13 Issues to Consider Before Selling a Small Business
September 3, 2015
Business environment is quite severe today and all the entrepreneurs are surrounded by tough competition. It is very difficult for thousands of small businesses to survive so failures occur more and more often. As result a flat-broke entrepreneur has 2 options: to liquidate companies formation or to sell it.
BizBuySell– famous business for sale marketplace– provided the Insight Report for the end of 2014 stating that almost 7 500 sales transactions have been made during the year which is the largest number recorded by the agency since 2007. There are 45-50 thousand of small businesses (retail stores, cafes and restaurants, service providers, cheap company formations and even manufacturers) usually listed for sale.
The causes which impel business owners to sell their companies are various. Sometimes external circumstances unpredictably change, or not all risks accompanying the project are considered, or the commercial idea turned upnot to be as demanded as it was expected. Under best circumstances, a deserving and promising business attracts buyers.
It is a dismal fact that many small business owners don’t have a chance to sell their enterprises. According to Statistic Brain, a community collecting statistics on the wide range of events, extremely high number of small businesses ceases to exist during the first five years.
Despite all the effort and initial enthusiasm many entrepreneurs end with an aspiration to recover at least some amount of invested capital. In such case the main goal is to minimize material losses and to preserve reputation. If an entrepreneur faces the need to liquidate the company then qualitative accounting and legal services are required. Otherwise the business should be evaluated by a special agency. Professional broker helping to find a buyer and negotiate the highest price possible is also required.
You may find investors who have been looking for a project performed by your business idea to purchase. They may even suggest you a seductive price. But don’t hurry to make a sale deal. If you are going to put your profitable or unprofitable business up for sale, find answers to these questions first.
7 Questions to Answer before Putting a Small Business up for Sale
- What next?
Ask yourself about what would be done as soon as you get rid of the business. Many people spend major part of their time while launching commercial ideas and overcoming pitfalls involving all personal skills and resources into the process. Thus, business activity becomes a significant part of an entrepreneur’s life and selling this business leaves a person without an incentive to rationally structure the time.
Some people launch new business ideas considering past mistakes and directing the released energy into the next project while others are stuck in one place without any clear idea about what to do next.
Just dip deep into the future and decide which step would bring you joy and happiness. Maybe current difficulties are given to you so that you could acquire some new knowledge and skills. And if the challenges are adequately met the solution will be shortly discovered.
- Who is able to buy a small business?
Awareness of the potential buyers increases the chances of a beneficial sale. Who can buy a ready-made company? It may be a competitor, one of your employees, company engaged in the same field as you and wishing to expand, huge corporations looking for opportunity to occupy your region, or an investor looking for new commercial adventure. The price of your project depends on how successful it is and on its demand from the side of a potential buyer.
Find out how and for whom your business may be attractive and make the benefits clear. Be sure that this step is very important if you want to get good money for the deal.
- Is your business competitive enough?
If you want to ask a high price for your company it should take a solid market share. How can you attract attention of a potential buyer or an unaffiliated? Do you perform a popular and high-quality product which has no substitutes? Do you have some special benefits against the other competitors? Will the company’s profit increase in case of investing a certain amount of money in it?
Answers to all these questions should be clear to a buyer. Someone will give good money for your business only when he or she is convinced that this is a lucrative bargain.
- What are the weaknesses of your business?
Be prepared to give an answer to why you have decided to sell a company. It is the first obvious question in such situation which surely affects the sales cost. Is your company financially instable? Do you have an outstanding bank debt or accounts receivable? Why? Is your product still interesting to customers? Do you have up-to-date technology and relevant prices? Here are some areas that you have to pay your attention to.
Make sure that you are able to provide the buyer with complete and accurate financial disclosures. This is the only way to estimate the cost of the project and to discover its mistakes and the potential. Lack of such information significantly reduces the price of your company. Besides studying the financial records may open your eyes to committed mistakes that will give you an impulse to recast the business by yourself.
Liabilities are inherent to all commercial structures as this is the most real way to extend, renovate, innovate, and even to start up. The owner is responsible for all debts when speaking about a sole proprietorship. Liabilities may consist of rental, business loans, lease payments, nonspecific loans and so on.Also pay attention to accounts receivable.So, make sure that all the debt is covered before offering your enterprise for sale.
It is quite normal for an enterprise to have profit-sharing, insurance or pension obligations, durable contracts with suppliers, partners or customers, legal action or outworn assets. But in case of company’s sale such obligations will not bring much fruit. This may even make the buyer change his/her intentions regarding your business.
Are your employees protected by a labor union? Which obligations do you have to employees? Will it be easy for a new owner to change employment contracts and salary amounts?
Do you have vacancies which are essential for the business’ vitality? Is it easy to find necessary skilled professionals in case of need and how much does it cost? Will the new owner receive contracts of all the employees to ensure business’s continuity?
- Is it possible to attract company’s workers to the sales process?
Business sale is not a matter of one day being accompanied by a due diligence process. Despite the fact that it is the buyer who is interested in investigating your business from first to last, you, your accountant, and some more employees will be engaged into the process. Take into consideration that detailed presentations, numerous meetings and phone calls, paperwork will certainly affect the usual schedule of the working day.
