How do you know what your business is worth? Most owners struggle with answering that question, but for a business owner, knowing the true measurement of your business’ value is a critical step before planning to sell that business. Today’s podcast is the first in a three-part series that will discuss the valuation of your business and the variables involved in the process of selling your business. We’ll be providing an overview today on the subject of how and when to plan ahead to sell your business in order to help owners be proactive throughout the process. Our goal is to help you learn about when to plan to sell your business and understand the process of business valuation before making that big decision to sell.
What we cover in this episode:
- 02:31 – Defining growth and value
- 06:46 – How soon to start planning the sale
- 07:30 – The importance of sustainability
- 09:48 – How late is too late?
- 11:21 – Structure of the sale
- 18:42 – Tax considerations
- 20:24 – What is the buyer going to look for in your business?
- 23:26 – What type of business valuation do you need?
- 25:18 – Bringing in professionals to minimize risks
Defining growth and value
In order to do a deep dive into this topic in later episodes, we need to lay the groundwork and start with the definition of growth and value in the business world. So, what does growth actually mean? Is it growth in revenue, growth in personnel, or adding locations? All of those things are related, but the true measurement of business growth is the value of the business itself. Now, what is value? The value of a business ultimately is what a willing buyer will pay a willing seller. Now… What exactly does that mean?
If you can put yourself in the position of the buyer, the definitions may become a bit clearer to see. As a buyer, what would you be looking for in a business you want to purchase? One way to gain perspective of a buyer is to look at the stock market. Larger businesses trade on the stock market, but smaller businesses don’t have that readily available. They are similar, however, from the outward perspective in the idea of stock prices. The price of a stock shows the value of that business and takes into consideration the many different factors that affect the value.
How soon to start planning the sale
We do get questions from clients from time to time regarding how soon is too soon to start planning the sale of their business. The answer really does revolve around what your ultimate goals are for yourself as an owner. Whether you are just a few years into your business, or on the tail end, and if your ultimate goal is to maximize the profits from the sale of your business in the future, then the answer may seem a little cliche, but it’s really never too soon to start planning. We typically say you should be thinking about this at least five years in advance, which we will discuss in the next section, but you can really start planning as soon as you start your business. There are many factors to consider and it’s a marathon, not a sprint, to create a business that has the sustainability and value you will want in order to sell.
The importance of sustainability
As you grow your business, you will want to make it sustainable. You’ll want to keep a pulse on the respective value of your business because that is what truly shows how you’re growing, if you are growing well, and if you are effectively adding value to your business. Some business owners do think they have a very valuable business if their business is lucrative, but that’s not the only thing that generates value. You will of course want to make good revenues and profits, but you also have to build a business that someone can step into and have the same continuity to give them a return on their investment. You should have good systems and structures in place so that you’re not required to be there to have sustainable growth. A business that has these things in place, and can continue growing without you as the owner, can make a buyer very interested and willing to pay top dollar.
How late is too late?
If you want to sell your business next month, it’s probably not the best time to start thinking about these things, right? We certainly don’t think so! You don’t want to end up in a fire sale situation. The more desperate you are to sell, the lower the price you’re going to get, and you won’t have the time to properly prepare.
Our advice to business owners is that you want to start planning at least five years in advance before you sell, if possible. Planning this far in advance can allow you the time you need to get a business valuation done, address any weaknesses, and explore areas that could build more value. Most buyers will want to see at least five years of financial statements and tax return history when deciding on a business purchase. Having a stable financial history in place, establishing key personnel in positions for several years, and showing that stability can put a business owner in the best possible position to sell for the best price. Owners should also keep in mind that this process doesn’t happen overnight. A private business sale is not like trading in the stock market, and the sale process can take up to a year or two, and perhaps longer.
Structure of the sale
There are many considerations when selling your business. Looking at current trends in your industry and marketplace may help you decide how you structure the sale of your business. There are some important points to plan for when structuring the sale, so you want to be sure you are ahead of the curve when you begin planning. You should be thinking about the basics first, such as liability issues, complexity, and tax implications. There are typically two structures when selling a business, a stock sale or an asset sale.
