HOW TO FIND AND SELL TO A THIRD-PARTY BUYER
Although selling to a partner or employee, a third party, or a family member have the same basic elements, the process or steps of selling to a third party are the most distinct and straightforward. The waters tend to get a little muddier with a family deal or an “in-house” partner/employee deal. People will cut corners, which I certainly don’t recommend, but because of the close relationships, there tends to be more of a DIY (do it yourself) approach.
However, sellers don’t cut those same corners in a third-party transaction. Business owners are more wary of getting ripped off and hence more willing to follow proper or traditional steps, including hiring a broker, appraiser, attorney, CPA, and a variety of other professionals to help them through the process.
Now, although on the surface it may seem that you are less likely to screw up the deal because of the support you are receiving or paying for, with more “cooks in the kitchen,” it’s actually easier to have a deal hijacked or cost you more in excessive fees.
Thus, in this chapter, I want to focus on the most common issues faced by a seller in a typical third-party transaction and help you avoid some of the pitfalls I’ve seen clients fall into over the years. First, allow me to put this process of selling a business to a third party in perspective by describing the typical steps you will go through to ultimately sell your business successfully. Figure 21.1 is a diagram to put a visual to it:
Figure 21.1—General Steps in a Business Sale to a Third Party
I understand that different businesses, buyers, and situations will drive the process. In fact, every business transfer tends to be different. There is always some hiccup or hurdle, and it’s important to expect those to pop up and not be dismayed when they do. However, the steps are generally the same in the end. Let’s talk about each of these steps in more detail.
As I discussed in detail in Chapter 18, it’s critical to start years in advance of when you may want to sell, especially, if you are going to shop your business to third parties. You’ll want to be able to put your best foot forward when the time comes. Don’t shortchange yourself. A mistake that many business owners make is that when they want to sell their business, they want to sell it NOW. This results in them selling far below the value of their business. In fact, circumstances in life can arise where the owner waited too long, and it’s now an issue of “must” instead of “want.” Please review the steps in Chapter 18 that you can take now to increase the value of your business for a potential sale so you don’t end up in a “must” situation. Doing the work now and envisioning a day in the future when you will sell can make the process much easier for you down the road.
I discussed the valuation techniques and options in detail in Chapter 19, but that doesn’t solve the problem of finding a buyer. This can be one of the biggest challenges with this type of transaction. A seller may not have a partner, employee, or family member with the will or interest to step up and buy the business. Thus, you have to take on a sales role you have never experienced before. You can put a great price tag on your business, and it could even be a great deal, but how do you find that perfect buyer who can pay the price and still not run your business into the ground?
To frame that question, let’s first consider the real issue here: many business owners don’t want to start advertising that they want to sell. Doing so can cause serious problems with employees or key management personnel who don’t want to deal with a buyer and will jump ship out of fear before you could even present an acceptable buyer to your internal team. Yes, you are going to have to “sell” the buyer to your employees and management as well. This is something the third party is also going to require (and it’s typically in the purchase and sale contract)—that you help make it a smooth transition and minimize the loss of any staff.
You also may have the problem of vendors and customers getting nervous and jumping ship if they hear you might be selling. You want to present the narrative of who the new buyer is at the right time and not get blindsided with a rush of social media or rumors that you are selling for some terrible reason.
RANDY LUEBKE
Keep in mind that when you sell anything, both parties need to benefit. Often, it’s tempting to see things from our own perspective and become unrealistic. It’s not easy to become unattached, unemotional, and objective when selling your business. That said, just ask yourself this question, if I were shopping for a business today, would I be likely to purchase my business with the terms I am offering? How do you judge fairness? I have a story that explains it very well. I don’t recall where I first heard this story, but I’ve told it many times. It goes like this: Two boys want to share a candy bar. Each of them wants an equal share, of course. The wise parent overhears their conversation and tells the boys, “One of you gets to cut the candy bar in two. The other gets to pick which half he wants first.” Problem solved, right? If it’s a fair deal for both of you, then that is the best deal. That said, often-times that is not the situation and one person has an advantage over the other. Perhaps the seller needs the cash. Perhaps the buyer has to complete a 1031 exchange or face a huge tax bill. In both situations, the motivations are unequal, and the candy bar will not likely be split equally. In fact, it does not have to be split equally. That said, when it comes to a situation like this, here is my rule, “Whoever wants it most, loses.” Another way to look at this is, “Whoever has the most leverage, wins.”
