Top 10 Things to Know When Selling a Small Business
Keystone Business Ventures
Selling a small business can be a daunting task. Especially if you are not trained in business valuation or have any prior experience in the field. There are many things an owner should know when inquiring about selling but we will break down what we believe are the top ten things you should know when selling a small business. Here are 10 things to know when selling a small business!
- THE BEST TIME TO PREPARE IS YESTERDAY
Prepare, prepare, prepare. You can never do too much research. The first and most important item on our list is to prepare the business for sale. You may wish it was as easy as a public listing and having a venture capitalist swoop in, but that is not often the case. If you need to sell your business without a lot of legwork, be prepared to make compromises, especially on the price. To get the best price possible, it is important not to rush the selling process. If you rush through it, you will have less time to formulate and analyze counteroffers. If you tell your buyer, you need out as soon as possible, you will get low-ball offers since they know you prioritize your time over the amount. The buyer will be less likely to negotiate because they know they have the upper hand.
It is important not to rush through things as the sale will take longer than expected. Besides the benchmark, there are many steps to finding a buyer. You must be content with knowing that it may be a few years until you are finished with your business’s responsibilities from the point you first decide to sell.
That is why it is important to prepare. You want to walk into negotiations with a proven value that you know the business is worth. When you get a fair deal and want to sell, you will not regret the sale. If both sides stride for a fair deal and not the best deal, you can walk away knowing you received the most you could for your business. If this is not the case, you may regret your sale like 3 of the 4 sellers according to a study by PriceWaterhouseCoopers.
Even if you do not have intentions of selling, it is always a good idea to have a grasp on the business’s current balance sheet and revenues. To learn more about why you should prepare to sell even if you are not going to, click (here) to view our other article on this topic.
- REVENUES DO NOT EQUAL SELLING PRICE
A common misconception about value is that “my business created one million dollars of revenue last year, so my business is worth one million dollars.” That is not usually the case. Revenues and selling prices are rarely a 1:1 ratio.
You must remember that the value of anything is the present value of its future cash flow. Simply put, the value is not based upon only the business’s past sales record but also its assets and future opportunities. Without future growth opportunities, the potential buyer will not be interested because it is tough to expand and predict opportunities for the business.
- GOODWILL ASSOCIATED WITH THE OWNER, NOT THE BUSINESS
The value of the goodwill associated with the business may impact the value. First, it is best to define, what exactly is goodwill. For the purposes of this article, we will define it as the value beyond the assets. To create this, you need an excess of cash flow. When a company pays more than the value of the assets, they will need this excess cash flow to cover that value.
Sometimes it is possible that the customers come to the business because of you. In this instance, people shop at your business to support you, not the business. It just so happens you have a product or service they want. This is an important distinction since if you are bought out, the new owners want to make sure they have a business and not a job. They may want a non-compete clause in the deal to make sure you will not start a competing business in the same industry near them.
In essence, is your business just you? If the business does not have any value beyond you, someone is just buying a job and maybe a piece of real estate rather than a business. This is the value of transferability. If someone else can run your business without you, it becomes more valuable. To maximize the value of goodwill, it will be vitally important to have a business rather than a job.
- THERE IS MORE TO SELLING THE BUSINESS THAN JUST SELLING THE REAL ESTATE
With the sale of a small business, real estate is often the most valuable asset. It is beneficial to own your land, so you have control of what happens on it. If you own the land, you may not need to lease or rent to yourself. You also don’t have to worry about moving or a bad landlord since you own the property. However, there is more to the sale of a small business beyond the sale of real estate.
It is not always beneficial to own the land. Sometimes it makes sense to lease. If you are not planning to make your location your permanent location or are looking for a spot near a major roadway or intersection, leasing is a viable option. Real estate is expensive so it may make sense to lease a unit of a strip mall in a highly trafficked area if you are unsure of your long-term plans or are just starting your business.
It is important to make sure to transfer a variety of things to the new owners. One of these are the current plans for guidance, goal setting, and success. You must make sure that if your company has them, the new owners receive the marketing plan, financial plan, updated financial statements and tax returns, clientele databases, and supplier contacts. Having all of this is part of the value of transferability discussed earlier. Something else to consider is to keep the previous owner on your team in a part-time consulting role to ensure success following the transaction. You can outline their specific duties in the contract to ensure they will not be full-time, but also have time to help with what you think is best.
Regarding the plans, why would a business want to buy out someone who does not have any roadmap to growth? There are a few possibilities here. An asset sale is where the business liquidates its assets for cash to pay off its liabilities and the assets go to the new buyer. After this, there is often little value left, so the business will close. Sometimes companies want to control market share. Other times, they may just want your real estate. You may have a good building or a prime location, both of which have value to a buyer. Lastly, there are preferential leases. Someone may want to have their business in that location so they can pay lower rent along with many other reasons.
It is important to plan, but also to pass on those plans so the new owner has guidance on how to market, budget, and pay off its outstanding debt. Being able to have a legible and accurate income statement, balance sheet, statements of cash flows and stockholders’ equity will show financial transparency. Having a steady cash flow will allow the owner to continue operations rather than having to rebuild them.
- A BUSINESS CAN BE WORTHLESS
There is the possibility that you own a business that does not have any value. A buyer is looking for something that has the potential to become more profitable than it is now. Throughout the valuation process, it may be possible that beyond the value of the real estate and other assets, there is nothing to sell. Although ROI is not a measure of growth, it is a good indicator to see if it’s possible that a worthless business can grow. These can be “hobby jobs” because there is enough profit and cash flow to keep the owner afloat, but there is little if any at all, room for growth. In this case, it will just take a long time to recoup your initial investment.
