A Better Way to Sell Your Business

A Better Way to Sell Your Business

The story is familiar – a business owner is getting older. He would like to sell the business to which he has devoted so much of his life and retire to a sunny climate while he can still enjoy it. Although the business is profitable, running it requires a great deal of experience and hands-on attention. He has had offers from time to time, but the bids have been too low to warrant consideration. One way for a buyer to offer a price more acceptable to the owner is a variation on the leveraged buyout that was once so popular for bigger businesses. In this first part of a two part discussion, the purchase proposal is viewed from the needs and point of view of the buyer. The upcoming second part of the discussion, A Better Way to Sell Your Business, focuses on the seller’s needs, perspective, and a how to buy a company with no money down.

Common practice

In a typical situation, the buyer (often one or more or key employees or a younger relative) has little or no money of his own to put into the business. What the buyer does have is the ability and determination to learn to manage the business as quickly as possible and to keep the enterprise profitable and growing. Typically, where the buyers are current minority owners or key employees, the learning curve will be dramatically shorter.

The seller and the buyer both seek an arrangement in which:

• The business eventually gets transferred to the new generation of leaders;
• The seller is fairly compensated for the business that he or she has nurtured since its inception; and
• The buyer is able to keep the business running profitably in order to generate sufficient profits to pay the founding seller and build additional capital for future growth.

How to Make Ownership Transition Work for All Concerned

With the cooperation of the owner and proposed buyer, a full set of financials for the business is prepared. The financial statements for the business should include a current balance sheet, sales and earnings statements for at least the last two years, revenue and cost projections, and a detailed list of “bankable” assets (including inventory, receivables, real estate and similar hard assets). Work in process should be included as part of the package.

The purchaser and seller work out an agreement, subject only to the receipt of financing, in which the buyer will acquire the business, using a portion of the profits of the business to pay the purchase price and, where a down payment is required, bank financing is used to make a down payment to the extent of which the buyer lacks personal finances and family resources are insufficient. If necessary, the seller is a guarantor for all or part of the bank loan or other outside financing source.

The transition

To ensure the business continues to be successful, so that there will be enough future profits to pay off the full selling price, the original owner agrees to stay with the business long enough to fully train the new management and pass on existing customers to the new owners. Founders are generally not motivated to cut corners. It works to their benefit to assist the new owners, if for no other reason than financial self-interest. New management benefits from the reputation, professional good will and experience of the original owner.

If the buyer is not able to fully convince the seller that the buyer will be able to pay the full purchase price over time, the parties may agree to test whether this type of transaction will work. The seller may give his new “partners” a contract that calls first for a trial or transitional period to develop the new relationship. That way, if the arrangement does not work out, the contract allows the owner to rescind the agreement, but can allow for some payment to the buyer for the time and expense, using a short term buyout “call” that the seller can be given on the equity being purchased by the buyer: a six month option to pay the buyer back and opt out, for example. If the arrangement does work out, the opt-out period expires, and the buyer is secure in the knowledge that the transaction has fully closed. The equity transition can also be structured in several different ways, so as to consider tax and other considerations of the seller, further discussed in Part 2 of this article.

Another benefit of this sharing of responsibility is that the best people can be attracted to stay with the business, they’re motivated to remain with the business, and the newly enfranchised management talent has added incentive to take a more proprietary and aggressive role in the growth of the business.

Another Way

There is also now the new possibility of funding the transfer through crowdfunding.

A variation on the above arrangement is where all or a substantial part of the initial funds for the purchase come from the new owners or through third parties, other than a bank. A candidate owner may be able to avoid bank financing by raising some or all of the initial purchase payment from other qualified investors in return for both interest on the loan and an equity “kicker.” Generally, the funds are provided by business partners, family members or friends. Securing the funds could also be arranged through brokers, who usually charge between 5 and 10 percent commissions. There is also now the new possibility of funding the transfer through crowdfunding. In any event, the buyer will still need to gather the detailed information, financial statements and business description and projections that any experienced investor or lender would require.

However such arrangements must always be highly sensitive to state blue sky laws and federal securities law.

Traps to Avoid

It is important that the key employment, stock purchase and option agreements be drafted carefully and not contain errors or loopholes. In order to avoid or anticipate possible disagreements that could develop between the parties, the legal documents should be drafted by experienced counsel with input, where needed, from experienced accountants.

Nevertheless, disputes do occur, even among reasonable and well-intentioned people. This type of transaction works best when both sides want it to be effective-and where the written agreements protect both sides in the event of a dispute. Experienced counsel can recommend whether or not to include an arbitration clause in the documents.         

However, this is only the beginning – check out the follow-up article: A Better Way to Sell Your Business Part 2.