Nearly 80% of small business owners plan to sell their small business to help fund retirement, yet less than 20% of small businesses put up for sale actually sell. Additionally, 85% of small business owners have not developed a plan to exit or transition their business.
So where do you start? What exactly is a transition or exit plan? What steps should you take to prepare to sell your business? This guide will provide an overview of steps you can take, options you can explore and the type of resources you may need.
Reasons to Sell a Business
If you own one of nearly 32 million small businesses in the U.S., selling your business is something you may be actively considering or have in the back of your mind. Selling may be part of a longstanding plan or the result of circumstances related to the economic impact from COVID-19. Most owners start preparing to sell their business for one of the following reasons:
- Approached by Buyer – If you own a profitable business that has been in existence for more than five years, you may find buyers interested in acquiring your business. This may include individuals seeking a career change, someone moving to a new location and seeking a source of income or investors that are buying several businesses like yours to gain efficiencies.
- Divorce – If you own a business with a spouse and are planning a divorce, you may need to consider selling the business when dividing assets. According to the American Bar Association, “the first determination that must be made with respect to a private business in a divorce is whether the business interest is considered a marital asset or separate property.”
- Personal Health – If you are in declining health or dealing with health-related issues, selling your business may be necessary. Running a business is hard work and doing so while in poor health not only hampers your business, it can add to your health issues. The time to sell is before things get serious with your health as buyers want a business that is running smoothly and may want you to help ensure a smooth transition.
- Retirement – It may be time for you to step away from the business and enjoy the rewards of your hard work while your business is still thriving. This is good news for you and the right buyer, and the proceeds from a sale can help fund your retirement.
5 Steps to Prepare for a Business Sale
Selling a business takes preparation and planning and we will provide more detail on each step below, in short consider the following.
- Develop a Plan – Nearly 85% of small business owners do not have a plan when it comes time to sell their business. While it is common to have a business plan for your business or a retirement plan that outlines the steps to achieving your goals, developing a plan for exiting your business may be something you have not gotten to or simply viewed as important. Let ExitGuide or a professional help you develop a plan that sets goals and timing, prepare the information needed for selling your business or another process for exiting. A good plan will make the process more efficient and less stressful and clarify what you want to achieve.
- Get Finances in Order – Developing a plan starts with having clear and accurate financials. Ensuring your financial records are up to date and historically accurate is a requirement. If you manage your own books, consider engaging a CPA to review them and ensure you can provide a potential buyer with accurate statements. Bookkeeping software, such as Quickbooks Online or Xero, generate reports including balance sheets, income statements and countless other statements to help ensure a smooth process.
- Small Business Valuation – Research shows that over 95% of small business owners do not know what their business is worth, which creates a serious disadvantage when negotiating with a prospective buyer. If you're in the very beginning stages, ExitGuide offers free tools to find your business' estimated value. Once you are serious about selling or exploring other options, there are financial professionals that can help with standard methodologies to value a business. You will need accurate financial reports and records to produce a valuation.
- Securing a Potential Buyer – Much like the business plan you wrote at the start of your business identifies target customers, your exit plan should identify potential buyers. This may include a member of the family, a current employee or group of employees, a professional investor or a yet to be identified individual. While word of mouth may attract interest, it may not result in getting the best price for your business. If you consider engaging a business broker, it is crucial to understand if they have worked with businesses like yours, how they plan to market your business and the fee structure. A broker should maximize the sale price more effectively than your own efforts. Often times a broker will prepare a prospectus which is a summary of the business, key financial metrics, customers and employees.
- Complete Due Diligence – A good plan helps you organize financial records, legal agreements and additional information related to running your business. This will be helpful when a qualified buyer needs to dig into the details of your business starting with reviewing financial reports including current and previous years. It is also common for a buyer to review leases, contracts and other key legal documents.
