CHAPTER 4
ONCE THE PROCESS HAS STARTED
Prior chapters covered big picture issues that buyers and sellers should be familiar with before they start the process of buying or selling any business.
This chapter will finish-up these big picture issues by focusing on what to do once that process has actually started. We will provide some tips on how to set the stage for successful negotiations, some crucial points you need to know about tax control early in the process, and finish with suggestions on how to evaluate in advance the odds that a transaction will actually “pencil-out.”
Buying or selling a business is a lot of work, very time consuming and expensive, and the outcome is never certain. You can raise the odds of success if both sides are ready before the process starts.
For Sellers
Many successful business owners, especially founding entrepreneurs, have an intense emotional tie to their business. This is generally good, and may even be a key part of their success thus far; but it can also interfere when the time comes to sell. It is surprisingly common to find a seller who is so emotionally tied to the business that no offer and/or buyer will ever actually be good enough.
Therefore, before starting the sale process ask yourself honestly:
· Are you really a willing seller?
· Why is your business for sale? Why now? If you cannot answer these questions quickly and easily, you are probably not ready to sell.
· What criteria are most important to you in the sale? Are there specific things that MUST happen as a condition of the sale, such as job security for certain long-term employees?
· Who are your best potential buyers? Your business is worth more to some than to others. Are there other businesses that would be a particularly good fit with yours? If the buyer would be an individual rather than another business, are there certain skills that would help an individual succeed if they bought your business?
· Are you willing to help the buyer succeed post-sale? How and to what extent and for how long?
· Are you willing to sell for a realistic price and terms? Do you know what realistic price and terms actually are? The majority of sales include seller financing for part of the price, and may include an “earn-out” for part of the price as well based on the buyer’s retention of key customers or various gross revenue targets.
Just how strong does a buyer need to be financially for you to feel comfortable with the deal? Will you provide seller financing for part or even the entire purchase price, or will only an all-cash deal (generally at a lower price) suffice to meet your particular needs financially and emotionally?
If you do not have realistic expectations as a seller, you are probably wasting your time as well as that of any prospective buyer.
But if you are really ready to sell, then you owe it to yourself and to your family to do the job right. Never lie or misrepresent; but be ready to clearly show a prospective buyer the true financial benefits of ownership plus all the other reasons why buying your particular business makes sense for that particular buyer.
For Buyers
What are your (and your own present business’s) strengths and weaknesses? In light of that, what other businesses could you buy that result in a combined business worth more than the sum of its parts (i.e., 1+1 = 3 (or 4))? Given the cost (both time and money) and the risk (all business acquisitions are risky), you might not want to buy at all if 1+1 is not going to be more than 2.
Most likely, if you are interested in buying a particular business, then someone else is too. It’s not all about the money. Why should the seller sell to YOU? Are you ready to “sell” yourself and your company as the best option for the seller to choose?
Especially if you already have a business to run, do you have the time and management depth to make sure the acquired business is a success post-sale as well?
Are you strong enough financially? Do you have a good enough banking relationship to borrow the down payment, or enough cash from your own funds to fund that? If borrowed funds or seller financing are involved, are you (and your spouse) willing to personally guarantee payment of the purchase price?
In other words, are you READY to buy?
For Both Sides
It is rare that either side is compelled to proceed, regardless of how the transaction is shaping-up. Once either side concludes that the sale is a “lose” for them, the sale is most likely off. This is so important, that we strongly recommend both sides explicitly commit to negotiating for a “win/win” result while it is still early in the negotiation process.
If it becomes apparent that the sale is not likely to actually happen, it's time to politely walk away. But don’t burn your bridges; the time for a sale may very well be better at some point in the future. Nevertheless, it is generally a waste time and money to chase after a deal once one side or the other feels the sale has become a “lose” for them.
Start With The Big Picture
Once both sides are talking, start with the big picture. Any deal needs to work well for both parties in the end. The seller needs to understand that the sale must “pencil-out” for the buyer, that the risk (both ways) must be acceptable, and that cooperation from the seller is likely to be needed after closing.
