business owners go through the sale of a business only once in a lifetime.
Unfortunately, many are ill equipped for the venture and become overwhelmed
by the process, or else they make some very costly mistakes. While its
somewhat daunting, selling a business can be managed with the right amount
of preparation and professional guidance.
Robbins is the owner of Robbinex Intermediaries. Robbinex is a firm that
specializes in business sales and business valuations and is headquartered
in Hamilton, Ontario, Canada. According to Robbins, there are over 200
steps involved in selling a business, and the process, which typically
takes 15002000 hours, can easily be drawn out over a year or longer.
my 18 years in commercial lending, I have seen many businesses change
hands. My experience has shown me that the business sale process works
much better with a financial intermediary involved.
dont just stick a For Sale sign on the front lawn of your office
building or plant, explains Robbins. Selling a business is
a long and complex proceeding. There are many pitfalls and thats
why theres a growing trend toward using business intermediaries
to broker the deal.
financial intermediaries broker businesses for a living, they are much
more effective and efficient in completing the 200 steps necessary to
sell a business. And while the seller must pay the broker a fee for his
or her services (typically 4 to 12 percent, depending on the size of the
business), the seller generally comes out much better than if the business
had been sold on a direct basis to the buyer due to maximizing the price
and minimizing the amount of time required of the seller in the sales
where should you start if you are contemplating the sale of your business?
The first step is to ask yourself the question, Why sell?
Before you get too far into the process, examine your reasons for selling.
You dont want to make a decision that you will later regret. Robbins
says there are many reasons to sell a business, including:
Retirement one of the best reasons to sell a business.
Lack of capital usually results in selling the business in a hurry
and at a discount.
Growth requires more capital can be a good reason if your business
is profitable and you can still dictate sales terms.
Burnout might want to consider taking some time away first (even
a four- or five-day getaway trip) to think of ways to reduce stress before
selling simply because you are burned out.
Boredom wait a while . . . if you are still bored, then maybe it
is time to sell.
Partnership dispute if you cant resolve your differences,
make sure both parties are committed to selling at a fair price, not a
Divorce a very difficult situation if the husband and wife have
been working together.
Failing business almost impossible to sell for more than liquidation
All equity tied up in business you may be ready to diversify your
No personal time for family and friends can be a good reason if
youre working a lot of 16-hour days.
Outside economic factors becoming more common than it was in the
Illness usually not a good time to sell, but all too often this
is the reason.
concurs that you should have a well-thought-out reason to sell your business.
This is because your object in selling is normally to realize as much
as possible from the sale and then redirect your attention to whatever
you want to do in the future. Oftentimes selling for the wrong reason
hurts the seller on both counts. For one, you wind up receiving a below-market
sale price for your business. Frequently this also means that your future
options are limited by your age and financial position. So you might wind
up selling without getting enough money to retire on and then need to
seek employment where youd be making a lot less than if you had
simply kept the business! In any case, if you become convinced that your
reason to sell is viable, the next key step is to allow plenty of time
for the sales process.
want to emphasize that the timing of a business sale is critical,
Robbins says. Consult with your intermediary to determine how you
can achieve a smooth transition from owner to owner. And above all, remember
that planning ahead is key. I find that too many business owners fail
to plan for the day when they will want to sell. Then something happens
most often a health problem and they are forced to sell
Why Buyers Buy
you have decided to sell your business, you need to start thinking like
a buyer. In so doing, you will take steps to make your business more attractive
to prospective suitors. From a financial perspective, the buyer will be
looking for three key results on the other side of the purchase. He or
she will want to earn a decent living, repay debt and generate a sufficient
return on investment. Of course, all three are subject to interpretation,
rendering the process as much art as science. Says Robbins, The
buyer rarely buys what the seller thinks he is selling.
to Robbins, potential buyers can be divided into these seven categories:
Next generation (i.e., children)
buyer types will focus on one key financial factor return on investment
(ROI). In simple terms, the ROI is calculated by dividing the net annual
return by the dollars invested. But this calculation is anything but simple
when it comes to the sale of a business. Says Robbins: The buyer
wants the highest ROI (implying a low purchase price), while the seller
wants to maximize the sales price. The process is naturally confrontational.
