Maximizing The Sale Price of Your Business

When the time comes to sell a business, the owner typically wants to sell for the highest price. There are times, including the sale of the business to a family member, when the highest price is not the objective. But when the buyer is an unrelated third party, the highest price is the main priority.

Selling a business is much like selling a house. The work involved, and the sale process, are usually much more complex, but the nature of the work is the same. All the little imperfections that one lived with for years need correction to show the house at its best. You replace the stained carpet. You finish painting the repairs you primed two years but never got around to painting. The sickly-looking shrub gets removed and the garage finally gets cleaned up. You want the house to show like you have taken care of all problems.

The same concept holds when selling a business. The difference is that while the house preparation involves correction of physical conditions, the business equivalent concerns the company’s due diligence items. This article is adapted from Business Succession Planning by Steve Goodman, CPA. Mr. Goodman is a Long Island, NY based estate planning professional with 25 years of experience. He has assisted numerous business owners to minimize taxes and either sell or transition their businesses to their children or other relatives.

Business Succession Planning

The Decision to Sell

When the day comes that you decide to retire and sell the business, you want to get the best price for the business that you can. With all of the planning that went into starting and operating the business, many owners fail to create an effective plan for creating value in the business prior to transferring ownership.

Just as you cleaned house before you put your home on the market, business owners need to “clean house” before putting their business on the market. They need to put themselves in the shoes of a potential buyer. What would a potential buyer (and the potential buyer’s counsel) want to see when they inspect your business? Just like the sale of a home, the sale of a business often involves negotiation. Having your “house” in order creates leverage in these negotiations and can have a substantial effect on the amount a buyer will pay.

The following is a sample presale due-diligence checklist that a potential buyer would go through with counsel. Owners should consider the availability of documentation and whether or not improvements can be made in any of these areas prior to the potential buyer’s inspection.

Sample Pre Sale Due-Diligence Checklist

1.Business Operations and Property Information

• • description of business operations, products, diversity of products, pricing, sales volume, trademarks, copyrights and patents, trade secrets, etc.
  • operating facilities, descriptions, layout, maintenance costs, access to facilities, need for additional facilities, facilities that are underutilized, the potential for expansion, lease and rental agreements, zoning and building code restrictions
  • list of machinery, plant equipment, vehicles, and any other assets necessary for production—include age of the property, maintenance costs, insurance coverage, need for additional equipment.
  • real estate—include copies of leases, rental agreements, description of the property, zoning information, restrictions and easements, insurance coverage, taxes, cost of maintenance and utilities, advantages or disadvantages of location
  • list of top competitors, competitive advantages and disadvantages, market share
  • list of top customers, diversity of customers, revenue generated by these customers as a dollar amount and percentage of total revenue, special considerations for these customers
  • marketing and advertising efforts, cost/benefit analysis, results.
  • business licenses and permits required to operate, effective dates and termination dates, a method of obtaining
  • documented history of sales activity
  • research and new product development efforts
  • distribution methods
  • information systems capacity, software, and hardware, record keeping systems, need for special training to operate
  • written business plan with forecasting
  • trade associations, involvement, and activity
  • press releases issued by the company in the past three years

2. Financial Information

• historical financial statements (with notes, audits, etc.) for the past five years
• income tax returns for the last five years
• projected financial and cash flow statements for the next five years (with explanations of assumptions)
• schedule of bad debt, write-offs, aged trade accounts receivable
• inventory, valuation method, finished or work in progress, costs associated with inventory, location, control methods, the source of supply with the list of possible alternative sources should supply be cut off, contracts and notable dealings with suppliers.
• schedule of notes and loans payable for the past three years (with copies of agreements), lines of available credit, personal guarantees and indemnification arrangements, etc.
• financial information by product line—revenue and gross profit
• description of accounting policies

• Employee Information

1. 1. • organizational chart with a list of key employees, compensation, job duties, education and unique skill sets, golden-handcuff agreements, potential successors, stock or stock options granted, etc.
      • census of employees, compensation, job duties, full- or part-time, cost of benefits, employee turnover experience, records of performance reviews (including terminated employees), records of outside consultants with copies of employment agreements
      • details of any employment agreements entered into
      • company employment policies (employee handbook)
      • qualified and nonqualified retirement plan information, administrative costs, account balances, copies of 5500s and DOL letters, trust documents, summary plan descriptions, etc.
      • benefits information, medical, dental, vision, sick-pay, life, and disability—include summaries, cost, and experience, and claim information
      • key man life insurance policy information, including reasoning for the amount purchased
      • pending employment issues, controversies, litigations, union or nonunion, EEO and ADA claims, OSHA compliance, etc. • availability of local competent skilled employees for hiring

