Articles

Selling Your Business

“When is the right time? How do I do it?
What will I do after I do it?”
or maybe, “Darn, what a mess you left me!”

by Gerald Merfish, Silver Fox Advisors

One might rightfully wonder; what kind of title is that and what are you talking about? I am referring to the thoughts one may have when contemplating selling their business and what happens when the business leader unexpectedly becomes ill or passes away.
When is the right time to sell one’s business? That is a question only the business owner and their family can answer. The obvious dilemma is that one cannot predict the future, so the best time is when the business is doing well, when the owner has developed leaders in the business that can run the business in the owner’s absence, the owner wants to do something else at that point in their lives, or the owner has fallen ill or passed away, are just a few of the reasons it is time for a business to be sold.
The truth is that not all businesses are easy to sell. If the business is properly prepared to be sold and a diligent effort is made to find a buyer, then it is reasonable to believe that every business can be sold, however, the price the business sells for may not always be the price the seller wants. The businesses that generate the highest price are usually those where someone other than the owner can run the business and can serve the new owner.
I was in this predicament as a 61-year-old owner of a family business. Our children had decided not to go into the business, each having professional careers. My motivation to sell was driven by my recognition that if I was disabled or passed away unexpectedly, the business would be worth much less and my family would be challenged with running or liquidating the business in my absence. Our family’s largest asset was ownership of the business, which in and of itself, motivated me to seek more financial diversification. Fortunately, a Private Equity firm bought our company, I reduced my ownership to 20%, achieved my goals, and remained the CEO. With the Private Equity firm’s assistance, we grew the company further, increased the value, and sold the business to a strategic buyer some 9 years later.
Selling one’s business is a personal and emotional decision, impacted by each seller’s personal situation. My belief is that one should realize that there is a time to sell and a time not to sell. As I grew older, I realized that my window to choose the right time to sell was becoming shorter. By this, I mean that as I grew older the likelihood of a health event occurring within an industry down cycle was more likely as there were not going to be a lot of cycles left in my remaining years.
I was also concerned with the change in my daily activities when I no longer had a business to run. I struggled when people said, “you will get to do the things you love to do.” To which, I would think as a business owner, I am doing what I love to do right now. People would also say to me that “when a door closes another opens”, but I doubted this was true. However, I learned that, in fact, this is substantially true. Of course, it was not the same door that was open when I ran the business and at times it was not easy, but things developed, and doors did open for me. I am enjoying the life I now live, enjoying family, spending time with my friends, and travelling without as many worries. Now, I sleep better at night and can spend more time staying healthy. Many of my friends that own businesses do not sell due to the concern associated with this change. I can only hope for those business owners that they will not leave their family a mess.
Finally, I have heard sellers say, “why sell it when if I keep working, I will earn that much in 4 or 5 years.” Sure, that makes some sense but if you were like me, there was a substantial percentage of our familial net worth tied up in the business and that kind of concentration that has risk. As we all know, the unexpected can happen and when it does it can be very ugly. This being another reason to sell one’s business to achieve financial diversification and reduce financial risk.
There are several questions that seller’s ask so let’s go over them here:
Who is going to buy my business? There are basically only two types of buyers.
Strategic Buyers—a strategic buyer is a buyer that is in the industry or a related industry. It could be a competitor or a buyer in a related business that wants to own your business as they see it as a logical pathway to diversification or wants to geographically expand into your market. Perhaps one or several of your employees will gather and do a management buy-out of the business. Usually, a strategic buyer will pay the highest price as they will then have operating costs savings in shared overhead like the accounting department. The odds are that you may already know the strategic buyer but perhaps the strategic buyer will be someone you did not expect to be interested.
Financial Buyers—a financial buyer is a buyer that will buy your company and strategically grow it with the intent to sell it as a larger more profitable company at a higher price at some point in the future. Another term for a financial buyer is Private Equity. If the purchaser is a financial buyer, it is unlikely you will have known of the firm before the transaction. However, when a financial buyer has already bought a company in your industry and they are trying to create size, then they become a strategic buyer. Usually, a financial buyer will ask you to roll over some of your ownership in the business and remain as part of management. This is what happened to me and remaining an owner in the business was an opportunity to get a second bite at the apple, which, in my case, was financially rewarding.
How much is my business worth?