Bottom line: it is safer to try to keep your plans to sell as confidential as possible with your employees, customers, and vendors. I’ve seen a number of clients hijack the deal themselves by having a “big mouth” and talking about selling. You may be excited about it, but that doesn’t mean everyone else will be. Take your time, be very “tight-lipped” about the topic, and you’ll know when the time is right to tell key people. Don’t brag or complain that you are anxious to sell. It’s not professional, and again, it can screw up your deal in ways that could surprise you and the potential buyer you are courting.
So, once you have committed yourself to silence and put on a poker face around the office, how do you find a buyer? First and foremost, don’t be dismayed. I think you have several great options that could surprise you as a qualified buyer. Let’s walk through some of the options you have for finding potential buyers:
A business broker. Yes, just like realtors help you buy and sell a home, there is a robust business broker community out there you may not have even been aware of. These are very skilled and qualified agents, for lack of a better word, who can help you find a buyer and act as a huge resource to you throughout the process. Yes, you will pay a fee for the service just like with a Realtor™, but it can be totally worth it. There really isn’t a Zillow© site for business sales; so start researching companies on the web that could help you in your particular industry, interview several before choosing, and make sure you meet offsite and never at your place of business. Again, be incognito.
A vendor or supplier. You may be shocked to discover that a vendor or supplier could be interested in expansion and getting into your line of business. Again, you have to be careful on how you approach them, but you probably have a contact at most of these organizations that you could “swear to secrecy.” Such a contact would be appropriate to float the idea by to see if it’s worth having more in-depth discussions. If you do start having discussions, make sure you sign an NDA early on (discussed in Chapter 18). Privacy is again critical, but your company data and security are even more important.
A competitor. It could be tricky to approach them, and it might show weakness or give them a competitive advantage with the knowledge you might be selling, but everyone’s business is different. It could be a great strategy for you to approach a competitor if the political climate is appropriate to do so.
In Chapter 18, I discussed the disclosure process in detail and the NDA (nondisclosure agreement). These elements are vital to your process, but I think it’s important to also address something called due diligence. In this case, that means you understand your potential buyer will be doing their due diligence by asking to see all documents and records associated with your company. Don’t be shocked when this happens and a buyer wants to see everything about your business, and I mean everything. You are probably asking a pretty penny for your business, so it should be expected that the buyer will want to double-check all your data and assertions.
In actuality, you prepared for the due diligence step and process back in the preparation phase we discussed in Chapter 18. You should be excited to show them how cool and amazing your business is! Show them the details of your normalized EBITDA, your systems, procedures, and intellectual property. With a proper NDA, this is your time to let your business shine and show why you are asking so much for your business. Don’t be intimidated by the due diligence phase—embrace it!
Now, it’s time to negotiate. I bring up this topic as an important step and process because of the competing issues facing a buyer and seller. Because there are many moving parts to a sale, negotiations can hinge on any of hundreds of complex topics. For example, let’s say you want to do a stock sale for a better tax result. Your buyer may want to simply buy your assets so depreciation is a possibility. Then, if you do settle on an asset sale (which is most common in small business), then how are you going to allocate the purchase price to different assets? The buyer and seller will generally not be on the same page in such a scenario. That’s just one example of how the structure of a deal could affect the negotiations and outcome. Everything—and I do mean everything—is negotiable.
Now, you may have an asking price or you and the buyer have agreed to have an appraisal, the structure of the deal can be just as much a negotiation as the purchase price. Unless you negotiate on a regular basis in your business already, I suggest you read a number of good articles and/or books on negotiation before going into this process—it certainly won’t hurt. You are negotiating your financial freedom!
This can also be the phase of the deal where your advisors, and especially your lawyer, can be worth their weight in gold. A good lawyer can close the deal and find a way to make it a win-win for everyone. A bad lawyer can screw up the deal so fast it will make your head spin. Style and personality will play a big role in this process. Make sure you are extremely comfortable with your attorney and the role they are going to play.
