Finding the right buyer is more difficult than you can imagine, but it’s only half of the battle. Consummating a deal is a long and arduous process as well.
External sales are usually funded by the buyer using both debt and equity capital. However, sellers are often required to provide seller financing for at least a portion of the selling price and receive payments over time. Some types of buyers want the sellers to stick around while others do not.
Third-party sales are typically transacted at “market value” or what the market dictates when you have a willing buyer and a willing seller but this can vary by type of buyer. Value is driven by the buyer’s perception of risk and reward-related to the acquisition target. Strategic buyers will pay the highest value since, by definition, they will realize immediate synergies (i.e., increased profits and a higher rate of return on their investment). Financial buyers will pay less based on their anticipated rate of return.
Understanding the selling process, what buyers and lenders are looking for, and how to position the business will improve your chances of having a successful external transfer. Check out the “Art of the Deal” chapter in our book Cashing Out of Your Business – Your Last Great Deal for a list of the “Top Ten Deal Killers” that you must avoid during the selling process.
PRIVATE EQUITY SALE / RECAPITALIZATION:
Financial buyers, such as private equity firms (PEFs) usually purchase a majority stake in the business, up to 80%, and allow current owners to keep a portion. Leveraging their capital, expertise, and relationships, buyers plan to increase value over three to five years, resell the business and lock in a large return for all shareholders.
The PEF generally wants owners to remain involved for a period of three to five years. This can be a good option for an owner who believes that a third party sale is the best option, but also wishes to remain involved with the business for a few more years.
Business Value: Financial market value
Funding Sources: Debt as well as equity capital
Owner Timeframe: Up to 5 years
Tax Implications: PEF sales/recapitalizations are stock transactions that are typically structured as asset sales in order to minimize taxes for the buyer. S Corporation sellers will pay ordinary income tax on a portion of the proceeds and capital gains on the rest. C corporation sellers will pay the highest tax at both corporate and personal levels.
Business and Owner Suitability:
- Companies with more than $1M in annual EBITDA
- Companies with strong growth or growth potential >20% annually
- Owner who wants to retain some ownership and potentially get a second payday if the company sells again
- Owner who is willing and able to work for someone else
- Key employees and/or family members may not have the desire or ability to be owners
SALE OF 100% OF BUSINESS TO A THIRD PARTY:
This type of sale may be to a financial buyer who needs to keep the existing business structure or to a strategic buyer that can realize synergies (i.e., reduce operating expenses) and increase profits as a result of the acquisition.
The buyer may be an individual or another company and they may pay the highest sales price, but you may or may not realize the highest net proceeds. You may not be involved with your business for very long after the sale.
Business Value: Financial or synergistic market value
Funding Sources: Debt, equity, and/or seller financing
Owner Timeframe: 9-12 months
Tax Implications: Most third party sales are asset sales that are taxed at least partially at ordinary income tax rates. C corporations will pay tax at both corporate and personal levels.
Business and Owner Suitability:
- Well-run businesses with solid financials and growth potential
- Owner doesn’t have family members or key employees who are able and willing to run the business
- Owner desires faster payout and shorter timeline for involvement
ADVISORS YOU WILL NEED:
Selling your business to a third party can be a minefield for business owners if you don’t have the proper guidance in navigating the marketplace. This is a complex world of brokers, investment bankers, private equity groups, lenders, buyers, lawyers and due diligence. Getting prepared for a possible transaction and minimizing taxes and fees takes time, preparation, and the assistance of a skilled advisory team.
The advisors you should select for an external sale include:
- Business transition advisor
- CPA with experience in tax planning for business sales
- Transaction attorney
- Business intermediary (business broker or investment banker)
- Personal wealth advisor
THE PROS AND CONS OF EXTERNAL TRANSFERS:
- May be higher gross sales price than internal sale
- Owner may be able to walk away from the business
- Owner likely to receive most of the money upfront
- Higher taxes and fees
- May take significant period of time to make business attractive to buyers
- Ability to consummate a transaction is dependent on economic conditions and the market for business sales
- Owner has no control over the future of the business, including location and employee security; can be disruptive
- Complex and stressful due diligence process and negotiations
- Owner may experience seller’s remorse
- It can be difficult to find a buyer and close the deal