Thinking of selling your business? Start planning today
You’ve built your business, it’s thriving, you may be looking for other challenges or you may be ready to retire. Whatever the reason, you’re considering selling your business.
The first and most important question you ask is “how much is my business worth.” There are many schools of thought and so-called industry standards as to how to value a business. However, while these so-called rules of thumb can help you with a very general understanding of value, the true value is what a willing buyer and willing seller agree upon as the sales price, period.
Every business has unique characteristics and components of value. No one formula or rule of thumb can take these items into account.
Further, businesses have varying organizational and ownership structures. These items all factor into what a seller may require in connection with the sale of the business. The valuation quagmire affects small business owners far more than medium- to large-sized businesses as the larger you are the more resources you typically have and with such size and growth you’re more likely to know and better understand the value of the business. Larger companies are also more likely to consult with legal counsel and financial professionals as they’ve grown.
Unfortunately, the small business owner doesn’t typically have the time or the resources to consult with a lawyer or accountant on a regular basis. Completely understandable. But it’s imperative that prior to entering into negotiations to sell your business that you understand the value and the components that affect value. It’s been all too often the case that I’ve been presented with a potential transaction and upon review and consultation with the client’s accountants or other financial professional it’s been determined that the client has missed significant aspects in negotiating the transaction both from a valuation and structural perspective.
For valuation questions, it’s imperative that you start early to plan the sale of your business, to understand the value components as well as the liability components and to structure the operations of your business in a manner that facilitates a sale on the most tax advantageous basis for you basically, to have a transition plan. In some instances, this planning may need to be started several years prior to the anticipated sales date. For example, is your business structured as a “C” corporation? Why? Usually the answer is that the owners never got time to do it right, but now it’s too late. The bottom line is you have to take the time and consult with your legal and financial advisors early to make sure that the value you worked so hard to create can be realized.
So following the advice above you’ve taken the time and created and followed that transition plan. The next questions are typically, “how is my business sold” and “how do I get paid.” There are two ways a business is sold: 1. an asset sale; or 2. sale of the ownership interests (i.e. stock, membership interests, partnership interests). By far, most businesses sell their assets to the buyer, meaning that specific assets are described in a written agreement, typically titled an Asset Purchase Agreement. The Asset Purchase Agreement will also typically expressly describe any liabilities that are to be assumed by the buyer if not so described in the Asset Purchase Agreement, that liability remains with the seller.
The sale of ownership interests, which, in the case of shares of stock in a corporation will be titled a Stock Purchase Agreement, is quite rare because the buyer, as the new owner, will be assuming all liabilities associated with the business, not just certain selected liabilities, as is the case with the Asset Sale Agreement. When a stock sale, as opposed to an asset sale, occurs it’s typically because the seller has the bargaining power over the buyer to require it as, in some cases, a stock sale can have significantly better tax implication for the seller as opposed to an asset sale. However, as you can imagine because all liabilities remain with the business, in a stock sale the due diligence examination of the seller’s business will be far more extensive as will the provisions in the sale agreement regarding representations and warranties and indemnification and will, potentially, include purchase price hold-backs to secure the performance of the seller’s indemnification obligations. A stock sale creates more risk for a buyer so it’s likely that such additional risk will be reflected in a lower purchase price and/or negotiated payment terms that impair the ability of the seller to realize all of the value of the sale for a long period of time. So again, it’s imperative that the owner take the time to develop and implement a plan for selling the business.
The sales agreement will also address how the purchase price is paid. Ideally, a seller will want all cash on the date of closing. But a buyer may want to make installment payments, essentially paying for the business with proceeds from the business, or the buyer may need further services (such as consulting services to transition customers) from the seller and will want seller to stick around and negotiate a portion of the consideration to be paid through consulting or employment agreements. Even if an all-cash deal can be negotiated, it’s likely that the sale agreement will have indemnification obligations owed by the seller to the buyer in the event that a representation or warranty of the seller made in the sale agreement is untrue.
How the purchase price is paid is dictated by many different factors that are unique to each business, but also to the seller and buyer, who have competing interests related to risk and obtaining the most tax advantageous arrangement possible. Again, taking the time to correctly plan for the sale of your business can streamline many issues in relation to the sale of your business and will undoubtedly aid you in realizing that value which you’ve work so hard to create.
Gregg P. Barnard is a shareholder in the Nevada law firm of Woodburn and Wedge with a practice focusing on business, corporate and real estate transactions. Contact him at 775-688-3000 or firstname.lastname@example.org.
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