RANDY LUEBKE
One of my favorite stories is one that Jon Huntsman, Sr., recounts in his book Winners Never Cheat: Even in Difficult Times (Pearson FTP Press, 2008). In 1986, after lengthy negotiations with Emerson Kampen, chairman and CEO of Great Lakes Chemical Co., there was an agreement to buy 40 percent of a division of Huntsman Chemical for $54 million. A handshake between Mr. Huntsman and Mr. Kampen sealed the deal. After seven months of lawyers haggling the details and drafting documents, they were finally ready to sign. In the interim, the price of raw materials had decreased substantially. Mr. Kampen called Mr. Huntsman, saying the price of Huntsman Chemical had increased greatly during that time and that he would pay half the increase in value. Huntsman’s answer was no. Kampen said it wasn’t fair to the Huntsman Co., but Huntsman stuck to his handshake agreement. We need to understand how important it is to keep our word and negotiate with fairness and integrity. Don’t let your representatives in a deal sacrifice your character to gain advantage or get a few more dollars. It’s never worth it in the end. Huntsman summarized, “We will be remembered for truthful disclosures and promises kept.”
Ah, the part lawyers love. I joke about this for a reason. I have truly been shocked at the price lawyers have charged for helping to conduct the sale of a business. It is sometimes highway robbery (I guess that doesn’t surprise some of you when I bring up the lawyer topic), but seriously, shop around to find the right lawyer to write up the docs.
Watch out for attorneys who charge large flat fees or a percentage of the deal because this is their expertise and what they do. You can certainly find excellent business attorneys that will charge hourly and be accountable for all the time they spend. Just this past year, I was shocked to see a lawyer charge nearly a six-digit fee for a generally simple business transaction where an owner only sold 10 percent of his company. Yes, there were a lot of dollars that changed hands, but that was no reason for the excessive fee in my opinion.
So, who is the right lawyer? Regrettably, your family attorney may not be the best to handle the transaction. Although you trust them and they won’t rip you off, they may not handle purchase and sale agreements on a regular basis. There are a lot of tax issues and legal exposure topics that just aren’t common in other areas of the law. Try to get a business attorney to handle the transaction, and make sure they have a strong tax background, or ensure that your tax advisor is at the table at all points of the discussion.
I also want to summarize the two primary options small-business owners use in the documentation to transfer and sell their businesses.
Asset Purchase Agreement
This is probably the most common method used to sell a small business because it allows for a seller to classify some of the sale as “goodwill” and recognize capital gains for tax purposes. Conversely, the buyer is able to get “stepped up basis” on a lot of the assets and start depreciation and amortization to also benefit from some tax planning. In other words, the buyer can begin to “write-off” a lot of the purchase, even over time, and thus create expenses from the purchase to save taxes in future years. The foundation of the transaction is the Asset Purchase Agreement, but there can be a host of ancillary documents like the Promissory Note, Noncompete, Nondisclosure, Security Agreement, Lease Agreement, and Consulting Agreement, just to name a few.
Stock Purchase Agreement
This type of transaction is more rare in the small-business world and far more common on Wall Street and with large companies. Yes, for the seller, a stock purchase is fantastic for tax planning but it is typically a disaster for the buyer—at least to a small-business owner. As such, this isn’t a typical transaction for me or my clients. Nonetheless, it’s important to be aware of this strategy because during negotiation, it can impact the purchase price if thrown on the table. Of course, all the other ancillary documents are similar to the ones I listed above that are oftentimes included with an asset purchase agreement.
As I indicate above, there can be competing interests between the buyer and seller regarding which method to use for the purchase. This can certainly make for a more robust negotiation regarding the price to be paid for the business. Figure 21.2 is a diagram to illustrate the pros and cons of each method.
Finally, and most importantly, make sure you understand every line of the contracts and agreements. The primary purpose of the lawyer is to draft the agreement and explain it. If you don’t understand something, stay at the table until you do. Remember—you are paying them, so get your money’s worth.
Figure 21.2—Asset Purchase versus Stock Purchase
Believe it or not, closing and transfer of assets don’t always happen on the same day. In your situation, it may be as easy as tossing the new owner the keys to the front door, but that’s not always the case. Inventory, equipment, and client relationships may need to be carefully handled in the transfer. This is what I alluded to earlier when it came to employees, vendors, and customers and letting them know when and how the purchase will take place at the right time.
