My niece runs the hurdles in track. I love to run, but don’t think I would enjoy running nearly as much if I had to constantly jump over hurdles in my path. The thing about hurdles is they stand in your way, slow you down, and sometimes take you out. It makes me grimace to see a hurdler faceplant after being tripped up by a hurdle, and the same thing can happen with business sale transactions.
Over the years I have seen business sale transactions fail, after the parties had agreed in principle to a price and basic terms, for a number of reasons. As a business broker, I try to anticipate these hurdles and ensure that they are addressed prior to marketing the business. I don’t want to find out a week before closing that there is a serious that will delay closing or, worse, cause the agreement to unravel. Nor does the seller want this to happen, after losing many months of market time. Nor does the buyer, after investing much time and expense in pursuing the transaction. Some issues are difficult to identify, and surface only as the buyer conducts a comprehensive due diligence. However, there are a handful of common issues that tend to recur . . .
Financial Statements. Clean financial statements and tax returns are worth their weight in gold. Literally. Good financial statements will increase the value of your business enough to buy their weight in gold when you get paid at closing. Many business owners seem to be doing quite well financially, as evidenced by where they live and how many toys they have. However, if they do not have clear financial statements that match the tax return and include all of the earnings of the business, the business will sell at a discount, if at all. Many buyers make offers on the basis of advertised revenues and earnings figures, but if the figures cannot be proven by the returns and financials, the deal will fall through during due diligence. Sales revenues that don’t make it to the tax return – because, “you know, it’s a cash business” – will not count as sales revenues when the business is marketed for sale. Aside from the legalities of it all, business owners should report revenues consistently if they expect a buyer to pay for them. If your financial statements and/or tax returns are not professionally done (either by knowledgeable you, or by a CPA), make the investment to hire a reputable accountant to compile financial statements and prepare tax returns for the next few years, and it will pay off great dividends at the time of sale.
Employees. Remember that when you sell your business, you will not likely be working there any longer. That may be obvious to many owners, because the reason they are selling is to retire. Others may be willing to continue working, but SBA lending rules or a buyer with other plans may prohibit it. Either way, you must ensure that the business can operate without you, preferably because you employ knowledgeable, well-trained people who fulfill all necessary functions. If not, you will need to identify a prospective buyer who can be trained to fill your shoes, which necessarily limits the market of prospective buyers. Typically financial function and even sales function owners can be replaced, but it will be more challenging if the owner is also the shop manager, or possesses critical technical skills. Do you have key employees who could hurt you if they were to leave? Consider bringing them in on your plans to sell the company, paying them a bonus to assist with the transition, and getting them under an employment agreement with non-compete and/or customer non-solicitation covenants. I recall a fairly large transaction that nearly fell apart days before closing, when the buyer presented employment and non-compete agreements to a few key sales personnel they wanted to retain. Turns out that two of those employees did not want to sign because they had plans to leave and start their own competing business soon after closing, which they were convinced to forego only after great consternation and expense to the seller and buyer.
Contracts and Licenses. Consider all of your key contracts, and whether they may need some updating. Do you have key customer contracts that are expired, or perhaps outdated in comparison to your current business dealings? Are any of your key business relationships undocumented, oral contracts? Several years ago I saw a transaction fail because the owner’s franchise agreement did not support the exclusive territory that he claimed in marketing the business. Does your business hold key contracts or licenses that are critical to operations, and are these contracts or licenses transferable to a buyer? In many cases they are not transferable, or may require permission of another party or a government agency, so it is important to have a game plan for how this issue will be addressed with a buyer, prior to marketing the business. Remember that most buyers do not want your stock, they want your assets, and so the buyer will need their own licenses and contracts if yours cannot be transferred. Most of these issues can be overcome, but it is important to have a plan.
Pricing. This issue is a little different than the others, in that it derails transactions before they ever happen. The majority of businesses advertised for sale in the marketplace are over-priced, and statistics show that a very large percentage of them will not sell. Perhaps the owners become exasperated and just sell to an employee, or in some cases just close the business after seeing little interest. Many others are probably sold eventually, at a lower price, but only after substantial delay due to unrealistic pricing. The reality is that in general, buyers will not overpay for a business. Some buyers will overpay, but there are not enough of those buyers around to buy all the over-priced businesses. Look at your business from a buyer’s perspective. Is there enough cash flow to pay a reasonable owner salary, debt service on acquisition and working capital borrowing, and a fair market return on cash invested? Returns on cash invested in a small business should typically be in the 25% to 35% range. The average business owner will not think that their business is a high-risk investment, but the average buyer will. While many business owners scoff at seller financing, a seller can ask significantly more for a business if seller financing is offered, since the seller is sharing the risk with the buyer. If you don’t look at the asking price from the buyer’s perspective, know that the buyers certainly will!
This is a short list of hurdles, but the most common in my experience. Address these issues, and then look at your business critically, through a buyer’s eyes. You know your business better than anyone else, so take time to think through the things that buyers will find challenging, and come up with a plan to address them. Doing this now, before you try to sell your business, will save you heartburn later, improve the value of your business, and hopefully get you to closing unscathed. So stretch out well and hit those hurdles!
Steve Minnich, J.D., CBI
President, Piedmont Business, LLC