Most businesses have key customer and/or vendor relationships that must be preserved, and specialized expertise that must be taught to the buyer. Sellers should commit to helping the buyer with these key items. This reduces the risk for the buyer, and raises the chance that the sale will actually be completed. It may justify a higher price as well.
Sellers must also recognize that buyers are not interested in competing against the seller after the sale.Therefore, a seller’s reasonable agreement not to compete is an essential part of virtually all business sales.
Buyers need to understand that this prospective deal is much more than just a financial matter to the seller. The successors should make an extra effort to respect the person selling. We are dealing with people here -- not machines. They have expectations, dreams, fears . . . some rational, some not; but all are very real. If you do not recognize and address their "felt needs", you’re probably wasting everyone’s time.
Therefore, we recommend that you address the people issues first. The parties need to clarify what matters the most to each of them. Don't assume those items are self-evident, and do not leave until the 11th hour the issues you believe are likely to be the most difficult. It's better to discover and address these early-on, than to waste everyone's time and money working on a prospective transition that’s realistically never going to happen.
Risk can be more important than price for both the buyer and the seller. The buyer’s risk is well known (most buyers assume Murphy was an optimist…). But sellers are heavily influenced by risk as well. When a seller demands a large down payment, the reason is often their concern about not getting paid if the business does not do well after the sale.
Payment terms have a huge effect on cash flow, taxes and risk. Terms can even be more important than price! Terms can be so powerful that it’s sometimes possible to lower taxes, improve after-tax cash flow for both the buyer and the seller, reduce risk for both the buyer and the seller, and LOWER the price – all at the same. We’ll talk more about how to do this in later chapters.
Plan Early for Tax and Legal Issues
There are at least three parties to every sale: The buyer, the seller, and the IRS. The IRS thinks it is entitled to a big part of the seller’s cash sale proceeds, plus a big part of the buyer's cash as well. In a worst case scenario, the seller’s taxes alone can exceed half the value of the business, with the entire tax bill due before the cash to pay the taxes has even been received by the seller (we’ll explain how this can happen, and how to reduce the problem, in later chapters)!
Maximizing long-term after-tax cash flow for both the seller and the buyer, with acceptable risk should be a fundamental objective for everyone involved. A carefully structured sale can be a win/win/lose (the "loser" being the IRS).
Bring in the attorneys and C.P.A.s early, before the parties' respective positions become "set" and ego prevents them (or their respective C.P.A.s and attorneys) from coming off of their respective positions. Tax and legal expertise can easily make or break a deal! Experienced advice early in the process can prevent irreparable errors in structuring the sale, and may keep the process from falling apart at the last minute when advisors point out unexpected legal and tax problems for the first time.
Cash Flow
Cash is king! There must be enough cash for the buyer to earn a reasonable wage, make the required payments to the seller, earn a reasonable return on his or her money invested in the deal, and make the additional investments if necessary to keep the business viable.
Cash flow “scenario testing” can be used to assess the potential cash flow. A "scenario" is a collection of assumptions. "Scenario testing" uses a set of assumptions as a way of estimating future after-tax cash flow for both the buyer and the seller. Simplifying assumptions will be necessary, so don't expect exact results even if by some miracle you're fortunate enough to develop a set of assumptions that exactly match the future results. But since no one knows the future, be sure to test more than one set of assumptions.
Cash flow scenario testing on an estimated after-tax basis is absolutely essential as part of the buyer’s due diligence. Taxes can be so high that what looks like plenty of available cash flow may not actually be enough to sustain the deal. Therefore, without including estimated taxes in the analysis, you have no way of knowing if a transaction is likely to make financial sense for the buyer.
