Preparation Goes a Long Way for Your Business Sale

 

As surprising as it may sound, business owners are often unprepared to sell.

 

“About 90% of the time, we work on sales where the owners have done very little preplanning,” said Chris Caniff, Senior Managing Director at Periculum Capital Markets. “Many sales could benefit from more preparation beforehand.”

 

In Caniff’s line of work, as an investment banker, a little over half of his business-owner clients are cold-called with a purchase offer. While that’s a separate case, many of the rest put up their business for sale because of a family rift or a health incident. These are instances where thoughtful preparation may yield better results.

 

John Gregg, an 1834 Wealth Planner, agrees that a lack of preparation is common. He often helps clients with relatives’ estates and sees many situations where a business needs to be sold quickly, in a way that’s ultimately not as effective as it could be.

 

“You want to start planning about five years out,” Gregg said, “and you should always have a solid succession plan in place.”

 

So, even if you just think you may want to sell, it’s worth exploring the possibility—and planning for it—now. Perhaps you’ve long wrestled with whether to sell or keep your business in the family. Possibly you’re nearing retirement and you want your business to continue to run as-is, so that your employees can continue to thrive. Perhaps you see the competitive landscape shifting and you want to get ahead of a possible industry consolidation. Or, maybe your goal is to maximize your financial return, so you want to be ready to strike when the time is right.

 

In this article, we’ll review a few of the most common types of sales and the situations where each type makes the most sense. We’ll also cover some of the basic prep work that you should do before any sale. If you do end up deciding to pass the business on to family, either through a sale or gift, see our article on transitioning your business to the next generation for more details on that scenario.

Preparing for Sale: The Basics

While you always want to have your business running smoothly, there are several steps that will require attention—or increased attention—prior to a sale.

 

The Right Team. You’ll want experts in your corner. This includes a wealth manager, a financial planner, an accountant, an attorney and, mostly likely, an investment banker and an estate planner. Vet each one thoroughly—and introduce them to each other, so your team can work together to capture efficiencies.

 

Pre-Sale Considerations. Is your business really ready to sell? Are the profits, payroll obligations, industry outlook, contracts and KPIs where they need to be? Just as crucially, is the business valuable without you there, or are you an operational dependency? Set up processes now that would allow for an outside party to come in and run the business effectively from the outset. This is always best practice, even if it does take time and requires you to relinquish some control.

 

Estate Planning. How will this sale affect your legacy and the next generation? Do you need to consider a trust to effectively pass on the proceeds of the sale? Be sure to have detailed conversations with your family—as well as your advisors—on what this change may mean going forward.

 

Tax Consequences and Planning. The sale of your business will likely have federal, state and local income tax consequences, as well as transfer and conveyance expenses. Some aspects of tax planning, such as setting up a trust, need to be done well in advance. Other aspects of tax planning can’t be worked on until specifics of the sale are known. In both instances, work with your accountant to develop strategies that may reduce your tax liability.

 

Financial Planning. You’ll be receiving a large sum of money. What will you do with those funds? Do you need to deploy them in a way that continues to provide income? Or will you use the proceeds for something else entirely, like a vacation home, a luxury car hobby, or the start of a new business? Talk with your wealth advisor and portfolio manager about options that are right for you.

Why Do You Want to Sell?

As you prepare your business for a possible sale, you’ll start to better understand your goals for a potential exit. This will make it easier to figure out the type of transaction you may be interested in: a private equity sale, a sale to a strategic buyer, or an Employee Stock Ownership Plan. We cover the basics of each, as well as their virtues and drawbacks.

Private Equity

While private equity may get a bad rap in the news, for middle market companies looking to sell, it may make a lot of sense, particularly if your management team is not ready to exit with you.

 

If your company has strong management, good historic growth and solid margins, you may limit staff reductions or changes. In an ideal sale, your company is being bought because it runs well as is, and the private equity firm sees an opportunity to add financing and expertise to enhance growth. You may even be able to negotiate defined, guaranteed roles for certain star performers, like members of your management team or your sales team, as part of the transaction.

 

“When looking at a private equity sale, culture is important, particularly if you or your partners are staying on,” said Caniff. “You want a buyer that operates with your values and in the manner you do—that will make for a smoother transition.”

 

If you’re ready to leave the company at the outset, you could exit completely and gain full liquidity from the sale. Or, you may even be able to cash out at a level that satisfies you, while still retaining a share of the company and continuing to work there.

 

If you do negotiate to stay on, you gain in upside: the private equity firm should be skilled in maximizing your company’s profitability. Ultimately, when the private equity firm goes to sell again, you may realize a second substantial payout—this is the proverbial second bite at the apple.

 

However, there are downsides to the private equity track: while the initial sale may be agreed to on principle, there’s typically a higher risk of financing falling through with investor-led purchases. And, as mentioned before, with a private equity sale, everyone involved knows that there will be a second sale; it could take 5-7 years, or it could be in as little as 2-3 years. This may introduce a level of instability or uncertainty that you don’t want.