course, a business broker will provide a buffer to absorb many of the
confrontational issues. He/she also will help the seller sort out the
key components of ROI: cost of money, degree of risk, greed, liquidity
and future expectations of profits.
of money The cost of money has an inverse relationship with
the denominator in ROI. As the cost of money rises, profits fall and earnings
multiples also decline. Lower cost of money leads to higher profits and
higher earnings multiples. Interest rates for the cost of money are set
by government and market forces. A recent example of these forces at work
has been U.S. Federal Reserve Chairman Alan Greenspans lowering
of short-term interest rates an unprecedented 400 basis points from January
to October 2001.
of risk The more risk perceived by the buyer, the higher the
expected return will be. If your revenue and earnings have been erratic
in recent years, the buyer may perceive the purchase of your business
to be a higher risk than it would be to buy one with stable sales and
profits. If so, he will demand a higher return (which means a lower price).
Pure greed may motivate the buyer to try to drive the price
down. If you run into a potential buyer with a strong greed factor, it
will likely be difficult to consummate a deal.
Robbins points out that the easier it is to convert an investment
into cash, the lower the expected ROI and the higher the earnings multiple.
In other words, a potential buyer is going to expect a much higher return
buying your business than he could get putting the same amount of money
into Treasury Bonds.
expectations of profit The buyer will be more likely to pay
a higher multiple of earnings for a company that has sustained (three
years or more), positive sales and net income trends.
The calculation most often used to compute business valuations is:
Earnings Multiple x Net Profit = Business Value
because the earnings multiple is subjective and net profit fluctuates
and is subject to various adjustments, the process of business valuation
is quite subjective, particularly for privately held companies. Rules
of thumb are valuation methods that should be used as guidelines only,
advises Robbins. Valuations vary greatly from business to business.
The true value of a business lies in the future as seen by the buyer.
should be noted that the above calculation is not the only way to value
a business. The book value of a business is computed by adding
retained earnings, paid in capital, common stock and shareholder loans.
However, book value multiples are rarely used in computing business sale
calculations, because the buyer will be dependent on the earnings capacity
of the business to earn a living, pay back debt and generate an acceptable
return on investment.
will not be able to compute the potential sales value of your business
just from reading this article. Depending on many factors (business age,
location, market potential, financial trends, potential financial adjustments,
gross margin level relative to the recognition and identification industry,
and condition of business assets, to name a few), the earnings multiple
for your business could vary from 1x to 8x or possibly higher.
According to Robbins, there are a number of different financial earnings
measurements that can be used to value a business. The five most commonly
Shareholder discretionary earnings
Earnings before interest and taxes
Net profit before tax
Net profit after tax
Earnings before interest, taxes, depreciation and amortization
illustration purposes only, lets say you and your business broker
have determined a ballpark earnings multiple of 5x and your business earns
a consistent annual net income of $100,000. The value of your business
would be computed at $500,000 (5 x $100,000).
reiterates that each transaction is unique. Earnings multiples are
generally established as the result of a transaction, he says. They
shouldnt be used to drive a transaction, because there are so many
extraneous factors that affect the value.
other point regarding the business valuation process: Robbins strongly
advises his clients not to list an asking price when seeking to sell a
business. An asking price puts a ceiling on the value of your business,
explains Robbins, who suggests asking the potential buyer to make the
first offer. Understand how the buyer developed his estimation of
the value then be prepared to challenge his or her assumptions.
Importance Of Recasting
says that the historical financial statements alone seldom portray the
true financial picture of a business. It is virtually impossible
to value a privately held company without careful analysis and recasting
to determine the true level of profits, says Robbins.
is recasting? It is the process of adjusting the out extra
expenses that are typically run through a closely held business. These
expenses are designed to reduce the tax liability of the owner, but they
understate the earnings power of the business. It is up to the seller
to provide to potential buyers the detail on these expenses.
is an example of some of these expenses. The income statement of an engraving
business shows a pre-tax net profit of $100,000 for a given year. However,
included in the expenses are the following:
A $30,000 salary for a family member who works part time and could be
replaced by a part-time employee earning $10,000 per year
$7,000 per year for the owners leased vehicle
$30,000 in overly conservative inventory write-downs
$3,000 per year in country club dues
this engraving business would appear to have a net income of $100,000
at first glance, the recast net income number would be $160,000. This
could have a substantial impact on the potential sales price of the business.