The stock sale is just as it sounds and is similar to the version of a stock market sale where you provide a piece of paper to the buyer for the set price, and they take ownership of the same business, same business name, same corporation, LLC, or other structure. It’s a straightforward and simple process. Even though it’s a simpler process, many buyers don’t like to use this type of structure because when they purchase the stock, they also buy every liability and the potential risk associated. This means that if someone in your customer base decides they want to sue for an issue that happened prior to the sale of the business, the new owner would be liable.
An asset sale is where you take all of the assets in the business and you sell them to the new buyer. The buyer will most likely set up a new company, or absorb into a current business to receive the assets. This option is a little more complex because every asset within a business has different tax ramifications, and you will want to work with a tax professional to understand what those ramifications are before coming to an agreement. The business price also needs to be allocated to every asset, and the buyer and seller have to agree on that allocation and treat it the same way. This typically becomes a negotiation process, because a better tax situation for you, as the seller, is usually worse for the buyer. This process can be difficult and time-consuming.
When you reach a sales agreement with the new buyer, you may structure the sale to have the payment up front for the business, or it can be an owner carry which pays the seller over time. We advise our clients to be cautious with the owner carry situation because you’re no longer in control of the company and how it performs, and you may or may not get paid. You can set up vesting schedules so that if they default you can take ownership of the company back, or even have it structured so that the buyer stays on for a period of transition time from one owner to the next. Just remember there are options, and understand the risks that may come with all scenarios.
The number one thing you want to take out of this is to UNDERSTAND THE IMPACT. This topic can be very stressful for many business owners, so planning ahead and being aware of what to expect is key when selling your business. You will want to know upfront when you set that sales price what the tax implications will be and what you’re ultimately going to get in your pocket.
We strongly advise that you should work with a professional, no matter the structure of the sale, stock sale or asset sale, so that you can be as informed as possible and have no surprises when it comes to what you will be adding to your retirement savings or nest egg. We plan on getting into some specifics in our upcoming podcast, the third in this series, and dive deeper into a case study on this topic in the very near future.
What is the buyer going to look for in your business?
Normally, a buyer will want to look at three to five years of information before a decision to make an offer to purchase. They will be looking at your financial statements, balance sheet, profit and loss, and cash flow statements to gauge the value and stability of the company. The buyer may want to have an independent professional come in and do an analysis and business valuation. They will look at your infrastructure, client list, your team, and gauge how sustainable the business is without you.
You should also be sure to have a non-disclosure agreement in place before you give out any information to a third party, in order to prevent them from sharing this sensitive information with anyone. The information that you will be sharing is extensive and protecting yourself and your business is critical. Having that signed non-disclosure agreement in place before you begin is an important step not to ignore.
What type of business valuation do you need?
We are getting into the details of business valuations in our next episode, the second in this series of three, but we want to establish that there are different types of valuations. They vary in pricing depending on complexity. Planning ahead and budgeting for this expense when selling your business helps you know what to expect.
A business valuation provided by an expert can vary widely in cost but depends on your needs, size, and complexity of your business. The cost for an informal report can cost a few thousand dollars and can be useful in planning. On the other hand, a full, formal report that can stand up in court and details everything about your business can land somewhere around $20k.
Bringing in professionals to minimize risks
Seeking assistance during the sales process seems like a no-brainer, but what type of expert professionals do you need to engage to minimize your risks? A CPA can obviously assist with the tax implications of the sale, but you will also need a good attorney. Your attorney will be assisting with the non-disclosure agreement, and will likely work with your team to help determine what the best outcome is for you. Ideally, you’ll want to find someone who specializes in contractual law and has experience in your industry.
A good attorney can look at your business holistically, review all of the agreements you will need, and work as a team with your other trusted advisors. Having expert professionals collaborate and coordinate together is ideal for you as the business owner, and will put you in the best position for a positive experience in the sale of your business. Remember that PJS & Co. CPAs has a free discovery call that you can hop on at any time if you have any questions, or you can shoot us an email at firstname.lastname@example.org.
Planning ahead to sell your business is an important part of the selling process, and getting started sooner rather than later will put a business owner in the best possible position for the best possible outcome. You should understand the full implications of the sale before signing anything, or putting your business on the market, and it is imperative in order for an owner to walk away with what they need when selling their business.
In this episode, we cover the basics and some terminology you will see in the process of selling your business. This is to lay the groundwork for the next two episodes in this series, focused on business valuations and business sales.