Step 1: Develop A Plan
Whether you develop your own plan or get help from ExitGuide, a written plan will cause you to think through key issues as well as organize the necessary information. Going through this process may even change how you think about exiting your business. A strong plan will help you consider:
- Do you have a designated successor, a member of the family or current employee that might be interested?
- Do you plan to assist in transitioning the business to a new owner? If so, what type of commitment can you make?
- Do you plan to sell the business to a third party? Have you identified the buyer?
- Is the business generating enough cash flow to attract qualified buyers?
- Is your business in an industry that is growing or shrinking?
- Does the business own substantial assets that may attract a buyer interested solely interested in buying the assets?
- Describe the potential buyer(s) and if possible, provide specific names. Are they in a position to purchase your business or the assets?
Selling a business you started or have been operating for a long period of time can be very emotional. It is important to recognize this as well as consider how this may impact the timeframe. Many owners have vast amounts of “institutional knowledge” about how the business runs, how to effectively manage different employees, relationships with important customers and suppliers — all of which needs to be passed along to a new owner to ensure a successful transition.
Step 2: Cleaning Up Your Business Finances
Before you provide a potential buyer financial statements or any confidential information related to your business, it is wise to have both parties sign a Non-Disclosure Agreement (NDA). When it comes to NDAs, there are one sided agreements that are suited when one side is providing nearly all of the confidential information. Mutual NDAs provide equal protection for both sides, a buyer may want the same protection if they are going to share information about their financial resources and ability to buy the business. Here's what you should be prepared to provide:
- Financial Statements - A buyer will typically want three and sometimes five years of financial records. Generating these reports and statements from software like Xero or Quickbooks Online is straightforward, provided you or your bookkeeper has been diligent about keeping things current. If you think this is not the case or you are not sure, it is wise to engage an experienced bookkeeper or CPA to review your records and make updates and corrections.
- Balance Sheet – This is a report that summarizes your company's assets (what it owns), liabilities (what it owes) and owner or shareholder equity, at a given time. Assets may include real estate like a building or warehouse and liabilities may be the amount left on a loan on the real estate. If you plan to sell the assets owned by the business instead of the business itself, the balance sheet will be used to determine what proceeds you can take out of the business.
- Tax Returns – In most cases, a small business owner will file a business and a personal tax return. Keeping your business and personal expenses separate makes filing a return easier and provides a more accurate summary of your business. You will likely need at least three years of tax returns for your business and in some cases five years.
Step 3: Determine the Value of Your Company
There are a number of ways to value a business depending on the goal. A buyer will want to understand the future income potential of the business under their ownership, or you may want to value the business purely on the assets if entering into an Asset Purchase Agreement. While some CPAs may have experience with valuations, it is more common to hire a specialist such as a Business Valuation Analyst or Business Appraiser who not only brings experience to the table but access to data, including comparable businesses.
How to Value a Business for Sale
When it comes to the nuts and bolts of small business valuation, there are four commonly used methods:
- Capitalization of Cash Flow Method (CCF) – This method assigns a value of the expected cash a new owner will generate over a period of time, typically one year. To determine the value, use the annual cash flow generated by the business after removing the owner salary then then divide that over the same period of time. If you take two years of cash flow then divide by 24, one year by 12 and so on. This is used for stable businesses that have several years of consistent cash flow.
- Discounted Cash Flow Method (DCF) – Oftentimes the revenue and expenses for a business fluctuate, which means cash flow is inconsistent and more difficult to forecast. This is when an appraiser will use a Discounted Cash Flow Method to value a business and will use software and tools to help run different scenarios. The basic principle behind this approach is that money today is worth more than it is in the future when compared to other alternatives. Since these calculations are more complex, hiring an appraiser or valuation analyst is highly recommended.
- Adjusted Net Asset Method – This often mirrors what is on the balance sheet and is a matter of subtracting total liabilities from total assets. If you own property or equipment, these are assets that have an assigned value on the balance sheet. Any loans, debts or other payments due to vendors are liabilities that must be subtracted.
