Selling a business is a complex process that requires careful planning and a clear exit strategy. When thinking about a business sale it’s possible to maximize the chances of success by examining the reasons why the sale is taking place, and defining the specific goals and objectives.
Gaining an insight into the process itself is also helpful. Knowledge of how the business sales process works in practice helps with preparations and allows business owners to gain more control.
This guide to selling a business looks at the selling process itself and examines some of the issues that require careful thought and preparation.
A trade sale takes place when a business is sold to another business, typically one in the same field that is looking to expand its operations. This route can result in a good final value if the seller prepares the business beforehand, making it attractive as a trade purchase.
It may be beneficial to incorporate the business if it isn’t already a limited company, as it becomes a separate legal entity on incorporation and might be perceived by purchasers to be less reliant on only the seller.
This is an important point, as the business needs to be able to run smoothly without the current owner or director – essentially, the prospect of a straightforward transaction and takeover could attract more interest.
Management or Employee Buyout
The existing management team or employees may want to purchase the business for sale. This can be beneficial to the seller given their existing knowledge and experience of the customer base, and in-house systems and procedures.
An employee buyout can also preserve jobs, which might be at risk if a third party purchases the business. A further advantage of a management/employee buyout includes reduced disruption to day-to-day business operations.
The fact that confidential business information doesn’t have to be disclosed to a third party in this scenario also has clear advantages.
When Is the Best Time to Sell a Business?
The reasons for selling a business typically dictate when is the right time. If a business owner is experiencing ill health, for example, a quick sale may be their main goal. On the other hand, selling a business can be part of an overall strategic plan formed when the owner originally makes their purchase.
Taking a long view in this way allows for better timing – selling when market conditions are favorable, for example, or when the business is experiencing continued growth – which in turn can increase its value.
It’s also common for businesses to pass down through the generations of a family, so in this case, the person taking over would need to be trained and prepared for ownership. Again, this isn’t something that can be rushed – it needs careful planning and preparation over a period of years.
How to Prepare a Business for Sale?
Planning and implementing an exit strategy can attract more interest and boost the final value of a business. Sometimes known as a succession plan, an exit strategy encompasses various actions intended to make the business a more attractive proposition.
Preparing a business for sale could involve:
- Bringing the accounts and tax payments up-to-date.
- Using comprehensive management reporting to gain a current view of different business areas and of the business as a whole.
- Dealing with ongoing disputes with employees or customers.
- Streamlining systems and processes to make it easier when new owners take over.
- Gaining control over cash flow by forecasting cash needs and identifying any upcoming shortfalls.
- Eliminating non-essential costs.
- Tidying and cleaning physical premises where applicable.
- Ensuring staff training is up-to-date.
- Delegating to management to make an exit smoother.
A business holds value in various areas, however, not only with regard to finances – goodwill, reputation within a community, and trust between a workforce and the business owners all carry a considerable value that isn’t tangible.
If business owners plan well ahead for a sale they can maximize this value, but how is a business’ value established?
Business Valuations and Tax
Earnings multiples and entry costs are just two ways to value a business. Using multiples of post-tax profits may be suitable for established businesses with a strong profit record. The entry cost method involves calculating the cost to set up a similar business to the one being valued.
A valuation can be affected by various factors, however, including tangible and intangible assets, the length of time the business has been in operation, and the reason why a business is being sold.
From a tax perspective, the funds generated from a business sale are taxed as Capital Gains rather than income so this can be a tax-efficient process for sellers, especially if they’re also eligible to claim Business Asset Disposal Relief (formerly known as Entrepreneurs’ Relief).
What Professional Help is Available When Selling Businesses?
Legal assistance is needed to draw up the various documents and information for prospective buyers, as well as preparing and checking the final sales agreement. A legal expert can also provide valuable advice on any indemnities and warranties that the buyer or seller wants to include in the transaction.
The initial Sales Memorandum that’s distributed to interested parties at the early stages of sale includes financial information such as profit and loss figures, balance sheet data on the business’ assets and liabilities, as well as cash and sales projections. Clearly, it’s important to ensure their accuracy, so an accountant is invaluable here – they can also be instrumental in arriving at a reliable business value.
3. Professional Valuers
A dependable business value lies at the center of a successful sale, and hiring a professional business valuer with experience in the sector is key. They will understand the inherent challenges and benefits of that business’ trading environment, and be able to incorporate them into a real value that can be relied upon.
4. Business sales brokers
Using professional business sales brokers can be beneficial because of their contacts and extensive knowledge of the process. A sales broker also acts as an intermediary between the buyer and seller, allowing sellers to step back from the process during the negotiation stage.
