This article originally appeared in the July 2020 issue of Security Business magazine. When sharing, don’t forget to mention @SecBusinessMag on Twitter and Security Business magazine on LinkedIn.
Often, a business owner will consider selling their company without a solid idea of its true value or how exactly they could find an ideal buyer at that price. This is where the services of an experienced business brokerage comes in – they can help an owner determine the “if, when and how” to transfer ownership in the most beneficial way. Business brokers fill this need and work for commission only – similar to real estate and in fact will often also sell the real estate as part of the transaction.
There are two main ways that a business transfers ownership: A “stock sale” is where the buyer is purchasing an entire company; an “asset sale” is where the buyer is only purchasing the assets of a company. Both methods have valid reasoning behind them. In most cases, a buyer would prefer an asset sale to purchase the desirable assets and leave possible past liabilities out of the transaction – which also benefits a buyer with certain depreciation tax advantages and a far less risky acquisition with no unknown liabilities. In many cases, a stock sale cannot be avoided, as the company operates with agreements, licensing or other obligations that force this type of transaction. The same company would arrive at two different values in each scenario; thus, each must be weighed carefully.
Determining Business Value
An experienced business brokerage will have comparable sales of “like companies” that will offer statistical indicators and guidelines. Based on research into these transactions armed with the location, industry type, employee count, inventory, hard asset value, product offering, customer mix, and a history of revenue and profits, an experienced broker can provide a valuation range from high to low.
Within this valuation will be a “multiplier” most often related to the company’s profit. Small business owners typically have personal write-offs within tax returns that will be added back into the mix so long as the buyer can easily agree to their validity. This valuation and its formula may very well lead the seller to hold onto the company until they can reach the desired profit multiplier by building sales and cutting expenses to command a higher purchase price.
As the saying goes, size matters – especially when it comes to selling a business. The exact same company on the market will command a higher multiplier based on its size. The market looks at a company with profits of up to $250,000 annually as “buying a job,” and that buyer is typically expecting to have full-time employment requirement to place those profits in pocket. When profits reach higher levels of $500,000, the buyer has room for a white shirt president salary. This semi-absentee ownership responsibilities results in a lower return on investment expectation and will drive the price higher.
Even higher profits of $1 million, $2 million and $3 million triggers a higher purchase price through a higher multiplier and reaches a higher sophistication of buyer. Larger business brokers employ expensive valuation software and rely heavily upon internal comparable data and experience to find that maximum pricing the market should be willing to pay.
The baseline to value a company is “cash free/debt free” with accounts receivable, outstanding debts, saleable inventory and works in progress separated out within the valuation. A careful, well-managed transaction will “true up” these items while a company is in escrow to satisfy both parties that a fair transaction occurs while taking these items into account. This allows for fluid negotiation to arrive at acceptable price and terms for both parties.
Marketing a Sale
Another key factor is the marketing of the business opportunity for sale. Common sense will tell you that a “business for sale” sign in the window is a really bad idea. Common sense also will tell you that your competitor’s gracious offer to “buy you out” probably is not at a price point that you should get for all your hard work. How do you find the right buyer, with the right background and know they have the ability and capital to get the deal done without letting your employees, vendors, competitors or others know that you are selling the company?
Professional business brokers will advertise a company for sale discreetly, with advertising that gives a buyer just enough to know it is something they want to see, without disclosing the identity of the exact company. The broker will receive this inquiry and immediately begin qualifying the buyer for capital, experience, geography to make sure they are a viable candidate.
Most brokers have an email list of thousands of potential buyers known to be active in an industry. To get the highest purchase price for any business, you need to reach the maximum number of eyeballs, and get the most inquiries possible to have the most possible qualifying sales conversations. Done right, a seller should be choosing from multiple offers and have the luxury of looking for the right culture fit in addition the final pricing and terms offered.
Non-Disclosure
A very candid conversation also needs to occur regarding the importance of confidentiality and the possibility of damages to the seller should this confidentiality be broken. Nobody can walk through the front door of a business and announce they are there to “look at buying the business” or any other disclosure without repercussions. The buyer is then required to sign a Non-Disclosure Agreement (NDA), which puts their understanding of this into writing and provides the seller a legal vehicle to pursue for damages should an unlikely disclosure event occur.
Once you have an NDA in place with a viable buyer candidate, this is where the rubber really meets the road. The qualified buyer with an NDA has said “yes I want to pursue this opportunity,” and now the selling business owner must show them exactly what it is that is for sale.
A business owner should have a comprehensive information memorandum (CIM) that describes the company in winning detail – giving a buyer everything they would need to make an actual offer. It should alleviate their fears and apprehensions, enable them to see where their expertise can make an improvement as well as how the company will bolt together nicely with their existing team and organization. Other elements might include a video tour of the company to provide the look and feel of the operation and proof of search engine optimization to remain on the top of search results.
The Role of the Broker
Experienced business brokers will bring the transaction smoothly all the way through the close of escrow for a fluid transaction. Negotiating leases, providing due diligence items, assisting lenders, transferring licenses and keeping a transaction on track while avoiding countless pitfalls are all put upon the broker instead of a seller. The escrow company acts as the third party, ensuring all details are handled precisely as the parties have agreed, holds deposited funds and meets all of the necessary federal, state and local compliance requirements to transfer ownership legally and ethically.
Even if you have already determined who you would like to sell your company to, a business broker could prove critical for actually getting it done correctly and avoiding pitfalls. We have all heard horror stories – and they often stem from napkin agreements in a for-sale-by-owner transaction. Doing it yourself with a sign in the window to save paying a small fee could end up being one of those horror stories.
Wes Lewison is a seasoned business broker with the Los Angeles office of LINK Business (https://linkbusiness.com), the largest business brokerage in the world, with 30 offices in four countries. Check out a two-minute video explanation about how the company works at https://youtu.be/-BhirGt5KZ0.