This is a very important question and one every seller wants to know. The two key components in determining the value are the firm’s EBITDA and ROACE, so let me define these two acronyms.
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EBITDA means the company’s “Earnings (net profit) Before Income Taxes, Depreciation, and Amortization”. This is a measurement of the core profitability of the company and is an easy, common metric for a buyer to use.
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ROACE means the “Return on Average Capital Employed” which is determined by dividing the EBITDA by the average capital used in the business, resulting in the ROACE percentage. Average capital is considered the average of the tangible asset value less any non-interest-bearing debt like trade payables. This is a measurement of how efficient the company is in the use of its capital. The higher the ratio the more valuable the company.
These two factors are the key determinants of the value of your business. The value will be a multiple of EBITDA and that multiple will be directly tied to the ROACE of your business. Let’s use the public stock market as an example. The ratio used in public markets is the Stock Price to Earnings ratio or more commonly called the P/E ratio. Tech and Service companies tend to have high ROACE percentages as they do not need large amounts of capital to produce stellar EBITDA and accordingly their P/E value is high. Conversely a public steel company, for example Nucor, will utilize substantial capital to deliver their earnings so their P/E ratio will be lower. Even though your company is not publicly traded, the leading indicators of value are the same.
The professionals you choose to help sell your business, be they investment bankers, brokers, M&A professionals, or Exit Planners/Advisors should have access to a database of private buyers that can be likely buyers. This becomes a reference point for many to determine "comparable" multiples. Hence, depending on tangible and intangible factors, the multiple will fall within a certain range depending on the industry and other factors.
How long will it take to sell my Business?
Selling a business at the highest price on the best terms to a qualified buyer is not a fast process. The business needs to be prepared to be sold. Perhaps the owner will incentivize key employees with what is called a “Stay Bonus”, so these employees stay throughout the sale process and go to work for the new owner for a set minimum amount of time, so they earn the stay bonus. Also, one will want to be certain that knowledge of the possible sale is controlled and does not leak out to competitors and non-key employees. On average, depending on the size of the company and the complexity of the transaction, the sale process might take as long as a year. A seller should understand this and be certain not to become impatient. Please keep in mind it is always easier to buy something than it is to sell something.
What is the process to sell my company?
There are numerous ways to sell your company, and these are often determined by the company’s value. The answer to this question substantially depends on the size of the company’s EBITDA, ROACE and the company’s business sector. The setting up of something like an auction of the company will usually result in the highest price on the best terms. Of course, a seller needs to be very sensitive to the buyer’s ability and reputation to consummate the transaction. A high price on acceptable terms will not be realized if the buyer is incapable of consummating the transaction.
$2,000,000 Minimum EBITDA
Companies of this size count Private Equity, Family Offices, Strategic Buyers, and even current management as potential buyers. For companies of this size, an Investment Banking firm (IB) might be the best choice. The IB will help develop the sales strategy which usually includes sending out a tickler to perhaps hundreds of entities they think might be buyers. The tickler describes the company but does not name the company. Interested parties reply with interest based on the tickler. The IB will then have the interested parties sign an NDA agreement that not only requires the interested parties to not divulge any information sent to them but also restricts the interested parties from hiring any of the selling company’s key employees. The IB will develop a Confidential Information Memorandum (CIM) or Offering Memorandum (OM) that will identify the selling company and provide the base investment thesis—the CIM will often be as long as 30 pages.
The company will need to prepare themselves for the sale by asking the IB if the company needs to have their financial statements audited and if so by what size CPA firm. The IB might also suggest a Quality of Earnings (QoE) be prepared. For a QoE, a CPA firm that is not usually the financial statement auditing entity will do an examination of the Income statement and share their insights as to its reliability. The QoE will also generate an adjusted EBITDA removing any special circumstances. As an example, the owner of one of my client companies chooses to pay the COO in salary and bonus, 50% of the net earnings of the company, so upon a sale the COO compensation would be adjusted to market, and the difference counted as an add back to the adjusted EBITDA. There are numerous other EBITDA adjustments that the QoE might discover. A few other possible adjustments might include travel that is not really business based, use of vehicles, family members on the payroll that are not necessary for the business, and higher payroll than required paid to employed family members.
The selling company may choose to commission a sales study so they can have some input into the sales study report. Often if a reputable company performs the sales report, the buyer will agree to use the one commissioned by the selling company.
