Written by Christine Waldschmidt, JD, Vice President – Trust Advisor
One of my most important jobs as an advisor to a closely held business owner is helping the owner figure out a succession plan that makes sense. Every business owner has unique considerations, but common among them are family, key employees, and business legacy.
If there is a strong desire to keep the business in the family, and if members of the younger generations are interested and able to fulfill that role, succession planning may be more focused on estate tax planning challenges and utilization of lifetime gifting to accomplish the transition. However, that strategy does not work for every business owner. One of the challenges is recognizing when the right answer involves the sale of the business. If you think the best path forward might involve the sale of your business, consider the following tips:
TIP 1 – PREPARE FOR THE FUTURE: wANT TO SELL VS. NEED TO SELL
It is important to gain clarity around the desire and decision to sell the business when it’s at full strength. Over time, if there is a loss of enthusiasm or a lack of capacity or interest to take the business to the next level, issues can arise that will force your hand. These may be personal, such as health problems, or business-related, such as the loss of a key employee or other economic factors leading to a deteriorating business environment. These factors can dramatically affect valuation.
Get Your Trusted Advisors in Place
This is the point at which you should make certain you have the right advisors in place to help you through this process. Your business bank should be on board, as well as your personal wealth advisor. You should have your corporate counsel, your estate-planning attorney, business valuation expert, and your accountant involved in the planning discussions from the beginning. This team will make sure your ultimate business succession plan and sale are crafted to achieve your goals while minimizing tax consequences.
TIP 2 – ESTABLISH GOALS FOR THE SALE OF THE BUSINESS
Defining objectives and priorities relating to the sale of your business is key; many factors must be weighed, considered, and prioritized. Is your primary goal simply to maximize the sale price, or do you want to protect certain aspects of the culture or protect the interests of current employees? These goals and objectives will ultimately dictate the type of buyer you choose and the structure of the sale. Once you establish these goals, you must develop an exit strategy.
Define and Prioritize Your Goals
You will have to force a prioritization of your goals, and determine where you are and are not willing to compromise. For example, you may need to be willing to accept a lower sales price if you want to negotiate a role that would allow you to actively participate in the transition and retain a salary for a period of time after the sale. If you are not interested in personally participating after the sale, you may choose to accept a lower purchase price from a buyer who you know will value and protect the culture you created.
Develop an Exit Strategy
Your exit strategy will dictate your planning decisions, and should include the following:
- A plan for maximizing the value of the business
- A target date for your exit
- A consideration of tax consequences as you structure the sale
- An analysis to determine the feasibility of an internal or related buyer
- A plan for ensuring the continuity of the business during the transition to new ownership
- A determination of the role you will play during the transition and after the sale
- A long-term plan ensuring the financial security of you and your family
TIP 3 – KNOW YOUR MARKETABILITY
It is critically important to view your business from the perspective of a buyer; this will allow you to focus on eliminating the negatives while accentuating the positives.
Evaluate the Salability of Your Business
The key criteria potential buyers use when considering the purchase of a business are:
- Profitability – how are revenues and profits trending?
- Solvency – what does the balance sheet look like?
- Market position – are you strategically positioned and distinguished from competitors?
- Management/employees – can you retain key employees?
- Customers – is your customer base diverse and loyal?
- Viability of the business without you – are you expendable?
TIP 4 – UNDERSTAND WHAT YOUR BUSINESS IS REALLY WORTH
Valuation of a business is both an art and a science, and depends on many factors.
