Selling Your Business: Selecting a Buyer

Ben Franklin’s line “In this world nothing can be said to be certain, except death and taxes” should have a similar expression for owners of companies: The only two sure things in business are exits and taxes. Some companies listed here have found ways to avoid taxes. But no owner has figured out how to prevent their exit. Even if Warren Buffet is giving it a good try. Sooner or later, your ownership in your business will end. Selling your business can be scary. But if you’re prepared it can be one of the best experiences of your life.

Selling Your Business

The option most people think of is selling your ownership, which can create both excitement and terror. This transaction is usually the most valuable deal you will make in your life, and it can have far-reaching effects for the company. It is vital to make your exit plan now and revisit it over time. Once you have your idea for your exit, you can take steps to make sure you’re ready for the day it happens. Some common considerations are:

• What will happen to my business when it isn’t mine anymore?
• Will the new owners take care of my people?
• Am I getting the most money I can?
• What will my legacy be?
• Do I understand the terms of the deal?
• What will I do afterward?

This article is a two-part post on the selling process. Below, we will discuss the necessary things to consider when deciding if you are going to sell and in selecting the buyer. Our other post discusses the deal structure and other considerations for the transaction.

Types of Buyers

The main types of buyers are investor groups (like private equity), individuals, family members, the public (through an IPO), or your employees.

Investor Groups

Investor groups, like private equity firms, have developed a bad reputation. But they can be an excellent option for selling your business. If your revenue streams are stable, your cash flow margins are above 10%, and you have more than $5 million in revenue there is at least one private equity firm out there that will be willing to purchase your company. They can pay a premium for control, and there is a lot of cash sitting on the sidelines waiting for good deals to come along.

The downside is that some private equity groups have a well deserved poor reputation. This reputation is based on what they do to companies after they buy them or how they treat owners during the process. Often they will make a massive offer to get exclusivity on a deal. Then they chip away at your valuation as they make you think that you can’t walk away from the agreement. Before accepting any offer or LOI (letter of intent) that places an exclusivity period on your company, do your research on the company by calling their current portfolio companies and finding the original owners of those companies. Often it quickly becomes apparent which groups you should avoid.

On the positive side, there are some excellent private equity groups out there that care a lot about the businesses they buy. They take care of employees, maintain your legacy, and they live up to their valuations in a transaction. Signing an LOI with these groups will be well worth a more generous valuation from a bad one. Sometimes the lower offer even ends up being the highest because they do not knock down the value during the due diligence process.

Some issues you will have to deal with after the transaction, no matter which group you choose is financial reporting requirements. Most private equity groups require GAAP based accrual financials that are audited at the end of each year to protect their investors. They also usually need these reports monthly. These requirements can overwhelm accounting teams used to simple financial statements mainly used for taxes at the end of the year. Make sure you plan on providing support for your accounting team for this transition. Also, investment funds usually have pre-defined lifespans. So the group will have to sell your company at some point. It is essential to understand when this will need to happen. 

Individuals

One often-overlooked option is selling your business to individuals who can take over its operations. Individuals have access to SBA loans that can allow them to put much more debt into a transaction at lower interest rates than private equity groups. These loans come with some strings attached, including a much longer approval process. So your time to closing the deal could be much longer than with other groups.

The crucial areas to evaluate individuals as buyers are:

• Can they finance the transaction?
• How do they plan to operate the business after closing?
• Do they understand why the business successful?
• How long will you need to train them in running the business?

Family Members

Family businesses get passed down from generation to generation. It is essential to talk with your family members about if they want to take over your role as owner and leader in the business and plan for the best way to do that. If you and your family members wish for the company to stay in the family, then meet with an estate planning professional about the most efficient way to do that for your business.

The Public

Selling your business to the public through an IPO is a significant undertaking. It takes years of planning and extensive help from investment banks that are experienced with businesses of similar size and with your industry. There are significant reporting requirements as well. So you will most likely need to hire a CFO with prior experience in a public company.

Another consideration is the loss of control of the business. Once a company becomes public, then the executives and the board of the company are responsible for making decisions that are in the best interest of the shareholders, not the founders. If you are a mission-driven business, this is important to consider since your mission might end up taking a back seat to shareholder concerns in the future.

Timing is also a consideration. Selecting the right market to do your IPO in can change your valuation significantly. You may end up having to phase out your ownership stake over time instead of all at once. However, you can also pass part or all of your stock ownership to your family through your estate planning process.

Employees

An excellent option for companies with established cash flow is selling the company to employees. There are many forms of employee ownership, but the most popular is an ESOP (Employee Stock Ownership Plan). The shares are bought by the ESOP and held in a retirement vehicle on behalf of the employees. The shares are paid for by a loan financed through a mix of bank loans and seller financing (discussed more below). As the loans get paid off, the shares get allocated to the employees. 

Since the ESOP is a retirement vehicle, this option can have tremendous tax benefits. The company can become a tax-free entity once the ESOP owns 100% of the business. Another benefit for the seller is the ability to delay capital gains taxes from the sale by rolling the proceeds of the transaction into another investment asset. 

For ESOPs to be successful, the company needs to have strong cash flows to service the debt. It also needs to be large enough to spread the ownership between your employees. Since no employee can own more than 10% of the company. It is also essential to develop an ownership culture with your employees. An ownership culture helps them understand the benefits of employee ownership and drive the performance of the business.

The National Center for Employee Ownership has excellent resources for people interested in pursuing employee ownership. There are also many other forms of employee ownership beyond ESOPs. Atomic Object, a software development company in Ann Arbor, is one company that has found a different path for selling their business to employees. One of its founders documented his process in this series of posts. I suggest you read them if you are interested in forging a distinct employee ownership structure.

Strategic Buyers

Strategic buyers are other companies that get more value out of buying your company than the value of the business. They may be trying to enter new markets that you are entrenched in. That will allow them to grow the sales of their current products. Or they may have resources that can help your company grow quicker than it would for other buyers, like an established sales force.

Due to these additional benefits, strategic buyers can often give the highest offers. However, they can also create the most significant risk for the legacy of the company. One way they can “create additional value” is by laying off your workers because people already do their job. Also, merging the cultures of your business and the larger company is often tricky. This lack of alignment can create tension if the additional projected value doesn’t materialize.

It is difficult to know if any of these issues will happen when selling your business to a strategic buyer. During the transaction process, these groups will often make big promises. But, after they have control of the business, they don’t need to live up to them. If it is a company that has made acquisitions before, then visit the acquired companies. Pay attention to the moral of the staff. Also, check how many staff members were there before the transaction.

Excellent Resources to Check Out

Finish Big – Bo Burlingham’s book about how to prepare for your exit.

Darby Creek Consulting’s Consulting Services – How we can help you manage your exit.