Professional sales brokers also typically operate a database of potential buyers. They can market a business more effectively than a business owner in isolation, and with a broader understanding of the market.
What Are the Stages of a Business Sale?
This is a brief outline of the business sale process:
1. Marketing the Business
Potential business buyers are identified, and then appropriate marketing techniques used to present the business to this group. How the business is marketed depends on the type of business and industry in which it operates, and can range from purely online marketing to more ‘traditional’ methods.
2. Non-Disclosure Agreement (NDA)
A Non Disclosure Agreement protects sensitive business information and prevents competitors from gaining unfair knowledge of its operations. Anyone requesting information about the business should be required to sign an NDA.
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3. Information Memorandum
This document is sent out to interested parties during the initial stages of a business sale. It outlines the reasons why the business is being sold, provides historic financial data and projected figures, as well as legal information on the business’ suppliers, contracts, and members of staff.
Negotiations commence when one or two credible buyers have emerged. This is typically a crucial time in the process, and it’s important for the seller to clearly understand their goals and objectives in selling.
5. Heads of a Term Agreement
When these negotiations draw to a close, a Heads of Term agreement is drawn up. This document details the results of the negotiations and presents the terms that have been agreed – some of these may be legally binding, whilst others are typically agreements in principle that are dependent on the next stage, which is due diligence.
6. Due Diligence
A potential buyer carries out due diligence to check that the figures and information provided to them are reliable. They might also talk to members of staff with a view to gaining a first-hand impression of the target business.
7. Sales Agreement
If due diligence completes successfully, or the business owner rectifies any issues uncovered during the process, a Sales Agreement is drawn up. This formal document typically includes warranties and indemnities.
What Are Warranties and Indemnities in a Business Sale?
Warranties are written statements made by the seller to support their claims about the business. They’re intended to provide reassurance to the buyer – these are just a few areas they can cover:
- The condition of machinery used in the business.
- Details regarding staff pension liabilities have been provided to the prospective purchaser.
- Tax issues.
- Asset ownership, including rights to intellectual property.
Indemnities provide protection for the buyer from the consequences of known problems and issues within a business. Sellers typically need to limit the extent of any indemnities during a business sale, and it’s important to obtain reliable legal advice at this stage. Indemnities incorporated into a Sales Agreement might include:
- Claims made against the business by employees – unfair dismissal, for example.
- Tax issues, such as pending investigations or the potential for a non-standard increase in tax liability.
- Financial claims made by a customer – perhaps for a substandard product.
What Does Due Diligence Mean in Practice?
Due diligence is an important part of the sales process that takes place following acceptance of a formal offer to purchase. It involves the potential purchaser scrutinizing the information the seller has provided. This includes the cash position of the business and ownership of assets, but it’s also a wider exploration of the business as a whole.
The purchaser typically speaks with members of staff and management to obtain an overall picture of day-to-day operations. They’ll look at the systems and procedures in place for evidence of efficiency and agility, with the aim of satisfying themselves that the proposed purchase price is accurate and worthwhile.
At this point, any past or pending legal claims against the company will become known if they haven’t already been disclosed. It’s important that the seller cooperates with this process as much as possible – being obstructive or failing to disclose crucial information will only delay a sale, and could even dissuade the purchaser from buying.
It’s worthwhile for sellers to carry out their own due diligence from the perspective of a buyer, so they gain useful knowledge of potential problems and can improve or correct any issues before buyer due diligence starts.
How Can Seller Finance Help a Business Sale?
There are various stumbling blocks when selling a business, but a fundamental element of a successful deal is ensuring a prospective buyer has access to the funds necessary to complete the transaction.
This issue can be circumvented to some extent by offering seller finance. This is similar to a bank loan and is structured so the buyer pays a deposit to the seller, and then the remaining funds are paid in installments over a period of time.
There are pros and cons to sellers in this respect. There’s an inherent risk of the business failing or the buyer reneging on the deal, but the business acts as collateral in the event of default so this must be weighed against the benefits.
Offering seller finance encourages more interest and allows for the purchase of a business with less impact on a buyer’s finances. It’s even more important for sellers to be sure their buyer is the right one, however, and that they possess the skills and attitude to make the business a continued success.
The sooner a business owner starts to think about and plan for the sale of their enterprise, the more chance of a successful outcome. Selling a business is complicated whatever the industry, but with professional help and a guiding hand there’s no reason why owners can’t reap the rewards of their hard work and achieve the sales price they’re looking for.