You will want to work closely with a buyer to make sure the transition is handled in the most appropriate way to create a win-win. I suggest you work really hard at being a politician and diplomat after closing, even if you aren’t paid a consultation fee. Don’t run out the door and jump on a plane to Bermuda. The buyer’s ability to pay is oftentimes directly related to the ongoing success of the company. Help them to succeed without giving away too much of your time, but ensure they are off and running smoothly. Also, this is your legacy, after all. Help cultivate it for success with the new owners. Your knowledge of your business is limitless in value—share it with the new owners so they can continue your tradition of excellence.
Typically, the closing will be at an escrow office or title company, but they can also be handled between law firms, the procedure and goal being that the “keys” to the business are handed over at the same time the money/down payment is delivered and documents signed. Does this next point even need to be made? Yes, it does because I see a case like this every year. Do not, and I mean do not, take money or give control of your business until everything is reviewed, approved, and signed. It shocks me how many people start the transfer of a business on a handshake. I wish everyone would keep his or her word, but it also is a situation of memory loss. Many of these situations turn into selective memory issues and a “he said/she said” argument resulting in a lawsuit. Regrettably, you can’t trust anyone. I’m sorry, but we live in a different day and age. Protect yourself, your assets, your business, and your legacy.
You may think after closing and after the assets, customer lists, equipment, and keys have been handed over to the buyer that the deal is complete. However, typically that is not the case, and it results in ‘tail’ terms, or agreements and obligations after closing. Oftentimes, in a small-business purchase and sale, the owner is asked to stay on board for a few months or even years. This is typically in the form of a consulting contract, and I think this can be a really good fit for both parties.
As a prior owner, you can typically set up a new S corporation for the earnings you will earn as a subcontractor and can keep deducting a lot of the personal business expenses you have become accustomed to. It is also a good emotional transition. Leaving the business, believe it or not, can be a difficult transition. The business was your baby, and you want to make sure it’s in good hands. Starting a new consulting company (even if the only business you will consult with is the one you just sold) helps you move on and focus forward while continuing to influence the original company you worked so hard to build.
Also, the buyer can really benefit from a consulting contract with you since you are the prior owner. It can help in the transition with employees, management, vendors, and certainly customers because you will be a familiar face upon whom they can call. Of course, boundaries and duties need to be clearly defined. It’s not uncommon to have miscommunication regarding the expectations for this role on both parties. Prior owners sometimes try to do too much and step on toes; then, in other instances, they do too little and think the consulting contract is simply another payment for the sale of the business. Work with the new owner to create a set of expectations and role responsibilities (and boundaries) that satisfy both of your needs.
RANDY LUEBKE
If you sell your business, you owe it to yourself, your clients, and the buyer to do everything you can to ensure its continued success. It may be difficult to be inside your business and watch someone else make all the choices and operational decisions you once made. Do your best to stand aside and let it happen. Be helpful, be supportive, but most importantly, be quiet if at all possible.
Other “tail terms” include the seller signing a noncompete agreement to protect the buyer from the seller turning around and starting a competing business. Also, if there is a Promissory Note to be paid by the buyer (which is typical), the seller should have the stock of the company as collateral and regular reports from the buyer as to the condition of the company’s finances. It’s very common that documentation will allow the seller to step in and take over control of the business if the buyer defaults on the Note or starts to run the business into the ground.
We’ve covered the basic steps of preparing your business for sale to a third party, and it all looks good in theory, right? It does. That said, we all know that when humans are involved, so remember that anything can happen. Even buyers and sellers with the best of intentions can fall victim to sloppy preparation, loose contract language, and general misunderstanding.
In summary, books, classes, entire careers, and businesses are built on this important transaction of the purchase and sale of a business. I realize this book, and even this chapter, is a 10,000-foot look at the process, and I humbly hope that these thoughts and points on the sale of your business to a third party are helpful.
TAKEAWAY 1—Have backup or contingency plans in case any deal to sell fails.
TAKEAWAY 2—Vigilantly guard your company information and always use a nondisclosure agreement (NDA).
TAKEAWAY 3—The culture of the company may be diluted, changed, or erased once you’re gone. Be prepared for a new sheriff in town once you’re gone. If you want some control after the sale, negotiate a consulting agreement so you can shepherd the business through the “new owner” phase.
TAKEAWAY 4—If you don’t receive the majority of the cash upfront, make sure you have protections in place to retake control of the company if the buyer can’t stay current with the note.