 

“Often private equity firms are trying to cobble together many little companies that can operate as one even more profitable mass company, which then gets sold. The strength of private equity is being able to do this,” said Gregg. 

 

Even if you do stay on, when the company sells a second time, you’ll have no control over what the second sale looks like, or who purchases it. That may end up being disheartening.

Selling to a Strategic Buyer

A strategic buyer is any company (rather than investment firm) purchasing your business, whether it be a direct competitor, a company in an adjacent industry, or a company interested in yours because you could provide a vertical integration opportunity.

 

This option is more likely to garner the highest offer—and you’re more likely to see an outlier offer. With a strategic buyer, a sale is most likely to provide you with 100% liquidity. Additionally, the financing is less likely to fall through, because companies already in your industry can make a better case for the purchase to lenders.

 

However, you often won’t have the option to stay on or keep a share of the company. Moreover, your management team and many employees may not be retained. For example, if there are duplicate departments or multiple people in the same role (two CFOs, for example) someone will get let go.

 

You may be able to negotiate package on behalf of your management team, but it’s likely that your company will no longer be recognizable to you soon after the sale. Depending on your goals, this may be totally fine—or a non-starter.

Employee Stock Ownership Plans (ESOPs)

If your primary goal is to keep the business as-is, and keep your management team in place, then you may want to consider an ESOP. In this scenario, your company essentially forms a trust that takes out a loan to buy the business from you and slowly passes ownership to your employees in the form of shares that function much like a retirement plan for employees. 

 

One of the main benefits is that ESOP sales have limited disruption to day-to-day business or overall company morale. But you need committed management—ideally, even the next layer of management has been identified and the company has a strategy to retain this talent.

 

“An ESOP can be great if successful, but it may be very difficult to do,” said Gregg, “You need a strong management team in place, strong cashflow and a durable business model.”

 

If your company is of the size and strength for this plan to succeed, there are notable advantages: the ESOP sale will close as either an S-Corp or C-Corp, both of which provide substantial tax benefits compared to non-ESOP sales. You’d also be able to structure the deal so that you could retain some ownership of the company, if you’d like, and you could then continue your day-to-day involvement.

 

Many studies also indicate that ESOP companies have higher-performing employees and substantially higher employee retention than non-ESOP companies. In other words, this company-wide ownership mindset often shows in the bottom line.

 

“ESOPs typically are a great succession planning tool for business owners who are focused on their legacy and taking care of their loyal employees,” said Brian Henning, an Old National Corporate Banker with substantial experience helping companies with ESOP transactions.

 

That said, there are downsides. While an ESOP is a tax-advantaged trust structure, owners are unlikely to get top price from an ESOP sale. Additionally, selling owners of an ESOP typically get a portion up front, followed by incremental payouts that may last up to 10 years after the initial sale. For some individuals, that timeframe is untenable.

 

“If the business owner is looking to fully exit the company and maximize their price and liquidity at the time of sale, then ESOPs are typically not the best exit strategy,” said Henning.

Choosing the Right Offer

Any sale is unique. For example, certain strategic transactions can have characteristics you’d commonly expect from a private equity purchase—and the opposite is also true. That’s why canvassing the market and getting a good idea of what you want—and what’s possible—will help you with your sale.

 

When it’s time to sell, confidentially market the business to qualified buyers, to confirm that your desired valuation is obtainable.

 

Once you’re looking at offers, the size of your business makes a big difference. Caniff, who works primarily on transactions of $20 to $250 million, advocates for sellers to make sure they get the funds they need to meet their personal goals upfront in one payment

 

Gregg agrees that this is the ideal. “If you can get all the cash on day one, that’s the deal you take,” he said.

 

However, for smaller or niche companies purchased by other smaller companies or by an individual, this may not be realistic. For Gregg, who typically works with clients whose sales are in the $5m-$40m range, a structured payment plan may be the only option—even if it’s not the desired one.

 

There are other aspects of a sale that can also be important.

 

“Let’s say you own a business and your two siblings are two of your top managers,” said Gregg, “Once you exit, they don’t want to work there. You may want to go to the seller and negotiate a substantial package for each of them, as part of the conditions of sale—that could be important for you, and a way to make sure that everyone in your orbit is taken care of.”

 

In situations like these, make sure your advisors know your personal goals. Your team will have years of experience working on transactions similar to yours, so they can offer you insights and solutions you may not have come to on your own. That’s worth a lot.

Start by Building Your Team

Preparing to sell your business is as much about mindset as it is about specific details. Are you always looking for ways to enhance your operation? Are you regularly in touch with experts about best practices and opportunities? Do you check in with yourself on whether your business still fits within your broader financial and personal goals? A strong financial team will keep you on track.

 

At 1834, we know the value of a holistic approach to wealth—and building a team that’s dedicated to helping you pursue your long-term goals. If you’re curious about what wealth expertise could do for you and your business, let’s talk.