be ready for a sale. Addressing these items will go a long way to getting the business ready.
So, getting you and the business ready for sale is a complex process. You need to know the value of your business, how you would like the transaction to be structured and what your number is after tax and debt. Finally, getting you and the business ready for a sale is critical to your success in the selling process. You should have a team of people; your CPA, attorney, business broker or investment banker, to help get you and the business ready.