Ok, so in my recent article we discussed the Top 5 Sell-Side Advantages of M&A. Now assuming that you are a business owner and you have found yourself in a position to sell your business, for whatever reason, how do you go about it? What are some things you need to think about when actually engaging with a party that is interested in purchasing your business?
The most important thing to know is that selling a business is NOT like selling a hammer or a computer, or a even a car. The process of selling a business takes due diligence on both sides and tactical decisions that ensure that you not only maximize your return but that you also limit your liability post-sale.
One of the most useful sayings to utilize in life is, “you don’t know what you don’t know.” Unfortunately, there are many business owners who have never engaged in a business sale that attempt to navigate the transaction themselves. This is the best way to leave money on the table, have deals fall through, and/or unnecessarily leave yourself open to being sued after the business is already handed over to the new owner.
Here are 6 things that, if you don’t know, could be detrimental to the success of you selling your business.
Failing to Execute a Confidentiality Agreement
The first step to a successful transaction is having potential Buyers sign a confidentiality agreement. This document is used to protect all of your proprietary information should the deal go south. Failing to execute a confidentiality agreement means that if you bring in a potential Buyer and the deal doesn’t close, they aren’t under a legal obligation to keep that information to themselves or refrain from using any of that information to become your competition.
Companies having trade secrets, such as recipes or private client lists/profiles, can easily ruin their ability to sell their business if they fail to enter into a confidentiality agreement. Buyers are purchasing operating power and growth potential. If your business/industry is one where trade secrets is what gives your company worth and you have allowed someone to gain access to that information without being legally bound to confidentiality, they can completely recreate your operation, if the deal fails to go through, and diminish the value of your business. This is particularly true if another potential Buyer finds out that other interested parties have had access to this information without being required to sign a confidentiality agreement.
Neglecting to Vet Potential Buyers
A crucial downfall of many people selling their business is that they neglect to properly vet their potential Buyers. They don’t ask questions to figure out if the person is qualified to operate the business or if they have the ability to finance the deal.
One of the good things about a confidentiality agreement is that it gives you a greater ability to vet your potential Buyers. A confidentiality agreement usually works both ways and allows you to ask (and receive) certain information from the Buyer that will help you determine if they are the right fit.
Some questions to ask the buyer are:
– What qualifies you to buy the business?
– How much money can you put as a down payment?
– How do you plan on financing the deal?
– What concerns do you have about the business? (if a person is serious about buying your business they have considered the pros and cons and should be able to express those to you)
– What are your expectations regarding the transition period?
This is not an all-inclusive list, but the answers to these questions will give you a greater sense of the Buyer’s qualifications and level of interest in purchasing your company. Not vetting Buyers could lead to a lot of wasted time, energy, and effort on the back end.
Not Negotiating the Material Deal Points in the Letter of Intent
Once you find a Buyer that you are comfortable with, the next step is entering into a Letter of Intent. The Letter of Intent presents the optimal time for the Seller to negotiate the main terms of the deal. Prior to executing a Letter of Intent the Seller is able to entertain multiple Buyers and play their bids against each other in order to get a better deal. Once you execute a Letter of Intent you are (usually) not able to entertain anymore potential Buyers (due to a no-shop clause). You lose a good amount of leverage at the point when the Buyer knows that they have carved out a period of time where you cannot approach or be approached by any other Buyers.
Some material deal points to negotiate are price, timeline, reverse termination fee, type of sale (asset or stock), liability cap, and post-sale obligations.
Not Including a Reverse Termination Fee
After you enter into the Letter of Intent you are no longer able to entertain other potential Buyers. This puts your company at a “standstill” and the success of the deal becomes largely dependent on the Buyer’s continued willingness and ability to close. Because you have locked out other potential Buyers, you have to ensure that the Buyer is truly serious about closing the deal.
A reverse termination fee is a fee that is paid to the Seller if the Buyer decides to walk away from the deal due to no fault of the Seller. This fee, usually no more than 10% of the purchase price, is a monetary incentive for the Buyer to see the deal through to closing. This clause is placed in the Letter of Intent.
Failing to Cap Seller Liability Post-Sale
One of the main purposes of selling a business is to get rid of the obligations and duties that come along with running a business. A critical mistake that some Sellers make is that they don’t limit their liability to the company post-sale.
The final agreement the parties execute contains certain representations, warranties, and (typically) carve-out provisions. The carve-out provisions, along with any breach of representations or warranties of the agreement, present opportunities of liability for the Seller, usually in the form of paying back a portion of the purchase price.
It is imperative that you cap your potential monetary liability, usually 10-20% of the purchase price, and ensure that the monetary liability is the Buyer’s sole remedy under the transaction.
Failing to Charge a Premium if it’s an Asset Sale Instead of Stock Sale
In my previous article Asset Sale or Stock Sale: What’s The Best M&A Deal Structure For You? I highlighted the difference between an asset sale and a stock sale. There are significant tax advantages Sellers realize when they sale their stock as opposed to selling the assets of their business.
Likewise, the Buyer realizes certain significant benefits by purchasing the assets, rather than the stock, of a company. These benefits should always come at a premium.
Selling a business is a very strategic undertaking that requires a certain level of expertise. Not having the right team in place can lead to headaches, decrease in business value, and ultimately the inability to sell your business.