The business only generates so much cash flow. If both buyer and seller recognize that the sale must make financial sense for the buyer, and they agree on the basic reasonableness of the assumptions in the scenario, then the basic reasonableness (or lack thereof) of the proposed price and payment terms will become conspicuously self-evident from running those numbers. Besides providing a much needed reality check on the price and terms, this kind of testing can even reduce haggling dramatically. It becomes hard for a seller to insist on a particular price/terms combination when scenario testing demonstrates that that price and terms clearly cannot work out mathematically for the buyer even when using assumptions the seller agrees are reasonable.
IMPORTANT NOTE: Sellers should be careful not to make any promises or even predictions about future results for the company in the hands of the buyer. If the seller supplies the numbers and/or the analytical framework, be certain to include a very strong and clear disclaimer. Otherwise, you may have inadvertently "guaranteed" at least a minimum result and may even be vulnerable to rescission of the entire transaction later on! It’s better for the seller to simply provide historical information for the buyer, and let the buyer and his or her professional advisors come up with their own projections of future performance of the business.
Try to structure a transaction that still works under a reasonably foreseeable downside case as well. This can address the risk concerns of both buyer and seller. It can anticipate cash flow needs if things do not work out as well or as soon as hoped for, and can even lead to modified payment terms with flexibility built-in as needed to protect both sides later on.
For example, the buyer's Promissory Note could defer principal payments if operating results are poor in a particular year (continuing to accrue interest, and adding any deferred amount to a balloon payment at the back end of that Note). Initial payments might be interest-only, perhaps until an outside lender or prior acquisition has been paid off. Pricing based on customer retention could lower the risk to the successors enough that the seller can justify what will in fact become a higher price if customer retention is good (remember that “earn-out” concept described in a prior chapter). This also gives the seller a strong incentive to make things work after closing the sale.
No one wins if the seller does not get paid, and taking back a wrecked company is generally a lose/lose proposition for everyone involved. Cash flow scenario testing coupled with creative use of payment terms can dramatically reduce the chances of that happening, and we’ll be discussing those a lot in later articles.
ONCE THE PROCESS HAS STARTED
Prior chapters covered big picture issues that buyers and sellers should be familiar with before they start the process of buying or selling any business.
This chapter will finish-up these big picture issues by focusing on what to do once that process has actually started. We will provide some tips on how to set the stage for successful negotiations, some crucial points you need to know about tax control early in the process, and finish with suggestions on how to evaluate in advance the odds that a transaction will actually “pencil-out.”
Buying or selling a business is a lot of work, very time consuming and expensive, and the outcome is never certain. You can raise the odds of success if both sides are ready before the process starts.
For Sellers
Many successful business owners, especially founding entrepreneurs, have an intense emotional tie to their business. This is generally good, and may even be a key part of their success thus far; but it can also interfere when the time comes to sell. It is surprisingly common to find a seller who is so emotionally tied to the business that no offer and/or buyer will ever actually be good enough.
Therefore, before starting the sale process ask yourself honestly:
· Are you really a willing seller?
· Why is your business for sale? Why now? If you cannot answer these questions quickly and easily, you are probably not ready to sell.
· What criteria are most important to you in the sale? Are there specific things that MUST happen as a condition of the sale, such as job security for certain long-term employees?
· Who are your best potential buyers? Your business is worth more to some than to others. Are there other businesses that would be a particularly good fit with yours? If the buyer would be an individual rather than another business, are there certain skills that would help an individual succeed if they bought your business?
· Are you willing to help the buyer succeed post-sale? How and to what extent and for how long?
· Are you willing to sell for a realistic price and terms? Do you know what realistic price and terms actually are? The majority of sales include seller financing for part of the price, and may include an “earn-out” for part of the price as well based on the buyer’s retention of key customers or various gross revenue targets.
Just how strong does a buyer need to be financially for you to feel comfortable with the deal? Will you provide seller financing for part or even the entire purchase price, or will only an all-cash deal (generally at a lower price) suffice to meet your particular needs financially and emotionally?
If you do not have realistic expectations as a seller, you are probably wasting your time as well as that of any prospective buyer.