For example, using the 5x multiple example mentioned earlier, recasting
the business financial statements suggests that the value of the
business is really $300,000 higher.
says there are many expenses that can be adjusted out of the recast income
statement to maximize the reported earning power of a business. Some of
the most common are:
Excessive owner compensation
Family compensation to spouse, siblings or children
Owner expenses such as vehicles Owner perks such as club dues and
Accelerated depreciation or amortization
Use of nonconforming accounting principles
Conservative inventory write-downs
Conservative bad debt write-offs
Unusual expenses such as legal expenses associated with a lawsuit
Excessive maintenance that appears in one year
New product or division start-up costs
Capital items expensed (such as a new computer system) that could be depreciated
Toys such as boats, airplanes and cell phones
Structuring The Deal
the structure of the deal is more important than the actual sales price
of a business. For instance, if it is important for you to cash all the
way out now, you might take $100,000 less for a cash offer rather than
take another offer that requires owner financing. In fact, there are numerous
ways for you to be paid in the sale of your business:
Cash The most certain way to collect the entire sales price, but
has immediate tax consequences.
Secured notes Seller is paid over time out of the cash flow of
the business and has the right to foreclose as a secondary repayment source
if the buyer defaults.
Unsecured notes Riskier than secured because the claim is unsecured;
limited secondary repayment source if the buyer defaults.
Shares in purchasing company Typically only included as part of
the package when selling to a publicly traded company.
Consulting agreement Seller required to stay involved for a fairly
short period of time (usually from six months to two years) in exchange
for part of the purchase price.
Employment contract Seller required to stay involved on a longer-term
basis (usually three to five years) to help with transition to new owner.
Lease on assets retained by seller Most common with real estate
or equipment; if you agree to this, you should require the buyer to sign
a long-term lease (five years or more).
Non-compete agreement Seller receives payments over a period of
time (usually three to five years) in consideration for agreeing not to
open up a competing shop down the street.
Royalty program Seller receives part of sales price based on future
sales generated by the business.
Earnout Seller receives part of sales price based on future earnings
generated by the business; can be problematic if profits decline after
Selling shares vs. selling
assets Buyer purchases the shares of the business directly from
the owner(s) of the stock.
some businesses are sold on an all-cash basis, most sales include seller
financing in the form of a secured or unsecured promissory note or some
other form of future payout to the seller (such as a consulting agreement
and a non-compete agreement). This can prove beneficial to the seller
from a tax-planning standpoint. However, the seller becomes a creditor
and takes some risk that the business will continue to perform well enough
to generate sufficient cash flow to meet future obligations to all creditors.
Example Of A Sale
two deals are exactly alike, but what follows is an example of a deal
structure for the sale of an engraving business. Assuming that the buyer
is obtaining a bank loan to finance the purchase, the buyer will likely
be required to put down about 30 percent, with the bank and the seller
roughly splitting the remainder of the financing. With a $500,000 purchase
price, the financing might look like this:
Buyers down payment......$150,000
this scenario, the seller receives $325,000 in cash at closing ($150,000
from the buyer and $175,000 from the bank) with $175,000 payable out of
future cash flow from the business. The bank will require a first lien
on the assets of the business, leaving you limited collateral for your
loan. Still, you can ask for a second lien on the assets, as well as a
personal guaranty from the buyer. As for the loan term, you should negotiate
for a payback on the note of three to five years, maximum. The interest
rate on notes such as these typically is set near the Wall Street Journal
prime rate (at press time, 5.5 percent) and can be fixed or variable.
Of course, another point of negotiation for you as seller is to ask for
a high note rate.
Dont Fail To Plan
reiterates that the process of selling a business should not be rushed.
Concludes Robbins, Business owners never plan to fail, but they
do fail to plan, and that gives the buyer an advantage.
if you are considering the sale of your business, it is advisable that
you visit your CPA and involve a business broker in the process as early
as possible. If you arent sure how to go about engaging a business
broker, try contacting the International Business Brokers Association
(www.ibba.org) for guidance. And above all, be prepared for a process
that will require a great deal of time and effort that should pay off
in maximizing the sales price of your business in the long run.