Most business owners think that they simply will sell their business to a third party because they don’t have an option for selling their businesses internally and/or they think it will net them the highest dollar amount. While selling externally is often attempted, it is not often achieved. In fact, less than one in four of the businesses that go on the market for sale actually sell. Understanding the selling process, what buyers and lenders are looking for, and how to position the business can improve owners’ chances of success. But this takes time and effort.
There is no magic wand that can be waved to create a successful sale. Instead, it relies on planning well in advance—we recommend three to five years—in order to prepare the business and the owner.
If you’re thinking about an external transfer, there are a number of things you need to consider in order to achieve the best possible results. Here are 14 of the most important:
- Financial Structure - The sale of a business to a third party usually requires a substantial portion of the sale price be funded with third-party financing. In some cases, the seller may be required to or chooses to participate as the lender in the form of seller financing, receiving payments over time as an installment sale.
- Value Used for Transition - The business value used for an external sale will be “market value” or what the market dictates for an arm’s length transaction. Strategic buyers will typically pay the highest price while private equity groups or other financial buyers pay less. This value is driven by the buyer’s perception of risk and reward in the business acquisition.
- Percentage of the Business Typically Sold - The normal scenario in an external sale is for the owner to sell 100% of the company. The exception to this would be the sale to a private equity group, which typically requires the seller to retain ownership in the 20% range and remain involved for a specified time. This is known as a recapitalization. This can offer a benefit to sellers since they may be able to reap the rewards of a “second bite of the apple,” as it is referred to in the industry, when they sell their retained ownership in the future. Hopefully at that later date, the value of the company will have increased.
- Owner Perks - With the exception of the Private Equity Group Recapitalization, where the owner may remain involved, most external transfer options do not provide for the continuation of perks and benefits to the owner past the sale date.
- Owner Income Stream - With the exception of the Private Equity Group Recapitalization, the continuation of an owner’s income stream is usually in the form of consulting income for a short time (12‒24 months), payments from an installment sale, and/ or an earn-out.
- Typical Tax Treatment - The external sale generally creates the largest tax burden since the owner is selling all of his or her shares at once. The tax burden can be in the form of ordinary income, capital gains, or both. In a sale of the assets owned by a C corporation, double taxation occurs, once at the corporate level and again at the personal level. These taxes can seriously erode the net proceeds received by the exiting owner and should be carefully calculated and planned for.
- Fees - Other costs that can have a large impact on net proceeds are transaction fees such as legal, accounting, due diligence, and brokerage fees, which can be substantial. While an external sale to a synergistic buyer should provide the highest gross selling price, it may also carry the highest fees.
- Preservation of Legacy - The preservation of legacy and the continued employment of the current employees cannot be controlled in the case of an external sale. Even the location of the business cannot be certain since the new owner may be looking at combining locations with an existing operation.
- Operational Control - The seller’s operational control will normally cease on the day of transfer. Even in the case of a Private Equity Group Recapitalization, the selling owner will generally not maintain operational control over the day-to-day business activities post transaction but often continue with a board position and employment.
- Level of Seller Involvement - Seller involvement is usually limited and may be on a consulting basis only, generally 1‒3 years on average.
- Due Diligence - This is a very arduous process and requires a great deal of time, effort, and preparation. It can also be very costly in time and money. The due diligence period, depending on the business and complexity can require from 45 days to several months.
- Degree of Difficulty of Transition - The external sale is the most difficult to achieve since you have parties that have their own interests and have not developed mutual trust. These transactions require the assistance of legal counsel, CPAs, and other advisors for both buyer and seller so that everyone’s interests are protected and can be adequately considered and protected.
- Disruption to the Company - The external sale generally causes the most disruption to the company. There can be due diligence teams on site prior to a transfer, and post transfer there can be new management, procedures and processes. The culture of the company is one of the things at greatest risk in an external sale.
- Impact on Employee Morale - The impact on morale can also be greatly impacted since a pending sale can lead to uncertainty about continued employment. Employees can become fearful for their future and may even seek new employment prior to a transfer if they feel their jobs may be in jeopardy. Top-level management, unless included in the process, can be most concerned in these types of transfers. The company is at the greatest risk of losing key people during these transactions.
Typically 3-5 years are needed to adequately plan and implement a successful transition, yet most owners mistakenly believe planning is not necessary. When considering that an owner’s business transition will most likely create the single largest financial event in his or her lifetime, being prepared is essential. Don’t procrastinate. Seek the assistance of highly trained transition planning experts to protect your financial future and fully understand your best transition option.