Selling the business instead of passing it on

Not every business should stay in the family. Where no successor exists or none is suitable, selling is generally better than a transfer that fails.

The types of buyer

Strategic buyers — competitors, suppliers or customers who want the business for a specific reason.

Generally pay the most, because they can extract value from combining operations.

Financial buyers — private equity or investment groups buying for return.

Typically want the existing management to remain, and frequently structure part of the price as contingent on future performance.

Management, through a buyout financed from the business or externally.

Provides continuity and generally pays less, and is frequently the seller's preference for non-financial reasons.

Employee ownership, through an employee stock ownership plan, which carries specific tax advantages and substantial complexity and cost.

Individual buyers, generally for smaller businesses, frequently financed partly by the seller.

What makes a business saleable

The work that determines whether a sale is possible and at what price.

Reduced owner dependence. The single most important factor.

A business where the owner holds the customer relationships, the technical knowledge and the daily decisions is difficult to sell, because the buyer is purchasing something that leaves.

Documented systems and processes, so that operations do not depend on individual memory.

Clean financial records, ideally reviewed or audited, covering several years.

Personal expenses run through the business — extremely common in owner-managed companies — reduce apparent profitability and complicate diligence.

Cleaning these up takes two to three years of clean statements to be useful.

Diversified customers. Concentration in a few accounts substantially reduces value.

Contracts that survive a change of ownership, including customer agreements, leases and key supplier arrangements.

A management team who will stay, which is what a buyer is largely purchasing.

These take years to build, which is why the preparation period for a sale is generally described as three to five years.

Valuation expectations

Owners consistently overestimate.

Small businesses typically transact at multiples of earnings that are considerably lower than owners expect, and the multiple depends heavily on size, sector, growth and owner dependence.

Obtaining an independent valuation early, from someone with no interest in the transaction, is worth doing.

It also identifies what would raise the value, which is the more useful output.

Structure and tax

The structure of a sale materially affects what the seller keeps.

Asset sale versus stock sale. Buyers generally prefer asset purchases for tax and liability reasons; sellers frequently prefer stock sales.

The difference in after-tax proceeds can be substantial.

Instalment sales, which spread the gain across years and carry the risk that the buyer fails to pay.

Earn-outs, where part of the price depends on future performance.

These are common and frequently disputed, and the drafting of how performance is measured matters enormously.

Consulting and non-compete payments, which are taxed differently from sale proceeds.

Tax advice before agreeing terms is essential, since the structure is difficult to change once heads of terms are signed.

The process

Typically longer than expected — commonly nine to eighteen months from decision to completion.

Preparation, valuation, marketing or approach to buyers, negotiation of terms, due diligence, documentation and completion.

Due diligence is intrusive and time-consuming, and it frequently surfaces problems that reduce the price or delay matters.

Anticipating what will be examined, and fixing problems in advance, is the most effective preparation available.

Afterwards

Two things worth planning.

The proceeds. A substantial lump sum arriving at once requires a plan, and the period immediately after a sale attracts approaches from people selling investments.

Doing nothing with the money for several months is generally the right decision.

What you do next. Business owners consistently report that the loss of identity and structure after a sale is harder than anticipated.

Owners who had something specific arranged report better transitions than those who assumed they would enjoy the free time.

General information only, not legal, tax or business advice. Consult qualified professionals before agreeing terms.