Almost every business can be sold even if you winged it. Just lower the price enough and someone will bite. Selling it quickly at the best price possible, however, require proper planning, process and dealing with nuances the right way.
I’m happy to unveil some industry secrets that could help you sell a business quickly on your own and get the most cash in your pocket.
Let’s start off with the Business Sales Process in a visual overview. I will then go into each step in more detail as we go along.
Financial optimizations can net you as much as 50% more cash over valuation of your company.
You have worked hard, put in years of sweat equity into your business and grew it to what it is today. Now, at a time when you are ready to sell the business, you wonder “How much is my business worth?”.
Many business owners I meet have some idea of an industry average multiple for their business. They have a “guesstimate” of the multiple of SDE (Seller Discretionary Earnings) or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for their business.
A multiple of earnings is a good starting point for a “back of the napkin” calculation. The actual net cash proceeds you get from selling a business is often more than just a simple multiple of SDE or EBITDA. For simplicity’s sake, we will just address how the earnings multiple is derived.
The business valuation method illustrated here is used for small businesses, typically owned and operated by a single or few shareholders, and have revenues less than $10 million.
Here’s a brief overview of how to value a business to sell.
i) Normalize An Income Statement
Normalizing an income statements means removing any discretionary owner benefits and other items from earnings in order to show the true economic benefit of a business.
In order to get an accurate business value based on multiples, we need to make sure that the SDE or EBITDA is adjusted for any owner benefits and small business factors first.
For business owners, this would mean those expenses like your personal auto lease, health insurance and bills, telephone, home office, meals and entertainment.
Discretionary expenses are small business “perks and benefits” that an owner may expense to the business but receive some or all the personal benefit. We also sometimes call this “tax optimizations”. These items are adjusted from the income statement.
Which cash flow to use? SDE or EBITDA?
There are no specific hard and fast rules on when to use the two most common cash flow type: SDE and EBITDA. Generally, SDE is used when valuing an owner-operator business while EBITDA is used for owner absent businesses.
As a rule of thumb, businesses with less than $500,000 in income and where the owner is involved in the day to day managing of the business, SDE is used.
If the business is generating over $500,000 in operational income and where there is a General Manager or CEO in place, or if the role of the owner is that of a GM/CEO, EBITDA can and should be used.
Examples of this would be for a larger construction business where the owner is not going out estimating projects or responsible for project management. A simple litmus test is whether the business owner is involved in the day-to-day operation of the business. Can the business owner go for a 3 month vacation with no impact on business?
ii) How To Determine SDE and EBITDA
Once you have the individual 3 or 5 years of SDE/EBITDA values, add up the value from all the years and dividing by 3 or 5 to find average SDE or EBITDA. You may also use a weighted average figure.
iii) Determine an Earnings Multiple
Earnings multiples move based on more than one factor. There are different average multiples for different industries as well as for different company size.
For example, multiples will typically be higher for manufacturing and lower for general retail stores. Multiples will also be higher for a larger business making more EBITDA and lower for an owner operated smaller business with SDE.
You can find multiples by industry of previous businesses sold on Bizbuysell, or purchase data from private company transaction database which usually cost up to $500 for each data pull.
* When looking at industry average multiples, you need find out if the multiple includes working capital (net receivables and inventory) or not. Working capital, depending on industry, can skew multiples by as much as 0.5 to 1.5X.
In large business transactions, all operational assets including working capital required to generate revenues for the business are included in the enterprise value and asking price.
In short, if you ask 3.5X EBITDA for a large business, that typically includes goodwill, equipment, working capital (receivables & inventory), intellectual property and every other asset required to generate earnings.
For smaller businesses using SDE, the tradition started by business brokers is to sell a business without cash, net receivables, and inventory while trying to push the same valuation multiple as large companies. Buyer’s generally have to finance the acquisition plus inject additional capital for working capital and sometimes making an SDE multiple higher and offering lower return on investment, in relative terms, to buy a small business.