But if you are really ready to sell, then you owe it to yourself and to your family to do the job right. Never lie or misrepresent; but be ready to clearly show a prospective buyer the true financial benefits of ownership plus all the other reasons why buying your particular business makes sense for that particular buyer.
For Buyers
What are your (and your own present business’s) strengths and weaknesses? In light of that, what other businesses could you buy that result in a combined business worth more than the sum of its parts (i.e., 1+1 = 3 (or 4))? Given the cost (both time and money) and the risk (all business acquisitions are risky), you might not want to buy at all if 1+1 is not going to be more than 2.
Most likely, if you are interested in buying a particular business, then someone else is too. It’s not all about the money. Why should the seller sell to YOU? Are you ready to “sell” yourself and your company as the best option for the seller to choose?
Especially if you already have a business to run, do you have the time and management depth to make sure the acquired business is a success post-sale as well?
Are you strong enough financially? Do you have a good enough banking relationship to borrow the down payment, or enough cash from your own funds to fund that? If borrowed funds or seller financing are involved, are you (and your spouse) willing to personally guarantee payment of the purchase price?
In other words, are you READY to buy?
For Both Sides
It is rare that either side is compelled to proceed, regardless of how the transaction is shaping-up. Once either side concludes that the sale is a “lose” for them, the sale is most likely off. This is so important, that we strongly recommend both sides explicitly commit to negotiating for a “win/win” result while it is still early in the negotiation process.
If it becomes apparent that the sale is not likely to actually happen, it's time to politely walk away. But don’t burn your bridges; the time for a sale may very well be better at some point in the future. Nevertheless, it is generally a waste time and money to chase after a deal once one side or the other feels the sale has become a “lose” for them.
Start With The Big Picture
Once both sides are talking, start with the big picture. Any deal needs to work well for both parties in the end. The seller needs to understand that the sale must “pencil-out” for the buyer, that the risk (both ways) must be acceptable, and that cooperation from the seller is likely to be needed after closing.
Most businesses have key customer and/or vendor relationships that must be preserved, and specialized expertise that must be taught to the buyer. Sellers should commit to helping the buyer with these key items. This reduces the risk for the buyer, and raises the chance that the sale will actually be completed. It may justify a higher price as well.
Sellers must also recognize that buyers are not interested in competing against the seller after the sale.Therefore, a seller’s reasonable agreement not to compete is an essential part of virtually all business sales.
Buyers need to understand that this prospective deal is much more than just a financial matter to the seller. The successors should make an extra effort to respect the person selling. We are dealing with people here -- not machines. They have expectations, dreams, fears . . . some rational, some not; but all are very real. If you do not recognize and address their "felt needs", you’re probably wasting everyone’s time.
Therefore, we recommend that you address the people issues first. The parties need to clarify what matters the most to each of them. Don't assume those items are self-evident, and do not leave until the 11th hour the issues you believe are likely to be the most difficult. It's better to discover and address these early-on, than to waste everyone's time and money working on a prospective transition that’s realistically never going to happen.
Risk can be more important than price for both the buyer and the seller. The buyer’s risk is well known (most buyers assume Murphy was an optimist…). But sellers are heavily influenced by risk as well. When a seller demands a large down payment, the reason is often their concern about not getting paid if the business does not do well after the sale.
Payment terms have a huge effect on cash flow, taxes and risk. Terms can even be more important than price! Terms can be so powerful that it’s sometimes possible to lower taxes, improve after-tax cash flow for both the buyer and the seller, reduce risk for both the buyer and the seller, and LOWER the price – all at the same. We’ll talk more about how to do this in later chapters.
Plan Early for Tax and Legal Issues
There are at least three parties to every sale: The buyer, the seller, and the IRS. The IRS thinks it is entitled to a big part of the seller’s cash sale proceeds, plus a big part of the buyer's cash as well. In a worst case scenario, the seller’s taxes alone can exceed half the value of the business, with the entire tax bill due before the cash to pay the taxes has even been received by the seller (we’ll explain how this can happen, and how to reduce the problem, in later chapters)!