In most cases, the buyer determines the sale price and the deal structure. For instance, if the buyer is one of your executives, you may structure a deal in which you receive installment payments and the ultimate price will be based on the actual cash flow generated over the installment period. Or, if a buyer simply wants to buy and liquidate the company’s assets, then the value of assets will determine the sale price. You are more likely to receive a premium price when you sell to a third-party buyer than to an insider, such as a key employee or family member
||The Science of Valuing a Business
The best place to start is a professional appraisal by a certified valuation expert, who can value the business based on an income analysis of revenues and cash flow, or on the fair market value of the underlying assets.
||The Art of Valuing a Business
The science, or math, of business valuation is fairly straightforward. It’s the art – the valuation of the variables and intangibles – that is somewhat more subjective and makes pricing a business for sale difficult. It’s about many of the factors discussed earlier – employees, customers, market position, contractual arrangements, industry trends, environmental or regulatory issues — that, at any given moment, can be perceived by one buyer differently than another buyer at a different moment in time. The key is to understand how each of these elements impact the value of the business and take steps to optimize them for a business sale.
||Don’t Wait to Value Your Business
Valuing your business is crucial to developing and funding an estate plan, as well as developing a succession strategy. An objective valuation can also help you understand the strengths and weaknesses that will ultimately determine its sale price.
TIP 5 – MAXIMIZE THE VALUE OF YOUR BUSINESS
After determining the type of buyer and structure of the sale, you can take steps to maximize the value of the business to that buyer. This may mean focusing on increasing cash flow, reducing debt, or bolstering the value of underlying assets.
Prepare for the Transition
- Your business must be prepared to successfully run the gauntlet of the buyer’s due diligence:
- Make sure your books are in order and ready for examination.
- Address any regulatory or compliance issues.
- Review any real estate involved in the sale for environmental or title issues.
- Verify that intellectual property is protected.
- Review vendor and supplier contracts for assignment issues.
TIP 6 – GET ALL STAKEHOLDERS ON BOARD WITH THE PLAN
For any sale to go smoothly, all interested parties must be on the same page. Understand from whom you need consents and approvals. The time to have difficult conversations with stakeholders is before an agreement to sell is entered into, as objections from key parties could delay closing or scupper the deal altogether. Obviously any party with ownership interest must be involved, but do not forget about key employees, business partners, lenders, or other interested parties that could ultimately make or break a deal.
TIP 7 – UNDERSTAND THE PROCESS
The structure of the sales agreement will ultimately determine the process. A sale to a related party may be more streamlined and shorter than a sale to an outside third party or strategic buyer.
TIP 8 – MANAGE THE PROCESS THROUGH CLOSING AND BEYOND
Execution of the sales contract is really just the beginning; during the period leading up to closing, while the buyer is focused on due diligence and financing, you still need to run your business. This can be a challenging time, as you and your management team may be more focused on the sale than the day-to-day operations. Up until the deal closes, you need to run your business operations as if the sale isn’t happening, because nothing is certain until closing occurs.
Confidentiality vs. Communication
The period of time between execution of the contract and the closing of the deal is fraught with many challenges. One of the biggest challenges is the inherent tension between the need to keep the terms and nature of the deal confidential with your need to communicate to your employees and customers.
A good rule of thumb is to keep information on a need-to-know basis until you are confident that closing will occur. As you deal with vendors and suppliers and others regarding assignment of contracts and other issues, have NDAs in place with these partners as you work through the transition process. Remember that if the deal doesn’t close, you will still be running your business, working with these partners, selling to your customers, and positioning to put your company out on the market again; try not to take any actions during this transition period that you may later regret.
Your employees will see the activity around the sales process and know that something is up. This can cause anxiety and employment decisions based on rumor and speculation that could damage the business and the sales process. The decision of when and how to communicate to key employees and ultimately to all employees is highly fact-specific, and must be handled in a manner tailored to each unique situation. While key employees may be involved in the conversation prior to execution of a contract, general communication to employees should typically occur after a contract is executed.
Communicate to customers only when closing is a certainty. Depending on the nature of the business and your goals with regard to other business activity in the market after closing, the communication may be handled by the buyer, by you, or in a joint communication. You and the buyer should approach this in tandem to achieve a transition that benefits both the business under new ownership and your professional legacy. In sum, recognize that careful and deliberate advance planning with the right advisors is the key to a successful transition in the ownership of your business, in whatever form that takes.