Some exceptions exist for industries where inventory value can exceed enterprise value, it is common to price the business at 1-2x SDE plus inventory. Some people price their SDE business over 4X and the higher asking price may result in low inquiries of buyers failing to secure financing due to the high valuation. In some cases, the seller may decide to take on a higher % of seller financing to help with some financing.
Before you put your business on the market, there are two things you can do to maximize the outcome of the sale.
i) Business “Housekeeping” / Preparation
A business sale can derail late in the process from easily avoidable issues that can be addressed prior to any offers.
A former client of mine who had equipment financing and had paid it off years prior to the sale. However, the finance company forgot to take the lien off the equipment when the lease ended, and that lien showed up during legal due diligence.
While this was resolved, it adds unnecessary stress to the buyer or seller during a crucial moment. Both had already chalked up thousands in lawyer and accountant fees and did not want the deal to fall apart. And they do often during buyer due diligence.
You can avoid such mistakes with a business presale due diligence checklist on your business to make sure everything is in order and those that are not should be rectified ASAP.
Here are some things to start you off:
- If multiple shareholders, a resolution for the agreement to sell the business.
- All documents of lease or property title ownership.
- Financial transactions in the last 3 years for loans, leases, guarantees, etc.
- All contracts or agreements with any person or business.
- Documentation of all guarantees, warranties, or obligation by company for its products or services.
- Any agreement restricting the sale or transfer or any of the company assets (including liens).
- All customer, supplier, partnership agreements.
- Documents of current or anticipated legal proceedings.
- An organizational structure of your business.
- A list of all signing authority of the business.
- Stock option or profit-sharing agreements.
- Confidentiality agreements of employees or vendors.
- 3-5 years of accountant prepared financial statements or tax returns.
- List of all material assets including brand, model, date of purchase, cost, current fair market value.
- List of equipment leases if any.
- Copies of permits, licenses, and regulatory compliance papers.
ii) Business Optimization
You want your business to be operating as efficient as possible prior to a sale.
Business owners can unlock anywhere from 10-50% of the total value of their business by optimizing before the business is sold. This means that you could get cash in addition to the transacted sale price of the company.
* Almost all small business brokers are not aware or have the expertise to perform optimizations. These techniques appear more often in larger deals done by professional investors like private equity transactions.
These are some areas you want to ensure are optimized:
- Sell off excess inventory and liquidate dead inventory.
- Ensure your fixed assets are financially optimized.
- Ensure your receivables are paid within industry standards. This will increase your cash position by lowering working capital requirements.
- Pay your payables to the last day or two from due date. This keeps cash in your account longer thus lowering working capital.
- Sell off or liquidate any equipment not used now or in the future.
- Look through expenses and cut any expense that are “fat” like subscriptions no one uses.
Business transaction optimization require advanced finance and accounting knowledge from a professional to identify potential areas to work on.
iii) Decide On Your Offering
With business value determined, decide on the asking price and terms of sale you like to offer. A more generous terms of sale may help you sell a business quicker and for a higher price. Some terms like deferred payments also allow you to pay less taxes.
Here are common transaction terms you should consider for your offering:
- Seller financing a.k.a. Vendor Take Back (VTB).
- Term length of VTB.
- Buyer training and transition period.
- Inventory financing (if the business require stocking a lot of inventory).
- Are you selling the business inclusive or exclusive of working capital?
iv) Lawyer and Accountants
Prior to putting your business on the market, you should give your accountant and lawyer a heads up on your plans to sell your business.
Get in touch with them by dropping them an email or a phone call. Always remember that most lawyers charge for everything so if you drop an email with questions they may bill you for the time they take to type a response if it requires their professional opinion. Keep it short and sweet unless you have a real need for a legal opinion.
Typically, accountants will be the first to be informed.
Now that you have prepared your business for sale and you got a good handle on how much to list it for, it is time to put it on the market.
For Sale Documents Required
The sale of every business should always remain confidential so as not to unnecessarily disrupt business operations for employees, customers, and suppliers.