• Other

• • • product liability—open claims and closed claims for the past two years, required product standards (government, etc.), customer complaints, warning labels, safety instructions, and warranties.
    • other claims, judgments, or court orders against the company, officers, directors, legal costs associated with litigation
    • toxic substances used
    • method and availability of waste disposal

In addition to the items listed above in the due-diligence checklist, if you are considering a sale of your business to a third party, there are many other items you’ll want to consider prior to putting the business on the market or seeking offers:

1. 1. Agreements to lock in key employees post-sale. Businesses often implement executive compensation plans intended to provide key employees with an incentive to be productive and continue their employment with the business. Many of these plans contain a trigger that allows the employee to receive the full benefit of the plan upon a change in effective control of the company. A potential buyer would be leery of such arrangements. As an alternative, the seller may want to implement a “stay bonus” program well in advance of placing the business on the market. A stay bonus plan is a simple tool that provides key employees with a cash bonus upon certain triggering events. The bonuses are only paid if the key employee fulfills the obligations of the agreement. This obligation is met by remaining an employee of the business and performing the same duties they were provided prior to the change in control. The triggering event is typically a change in the ownership and control of the business that may be caused by the retirement, death, or disability of the current business owner, or a sale of the business.
   2. Your post-sale personal financial goals. By working with a financial advisor to determine your future cash flow needs, you will be in a better position to evaluate the terms of any offer you receive to acquire your business.
   3. Sale to a strategic buyer versus a financial buyer. A strategic buyer may be a current competitor or a business looking to expand into the products or services your business provides. Financial buyers are typically venturing capitalists, private-equity firms, and hedge funds. They are simply looking at your business as an investment. Their goal will be to turn a profit over a predetermined time period. A sale to a strategic buyer can be expected to take more time than a sale to a financial buyer, simply due to the fact that financial buyers are in the business of acquiring businesses so they will be more efficient at the process. When you sell to a strategic buyer, it may have a negative effect on your employees, as the strategic buyer may prefer to retain its own executives where there is duplication. Financial buyers, on the other hand, will need the expertise of your existing team. Strategic buyers are typically in it for the long haul, while financial buyers generally have a seven- to ten-year time horizon in which to realize their profit goals, at which time they will look to sell the business.
   4. Stock versus asset sale. For tax and other reasons, the buyer will typically want to purchase the assets of the business while the seller will want to sell the stock. By restricting potential buyers to those willing to purchase the stock, you will be substantially limiting the pool of potential buyers. On the other hand, a sale of assets may create additional taxes for the seller and therefore require a higher sales price to generate the desired net sales proceeds.

1. Controlled private auction or negotiated sale process. While most business owners who intend to sell their business to an unrelated third party have a pretty good idea who the potential buyers may be, depending on the nature of their business, it may be worthwhile to seek the services of an experienced M&A advisor. One topic the advisor may assist in is determining the sales process that would be most suitable for your particular business—a controlled auction or a negotiated sale. The controlled auction has the potential to bring a higher price and is often appropriate when there are multiple potential buyers; however, it is a more costly process and is less private than a negotiated sale.
2. Terms of noncompete agreement. Most buyers will have a vested interest in limiting your ability to compete against the business you are selling and will, therefore, require that you sign a non-compete agreement as part of the deal. It is important that the non-compete be reasonable in both its duration and the activities it limits. In addition, it is important to negotiate with the buyer as to how much of the purchase price will be allocated to the non-compete agreement. The buyer may deduct the value of the non-compete payments (over a period of fifteen years), and the payments will be taxable as ordinary income to the seller.
3. Earn-outs. An earn-out provision in a sales agreement allows the final sales price to be adjusted based on future performance of the business. This may provide an effective means for deferring the taxes a seller will recognize, but there are risks to the seller as well. Should the buyers run the business into the ground or not have the desired financial success, the seller may end up receiving a lower sales price for the business.

Conclusion

The checklist of due diligence items can be extensive. Copying documents and compiling them can be a time-consuming project. Not every potential buyer will want to see every document. For businesses that have been in existence for several years, documents may be filed in many desk drawers or misfiled in one of the dozens of filing cabinets and/or storage boxes. The collection effort is not an overnight exercise. Over the course of a year, many of the due diligence documents will be renewed or changed. Making a copy of all new or changed forms for the due diligence file over the course of a year should complete a good portion of the effort.

The time to collect the information is before a potential buyer asks for it. After being asked is not the time to realize that a key document is missing. Competency in collecting the due diligence items implies management competence in other areas. When selling a business, this can result in a faster buying decision at a more generous price.