A company can perform so poorly that it may be a better idea to declare bankruptcy than to continue operations. Sellers looking to sell a business like this may have more liabilities than the value of their assets. If they sold all their assets and stopped borrowing, they would need a few years to pay off debt. Nobody wants to buy a business with a poor financial track record and take on debt without a clear plan of how it will get paid. The prospective buyer will not use their personal funds to pay off debt on a business that they do not yet own. If this is the case, it may be possible that the business has a negative value.
- FINDING A BUYER IS JUST STEP ONE
Having a buyer already in line would make this process a lot easier, but in the case of most businesses, when they look to sell, they do not have a prospective buyer lined up. Finding the right buyer is a lengthy process so here are some things to keep in mind. Even if you are set on selling to family, you should always consider a third-party sale in case plans change.
- Someone who is looking to purchase
A qualified buyer should be one who intends to buy. There are many people out there who are just looking. They may want an idea of what businesses in your industry are worth and may consider buying a different one, so they want a comparable.
- Someone with the motivation to purchase
You also want one with the motivation to complete the sale. With a high-risk and high-dollar sale, you want someone willing to spend their money and finish the deal.
- Someone with the financial capability and the right motivations to purchase
You also need someone who has the financial wherewithal or has access to it to be able to take on debt and complete the purchase. You need to have good credit. These buyers want to buy. But, more importantly, they do not operate in your direct competitive market. It would not be ideal to have someone from one of your direct competitors learn about your business to use against you.
- PLAN FOR YOUR LIFE AFTER SELLING THE BUSINESS
Having a plan is a key step in the life of the business and your next steps as an individual. Once the business is completely out of your hands, you will need to find something new to occupy your time. Therefore, knowing your personal goals outside of the business is important.
An owner wanting to retire is a common reason for selling a business. Most of their wealth is in the business so they cannot retire until they cash out on their hard work. However, once the selling process is complete, the owner can now enjoy the fruits of their labor. You have kids or grandkids? Selling gives you more flexibility to spend time with them. Maybe you want to move? It’s common for retirees to spend their lives outside of where they grew up and ran their businesses. This is your chance to live in a different town or state or potentially move closer to family if they have also moved out of the area.
You will also have the chance to indulge in your hobbies. Everyone always has an interest in something else besides their business. Are you a sports and entertainment fan? You now have more time to go to games, concerts, movies, and performances. Take advantage of that.
There is also the possibility that you are not selling to retire. You want to start another business or try a new career path? This possibility is also common among sellers. Having ambition in other areas of life is always a bonus. If you can prove to the buyer that your business does not have any structural problems and you are selling because of personal ambition, the buyer may accept that as a valid reason for sale.
Regardless of your next steps in life, make sure you plan for what is next. Your business took up most of your time, and you now can find other hobbies that you enjoy, in which you can indulge. You have earned time off after years of demanding work.
- BEWARE OF THE TAX IMPLICATIONS
Remember, the value that is placed on the business is not necessarily your take-home dollar figure. There are several possibilities for tax payment depending on the outcome of the sale. When looking at business taxes, there are two important terms to understand, cost basis, and capital gains.
A cost basis is the price of the original asset or investment for tax purposes. This number is used to calculate capital gains, which is the difference between the original price and the market value.
You will be taxed on the gain of the sale from the original cost basis. You won’t be taxed on the cost basis since you already paid tax on that. It is also important to keep in mind that the capital gains tax rate could change upon a bill passed by the legislature. To learn more about cost basis and capital gains, refer to this article by Investopedia.
- HAVING YOUR BUSINESS LISTED FOR SALE MAY IMPACT THE CURRENT BUSINESS
Another important thing to know when selling your small business is that once you list your business for sale, your current business may be impacted by the listing. Especially if there is a public listing, your business for sale can be known by all, including your customers and suppliers. With a public listing, it may be harder to lock in long-term contracts due to the fact the supplier is unsure if the entirety of the contract will be fulfilled. However, with a public listing, you will be able to reach more potential buyers more quickly.
Even with a private listing, it is still possible for your business to be impacted by looking to sell. Some businesses may request to look for buyers outside of a certain area. Since word-of-mouth travels fast, starting to look for a seller that is based in your current market may allow for your competition to swoop in and make it harder for you to operate in the instance that the business does not sell in a short time frame. Depending on the seller’s preferences either one of these is possible, however, it is important to keep in mind that there is a risk involved with the sale, even if it is private.
Business brokers will help you make this decision. They will recommend keeping in private, so your competitors do not know you are on the market. They also have a better understanding of the legalities and processes to get a fair value for your business.
- THE MOST RECENT YEARS ARE THE MOST IMPORTANT
Buyers want to pay the value of the business now, not a decade ago. This is important to show the business is priced accordingly. Sometimes it takes a while to sell so it is important to not only be focused on selling but on continuing growth as well. When evaluating the company’s financial position, it is common to look at the last 3-5 years of statements. That means if your company was founded a decade ago, the first five years or so will be of minimal value and importance, especially if the company is performing well. A buyer will care about how much the assets are worth now and projected to grow and how much debt and other liabilities are on the books.
It is important to focus on growth because if you don’t sell, you just grow your business and, if you sell, you may get more money due to the higher value.
There are lots of moving pieces when looking to sell your business. From preparing to sell to understanding your financial situation to finding the buyer, this complex process is not easy to navigate. At Keystone Business Ventures, we will help you through this. As a company that specializes in mergers and acquisitions, we will guide you through this process to get your business sold. If you are interested in learning more or have any questions, feel free to reach out to us at firstname.lastname@example.org or call us today at 570-322-7700.
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