You need a Non-Disclosure Agreement that is specifically for selling a business to protect your company.
Even with an NDA signed, sensitive and confidential information should always be throttled during the buyer inquiry process on a need to know or request basis. On the other end, do not have such a tight grip on information that buyers lose interest or suspect you are hiding defects of the business, make a good balance.
This is a common flow of the inquiry process: The more a buyer finds out about a business, the more they will drop out. Usually as they find out that the business is not for them. This is normal.
With that in mind, your listing and process should be staggered as shown below.
i) What To Include In A Listing?
* Do not include your business name or address in the listing. It can identify your business.
- Business type/industry/non-identifiable description.
- 3-5 years of revenues.
- 3-5 years of SDE or EBITDA. You may also show the average.
- Asking price and what it includes or excludes (receivables & inventory).
- Asset values.
- Terms of sale: asset or share, seller financing, training and transition.
ii) Non-Disclosure Agreement
When you get a buyer inquiry for your listing asking for more information, send them the NDA to sign.
iii) Confidential Information Memorandum / Prospectus
* Get a signed Non-Disclosure Agreement prior to sending buyer this document.
A Confidential Information Memorandum goes by many names. They have been labelled as Info Memorandums, Prospectus, Brochure, Presentation Decks. This document should contain a list of information useful to help a buyer make a preliminary assessment on the business.
Majority of potential buyers will drop away after going through this document because the business is not a good fit for them.:
- Your business name and address.
- Description of your business and products or services.
- Business summary: number of employees, equipment value/list, premise square footage, business hours, website URL, etc.
- 3 to 5 year Income statement summary.
- Current balance sheet.
Getting an offer from a potential buyer can be exciting yet unnerving for many. It may seem like your life’s work is about to be “graded” and you are anxious what the number will be.
You should note that not all offers, especially first offers, will be for what you expect the fair market value of the business will be.
Be prepared that most offers will not meet your expectations. For one, your expectations could be too high, and on the other end of the spectrum, many offers can be low ballers.
When you do get a genuine offer, because you have a good, defensible small business valuation and a reasonable offering, you should be able to start off negotiations from a position of strength.
The Offer and Counter-Offer Process
- Buyer makes an offer with an Offer Letter or Letter of Intent.
- If the buyer used a proper offer letter meant for business sales, it will have an offer expiry date and time.
- Go through the offer on your own. An offer letter should not be complicated or have legal jargon where you need a legal interpretation. If you see any term that is out of the ballpark you do not need to respond or counter offer.
- If you feel the gap between the offer and your expectations can be closed, make a counter offer by amending with a pen or PDF app the terms you want to change. At the same time, amend the date and time of the expiry and give the same amount of time the buyer gave you i.e. 3 days or 48 hours.
- Offers and counter offers can go back and forth several times before a deal is made. If the offer letter becomes too cluttered, ask the buyer to create a new document with the updated terms. You can also do this yourself.
- If a deal has been made, congratulations! You are one step closer to closing the sale. Parts of the offer letter now become binding and the buyer begins due diligence to verify everything you have claimed about the business with their lawyer and accountant.
– Pro Tip –
The buyer due diligence process involves accountants and sometimes lawyers. This can be a costly process if the deal goes off the rails once this process has begun only for you to start all over again with another buyer. A properly worded Offer Letter with a deposit mechanism can help mitigate unqualified buyers who are not serious from wasting your time and money.
For most DIY business sales, buyer due diligence often gets messy. The buyer soon discovers that the SDE or EBITDA are not what its supposed to be, or the equipment are not as valuable as stated, the accounts are incomplete, plus a dozen other issues.
Fortunately for you, if you had done your presale preparation for buyer due diligence and valued the business using proper practices, things should go smoother during this stage.
Here’s what to do and expect:
Tips during buyer due diligence.
- The buyer’s accountant may have questions for your accountant. This is normal and you should provide your accountant’s contact info. Alternatively, you can serve as the middleman but this may be inefficient.
- You will receive requests for documents and information. Provide everything as an open book. A buyer needs to verify everything.