The IB will set a deadline for all interested parties to advise them of their proposed purchase price, terms and how they plan to fund the purchase. The IB will then make a recommendation to the owner and begin to work with the bidders to firm up their offers and encourage the bidders to increase their bidding price.
Once a bidder has been chosen as the likely buyer, documents will be prepared, and the buyer will begin to dig deeper into the affairs of the company during due diligence. The cost of selling a business of this size is not inexpensive and often the IB will want a minimum fee regardless of the sales price.
$1,000,000 to $2,000,000 EBITDA
In this range the seller may choose a business broker to sell their company. The process is not dis-similar to the higher EBITDA process described above, however, to hold down costs the process will be less intense and fewer studies will be commissioned. Business brokers may charge fees for this size company from 7% to 10% of the final selling price. The cost to sell a business will always be less if the seller can identify the buyer—maybe it is a key employee, or a relative or a friend. This is true no matter what the value of the business is, and this can result in substantial savings in the costs of selling. If the seller can identify the buyer, they can hire a member of the Silver Fox Advisors to help them through the sale at a much lower cost than a business broker.
Less than $1,000,000 EBITDA
Once again, a business broker might be chosen to sell the company. As the EBITDA declines, the percentage charged by the business broker increases. A fee of 10% to 15% of the selling price might be charged.
How will the sale be structured?
There are two approaches to a sale. One is a stock transaction and the other is a sale of the assets. Certainly, an acceptable selling price is important, however another consideration of the seller is to minimize income taxes associated with the sale. The seller seeks to take advantage of the Long-Term Capital Gains (LTCG) tax rate which is between 15% and 20% depending on one’s total income in the transaction year. The buyer will likely prefer an asset purchase as they can then reset the asset values and benefit from tax deductible depreciation of those assets. An asset sale could result in the tax rate being ordinary income, which can be taxed at as high as 37%. Although some industries do not qualify, one option is to do a Section 338 (h) (10) election whereby the seller is taxed based on LTCG while the buyer can gain the ability to reset the value of the assets to achieve some tax shelter in the future as the assets are depreciated.
Another possibility is an Employee Stock Ownership Plan (ESOP). ESOPs can be quite attractive as they allow employees of the company to own all or some of the company. An ESOP can have some unique and substantial tax advantages. ESOPs can be challenging to manage, and many employees will become aware of financial information they might not be adequately prepared to comprehend.
How will I be paid when I sell my company?
There are many options as to how a seller is paid that are negotiated during the sale process. These options include in full in cash, part cash and/or part over time with interest when the seller is willing to help finance the sale, part cash and/or part seller retention of a percentage of their ownership, part cash and/or the seller receives stock in the buyer’s company, to name a few of the most common. How a seller is paid may influence the price—for example, when a seller retains part of the company or accepts stock in the acquiring company, this is a plus to
the buyer as the buyer has less cash to pay at closing, possibly resulting in a higher price versus if the transaction is all cash.
What else might be required of the seller?
A seller can expect to be required to offer a set of representations and warranties, plus be willing to indemnify the buyer as to any unknown liabilities. These are very common, and from my perspective, very fair. The seller had the benefit of what occurred before the sale and therefore they should be responsible for any liabilities that occurred before the sale but were not accounted for during the sale process. An example of how this may apply would likely include if the IRS did an audit on a period before the sale and found an irregularity. The fine and the payment of the extra taxes should be the responsibility of the seller.
Recommendation & Summary
If a sale of your company is envisioned at some time in the future, it is never detrimental to begin managing the company in ready to be sold manner. This way, when the right time comes to sell the business, one can not only save time, but they will also be set up to take advantage of the best timing. Preparing your business to be sold, even before you are ready to go to market, can shorten the sale process by as many as 6 months.
Silver Fox Advisors includes several experienced business leaders that can help prepare the business for sale as well as a few Certified Exit Planning Advisors. The Advisor can also counsel the seller on the process and act as a confidential sounding board during the process.
Silver Fox Advisors includes members that have sold their companies, including some who have bought and sold multiple companies. There are also members of Silver Fox Advisors that have experience successfully marketing companies for sale with fees lower than traditional business brokers. One member of Silver Fox Advisors is extremely well versed on ESOPs as that person has been involved in over a dozen ESOP transactions.
One can find a snapshot of the business experience of individual Silver Fox Advisors at www.silverfox.org