Maximizing long-term after-tax cash flow for both the seller and the buyer, with acceptable risk should be a fundamental objective for everyone involved. A carefully structured sale can be a win/win/lose (the "loser" being the IRS).
Bring in the attorneys and C.P.A.s early, before the parties' respective positions become "set" and ego prevents them (or their respective C.P.A.s and attorneys) from coming off of their respective positions. Tax and legal expertise can easily make or break a deal! Experienced advice early in the process can prevent irreparable errors in structuring the sale, and may keep the process from falling apart at the last minute when advisors point out unexpected legal and tax problems for the first time.
Cash Flow
Cash is king! There must be enough cash for the buyer to earn a reasonable wage, make the required payments to the seller, earn a reasonable return on his or her money invested in the deal, and make the additional investments if necessary to keep the business viable.
Cash flow “scenario testing” can be used to assess the potential cash flow. A "scenario" is a collection of assumptions. "Scenario testing" uses a set of assumptions as a way of estimating future after-tax cash flow for both the buyer and the seller. Simplifying assumptions will be necessary, so don't expect exact results even if by some miracle you're fortunate enough to develop a set of assumptions that exactly match the future results. But since no one knows the future, be sure to test more than one set of assumptions.
Cash flow scenario testing on an estimated after-tax basis is absolutely essential as part of the buyer’s due diligence. Taxes can be so high that what looks like plenty of available cash flow may not actually be enough to sustain the deal. Therefore, without including estimated taxes in the analysis, you have no way of knowing if a transaction is likely to make financial sense for the buyer.
The business only generates so much cash flow. If both buyer and seller recognize that the sale must make financial sense for the buyer, and they agree on the basic reasonableness of the assumptions in the scenario, then the basic reasonableness (or lack thereof) of the proposed price and payment terms will become conspicuously self-evident from running those numbers. Besides providing a much needed reality check on the price and terms, this kind of testing can even reduce haggling dramatically. It becomes hard for a seller to insist on a particular price/terms combination when scenario testing demonstrates that that price and terms clearly cannot work out mathematically for the buyer even when using assumptions the seller agrees are reasonable.
IMPORTANT NOTE: Sellers should be careful not to make any promises or even predictions about future results for the company in the hands of the buyer. If the seller supplies the numbers and/or the analytical framework, be certain to include a very strong and clear disclaimer. Otherwise, you may have inadvertently "guaranteed" at least a minimum result and may even be vulnerable to rescission of the entire transaction later on! It’s better for the seller to simply provide historical information for the buyer, and let the buyer and his or her professional advisors come up with their own projections of future performance of the business.
Try to structure a transaction that still works under a reasonably foreseeable downside case as well. This can address the risk concerns of both buyer and seller. It can anticipate cash flow needs if things do not work out as well or as soon as hoped for, and can even lead to modified payment terms with flexibility built-in as needed to protect both sides later on.
For example, the buyer's Promissory Note could defer principal payments if operating results are poor in a particular year (continuing to accrue interest, and adding any deferred amount to a balloon payment at the back end of that Note). Initial payments might be interest-only, perhaps until an outside lender or prior acquisition has been paid off. Pricing based on customer retention could lower the risk to the successors enough that the seller can justify what will in fact become a higher price if customer retention is good (remember that “earn-out” concept described in a prior chapter). This also gives the seller a strong incentive to make things work after closing the sale.
No one wins if the seller does not get paid, and taking back a wrecked company is generally a lose/lose proposition for everyone involved. Cash flow scenario testing coupled with creative use of payment terms can dramatically reduce the chances of that happening, and we’ll be discussing those a lot in later articles.
Gary E. Jacobson, J.D. | 
Larry Morrison, MBA, CBA, CMA |
RSS Feed