- Seller’s Discretionary Earnings Method – This method is popular with interested buyers because it focuses on the income potential they can expect should they buy the business. This approach looks at the amount of cash it takes to run the business with the owner’s salary removed, as well as things like health insurance and some expenses that are seen as adjustable. A new owner may wish to take a larger or smaller salary, implement a new healthcare plan for employees or adjust some other expenses that are not considered essential to operating the business.
Step 4: Securing A Potential Buyer
It’s easy to get ahead of yourself and jump straight to this step. But before embarking on finding a buyer, developing an exit plan is essential. This should include a valuation that provides a range for what you are seeking as far as an asking price from interested buyers. ExitGuide provides a simple way to put together a plan that helps owners by providing a valuation as well as addressing questions to determine who is the right buyer, preparing necessary documents and having a timeframe to move through this process efficiently. A written plan can help save time and money and make the process less stressful.
Once you have a plan in place and are ready to sell, you may decide to take a for sale by owner approach. This can save fees charged by a business broker which typically range from 8% to 12% but it also requires more time of an owner. A business for sale by the owner makes sense when a qualified buyer is interested in the business and is willing to pay an asking price that is based on some form of a valuation. This process is likely to require each side hire an attorney to draft and come to terms on a final agreement, as well as a CPA to review the financial statements.
Hiring a Business Broker
Running a small business can be time consuming and leave little time for an owner to manage the process of developing a plan to engage interested buyers and identifying qualified buyers and negotiating a price as well as other conditions. A business broker is a professional that will manage this process in exchange for a percent of the transaction. A broker will perform a valuation, provide a list of the necessary documents and financial reports, as well as prepare a prospectus and then market your business to potential buyers.
There are approximately 3,000 business brokers in the U.S. and finding the right one to represent your business is important. A broker should understand your business and the industry as well as have a track record of selling similar businesses. Understanding the fee structure is essential before you sign any agreement with a broker. Also, this is someone that is representing your business to prospective buyers so you want someone you believe will represent you and your business as you would.
The Financing Process
Once you have agreed on a sale price for your business, having a clear understanding of how the buyer is financing the business is critical. If the transaction is all cash, it’s reasonable to ask for a Proof of Funds letter from a bank, typically your buyer’s usual bank. If the buyer is planning to take out a loan, a similar letter from a lender should be provided by the buyer that states how much is being financed, that the buyer has been pre-approved and that the combination of funds from the buyer plus the loan are the same as the agreed upon sale price.
Step 5: The Due Diligence Process
The final step in any sale will be a due diligence process. This is when a qualified buyer is preparing to make an offer (or has made a verbal offer) and needs to finalize what they will offer for the business in writing. It’s also when they’ll gain a deeper understanding of how the business really works.
In addition to reviewing your financials, they will need to review key contracts, review customer relationships, understand the employees and how a change in ownership may impact them, as well as other questions about running the business. Typically, a buyer will provide a due diligence checklist in advance to provide an owner time to gather the requested information. If you develop a solid plan, you should have much of this ready and available, which demonstrates to a prospective buyer that the business is well managed and prepared.
A buyer may also request things like asking you to commit to a certain amount of time to help with the transition and to sign a non-compete agreement to ensure you do not start a competing enterprise after selling the business.
Whether you are selling a business, the assets or not sure what to do, developing a plan is a great first step to organize your thinking and the materials you will need in just about any transaction. By the time you reach the due diligence process, you’ll be glad you spent the time on an exit plan.
DON’T WAIT, PLAN YOUR EXIT WITH EXITGUIDE
Transitioning out of your own business can be confusing and emotional. You have invested a lot into your business and taking steps to exit is not easy, in fact, most owners have never been through the process. You do not have to “figure it out” on your own. ExitGuide helps owners from start to finish by answering basic questions about the process, helping you develop a plan specific to your circumstances and then connecting you with expert resources to guide you to a successful outcome.