- The only information you should not disclose are business trade secrets and highly confidential information that will cause your business damage if the deal goes south. Examples would be secret recipes/processes and highly sensitive, high-profile customer or other business dealings where you had to sign an NDA on. If in doubt, seek legal advice.
- Ensure the there is a time limit for due diligence. The average time needed for small business DD is less than 2-3 weeks. Never agree to a 2 month process unless your business is complicated, cross borders, or have many locations and SKUs.
Once the buyer is satisfied with the due diligence, it is time to draft the Purchase Agreement. The buyer’s lawyer typically drafts the Purchase Agreement. Depending on the offer structure you used, sometimes a second deposit is placed.
Whether there are one or two deposits, the buyer should sign a waiver of conditions precedent where the offer terms now become binding. After this time, if the deal falls apart for any reason other than yours, you get to keep the deposit of 10-20% of the purchase price.
It feels like time to pop the champagne but this is a crucial time to still be managing the process. This is the time where your dozen pages of offer letter becomes a 50-80 page legal binding document that the lawyers will prepare. That’s dozens of pages to potentially disagree and agree on.
Naturally, both parties should continue in the spirit of the offer letter and work towards consummating the transaction.
Tips during drafting of the Purchase Agreement.
- The buyer’s lawyer usually drafts the Purchase Agreement. Do not offer your lawyer to draft it since it will cost you and is not convention.
- It is normal for lawyers to have the contact information and communicate with each other during the drafting of the agreement.
- Request to be included in all communications of the lawyers.
- Ensure both lawyers are not being too litigious and inserting too much protection for either client that could stall the transaction if the other party is not in agreement.
- Many deals have been killed by lawyers.
- Ensure neither your lawyer or the buyer’s lawyer does not start renegotiating any terms that have already been previously agreed on. At best the unnecessary back and forth could cost you hundreds or even thousands. At worst it could derail the deal.
- Ensure that the buyer’s lawyer does not go overboard with the warranties and representations. This can happen when an eager buyer engages a hot shot large corporate merger and acquisitions lawyer to do this small business sale. The lawyer makes the W&R so air tight that its too much protection for a small business sale and your lawyer would not let you sign it.
It’s an exciting time for both buyer and seller! The day is finally here and its time to close and transition.
In the past, both parties would meet at one of the lawyer’s office on closing day to sign the documents. Now with the internet and digital signing capabilities things have been made more efficient.
Both buyer and seller will go to their respective lawyers office to sign the documents, after which the lawyers will do an electronic exchange of documents. This is a welcome improvement especially for long distance transactions.
i) What happens before and on closing day?
- Prior to closing day, multiple things happen concurrently: buyer formalizes the financing for the acquisition, seller and lawyer completes all the conditions of the sale, buyer’s lawyer does legal due diligence like checking liens, or share transfer restrictions from any business loan covenants.
- If the tasks are unable to be completed and closing day is approaching, on mutual agreement the parties may amend the closing day to a later date.
- Once everything is completed and the lawyers on both sides are ready, they will let both buyer and seller know to visit their offices to sign the documents.
ii) Transitioning the buyer to the business.
The announcement of the business sale and new owner to the employees usually occur the business day after closing day.
The best time for closing day is Friday or Saturday. This gives one or two days for you to do an administrative handover to the new owner and to make the announcement on Monday during the first meeting of the week.
Let the new owner decide on the manner of the nuances of the transition like meeting key employees one by one after the announcement or other things he/she would like to do.
Some new owners may be very experienced other may not have a clue. Regardless, always try to assist to make their transition as smooth as possible. Afterall, they are going to continue your legacy!
The duration of your training and transition involvement would have been agreed to in the offer. Once you complete this period you would have officially fulfilled all your obligations.
Wish the new owner the best wishes and officially pass the mantle on. From time to time, you may receive an email or call with questions. You are not obligated outside of the agreed training and transition however, most business owners are more than happy to oblige and feel reassured that their legacy is in safe hands.