Except the time and efforts accompanying the sales process you will have to pay for the due diligence. Therefore, many small business owners who get involved into the company’s sale will discover that the result is far from desirable. Don’t deceive yourself that it is quick and easy to organize a transaction. Better calculate a budget and set a schedule to effectively perform the transaction.
- How will an internal and external surrounding respond to the sale?
Customers, suppliers, investors, partners, competitors are considered to be an external surrounding. Reaction of these groups of people on the sales process is very important and you will not have a chance to hide this fact from them especially on the stage of due diligence. Think of each group from external surrounding and find a mutually acceptable solution for each case. Use all your efforts to convince people that the sale process will not affect your business performance.
Company’s workers are referred to as internal surrounding. Find out whether they are affected by instability and going to find a new working place.
- Where to take money for life?
Being a business owner means getting tangible bonuses amounted to the annual income. Grasp all the benefits you receive as an entrepreneur even if your costs exceed profits. Being an owner you can drive several times higher income rather when being an employee so contemplate all the purchases made in result of such gain. You may have had numerous business trips and entertainments paid by the company, different expenses reimbursements, beneficial health and insurance policies.
Make sure that all the benefits of being a sole proprietor are clear to you before the decision on selling the business is taken. You may stop enjoying them afterwards. Prepare to the fact that your life will drastically change and the necessity to look for a new source of funding will inevitably arise.
There are several points which should be considered before setting out your business. Make sure that you clearly understand the whole picture of the process to avoid time and money loss. Here is the list of issues which you should pay attention to.
- Establishing a contact with the buyer
Establishing a contact between buyer and seller is the first step which should be done in case of sales transaction. This is the stage when parties would determine whether the deal is potentially lucrative for both of them. It is very important to demonstrate a moderate amount of flexibility and pertinacity at the initial meeting.
- Holding the preliminary talks
On this stage parties distinctly voice intentions and desired benefits for each, discuss non-negotiable points, sign non-disclosure and confidentiality agreements. Think of all points which you want to stay non-negotiable in advance. For instance you may need to insist on the fulfillment of the existing labor contract’s terms by the new owner. Also prepare not to leave your position for a certain time per buyer’s request. Buyer and seller also provide each other with the necessary legal and financial documentation.
- Due diligence
Due diligence is conducted by a buyer but nevertheless at the expense of a seller. Buyer needs to have verification of information provided by a seller in preliminary talks concerning company’s finances, real customers, corporate property, and so on. Company’s financials may be previously approved by an independent auditor which significantly simplifies the due diligence.
Anyways, this step is resource-intensive so you would better be prepared for it. Don’t forget that employees will also have to spend part of working time on the process.
- Evaluating the transaction cost
As result of preliminary talks and due diligence parties make a preliminary agreement –term sheet – which includes all agreed points and terms. The document is drafted after all the data, documents and financial disclosures are examined and approved. Term sheet is a concise version of the basic contract which will be signed and executed by both parties.
This is a stage when the business’s cost is determined. The price suggested by a buyer is usually calculated based on several indicators and ratios.
Revenue is the first indicator affecting company’s price. In 2014 the average price-to-revenue ratio was 0.6 what means that the company with $1 million gain would be sold for $600 000.
A company’s cash turnover also takes part in business cost calculation. In 2014 the business for sale price-to-cash flow ratio was 2.24. According to this a company with $500 000 annual turnover would be sold for $1.12 million.
Buyers also consider the amount and stability of the net profit. Especially the company would rise in price if its earnings regularly increase. The price-to-profit ratio may vary from 4 to 6. Let us say your business may boast with $100 000 average annual net profits. It means that the company may be evaluated from $400 000 to $600 000. If the profit is inconstant the ratio will be lower. Many buyers realize that information concerning the net profit may be distorted and thus don’t take this indicator into consideration.
There are some cases when net assets should be calculated with the help of estimated reserve values method. Businesses existing for a short time may possess undervalued assets because of amortization.
The statistical data in the section was provided by BizBuySell.
- Setting up the price
Once a buyer has examined your business and realized that it is worth the undertaking, the price will be adjusted. This is the last stage before signing up the basic agreement. However, some changes in the sale contract may be still initiated whether by a buyer or by a seller.
- Sales completion
Once the price is acceptable for both parties the sales contract is signed. The agreed amount should be transferred to the seller. Nonetheless parties may have to execute some obligations according to the contract. Both parties are held liable for concealed information. The seller may be required to help manage the business for the initial time. The new owner may be obliged to repay a certain percentage if company’s revenues unexpectedly increase.
Neither launching a business nor selling it is a simple process but both of them require meticulous approach. In both cases you expect to gain but the result depends only on the efficiency, timeliness and foresight of your actions. In the best case you will sell the business for a price higher than expected. Or you may keep working at the enterprise as an employee and earn money for a comfortable golden age. Or you may get involved in the new start up incorporation of a company. But remember that any of your decisions should be made with full awareness and responsibility.