Our goal in this three-part “Selling Your Business” series of the Cultivating Business Growth Podcast is to help business owners understand all the variables involved and show up better prepared when it comes to selling their businesses. In this third episode, we are going to talk about how to avoid common pitfalls that may come up during the process, as well as discuss some insights and real-world examples. We are speaking today with Jami Johnson, vCFO, Partner and Co-Founder at PJS & Co. CPAs, tapping into her expertise in the subject, and reviewing scenarios and case studies from the real world.
What we cover in this episode:
- 02:30 – Emotional fitness
- 06:20 – Don’t try to sell your business alone!
- 12:41 – Real-world examples & implications
- 14:00 – Company structure implications
- 18:58 – Taxation implications
- 24:28 – The changing times implications
- 28:46 – Misconceptions in equity implications
- 37:38 – Multiple bumps in the road
Per Jami “The number one underlying theme when you get into this process, whether you are a buyer or seller, is that the process is a marathon, not a sprint.” You should have the emotional fitness you need to go through this process because it can be very draining, and it is important to prepare yourself for any unexpected pitfalls or surprise circumstances that may arise. What can seem like a smooth process from the outside, can actually get messy in the real world. It was discussed in our first episode in the series that you have to prepare and ramp yourself up to go through this process.
You don’t want to walk into a process like selling your business unprepared. You hold much more power when you have the information you need about what your business is worth, its value, and a fair price. From an emotional fitness perspective, you need to be ready to hear from people who may have just taken a guess at the value of your company, not done their due diligence, and be ready for the highs and lows of that situation. There may be instances of highs where you’re thrilled and can’t believe someone is going to give you X amount for your business, and the lows of thinking “is this ever going to close?”, or “why aren’t they communicating?” Emotions tend to run high on both the buyer and seller’s sides. You should know your position in the market, and fully understand the implications of the sale before signing anything. The selling process can be draining, and there may be a large amount of back and forth, and quite a bit of waiting, so you should build your stamina to go the distance in order to have a strong position in negotiations.
As a seller, you need to understand why buyers may walk away, and if you have multiple buyers walking away, that could be a problematic sign. As a business owner, you’ve invested time, money, blood, sweat and tears, and you don’t want to settle, which is why getting a business valuation and setting clear and realistic expectations is crucial. You can put yourself in the best position possible with your emotional fitness if you have a strong foundation and know what your business is worth when navigating these types of negotiations and situations.
Don’t try to sell your business alone!
Having an excellent advisory team and good resources available during this process is very important because it will allow you to know where you stand at all times vs. trying to feel things out by yourself. A strategic advisor will be able to identify problems and give advice, offer corrections, and will help guide you as the owner in the right direction. It’s always better to know about errors or opportunities before you start the selling process than to find out later. We spoke at length about knowing what your business is worth in our second episode of this series and advise owners to have a trusted advisory team to get the correct and proper valuation of their company well before they begin the selling process.
An advisory team will be able to look at everything in your business from an unbiased perspective. They will look for improvements for the future operations of the business, improvements in processes, and changes that can increase the value of your company. An owner may need time to process and understand the proposed changes, and they may be hard to hear. If there are multiple owners in a business, an advisor can help the leadership team communicate and get on the same page to avoid any misunderstandings. Having cohesiveness amongst your leadership team and your owners is extremely important before entering into this process. You need to know where you stand, what you are willing to do, and it will save time on the backend. When you enter negotiations, it’s uncharted territory so any work you can do beforehand will serve you well.
Real-world examples and implications
Because the real world isn’t perfect, real-world situations can get messy. There is no cookie-cutter template for the sale of a business, and what you may encounter during this process and during negotiations can be completely different than what you would expect. We want to give real-world scenarios where errors were made, how to potentially avoid those errors and minimize risks.
Company Structure Implications
In one instance where PJS & Co CPAs was hired to consult, the selling process took two and a half years. Due to errors made prior to our firm’s involvement, there was a large amount of time and money spent by the seller, as well as the buyer, that could have been avoided. The PJS & Co CPAs team spent time doing due diligence and discovery and getting familiar with the business itself. The owner was considering a stock sale vs. an asset sale, and it was discovered that the previous professional financial team had actually made an error from a tax perspective that had to be disclosed to the buyer in order to be fully transparent. All the calculations made by the PJS & Co CPAs advisory team were given to the buyer so they could review, but the buyer decided they wanted to have their own discovery done and brought in an external CPA firm to validate the calculations and represent them in the sale.
The expense of the negotiations quickly escalated in this case, with multiple lawyers and CPAs involved representing both sides of the transaction, all working to get the side they represented in the best possible position. It was an unexpected expense and a really expensive one that could have been avoided if the original mistake had been avoided. The original financial team could have been more proactive in their tax approach and discussed company structure solutions that would have avoided these issues. It is best to work with professionals who are experienced, take a proactive approach, and establish checks and balances that can help catch errors like this before they become larger problems.
When we were brought in to evaluate another firm for a client, we first looked at the structuring of the business to determine if changes could be made prior to the sale to reduce the taxation implications. Since we were brought in later in the game in this instance, there was not enough time before the sale to make any changes. In this instance, if our team had been involved to provide proper advisory, we could have elected to split the company’s assets up, and then sold them as two different companies, saving the owner quite a bit of money from a taxation perspective throughout the years, (potentially hundreds of thousands of dollars) as well as increased the profits for the client at the time of the sale.
It is very important to be proactive regarding taxation implications and have a solid tax foundation when considering and planning to sell your business in the future. This is why we at PJS & Co CPAs always preach to begin planning early and advise to start at least five years ahead of time. Changes in legislation and tax codes can happen at any time, and they can really affect your business. Owners need to ask themselves if their current CPA or financial team are keeping up with those changes, and what the standards are for their industry. If you are not having those conversations with your accountant or financial team, it can affect your business health and should be a red flag for owners that needs to be addressed.
The changing times implications
When you are looking at the companies that are currently selling, the majority were most likely formed over the last 20 to 30 years, say in the early nineties, and at that time there were only three options when it came to company structure; sole proprietorship, partnership, or a C-Corp. Many owners felt comfortable with those choices, especially the legal liability a C-corp provided. But as the two thousands rolled around, the limited liability company and partnership options came about and changed the game. Without the help of an experienced advisor, the options to make changes in their business and structure, changes which could minimize risks, were not implemented.
We had a client in the past where their CPA did not set up their structure properly, did not know that they qualified for a new option that would have given them the same veil of protection that they were currently structured under, and would have allowed for a better taxation liability position. Perhaps the CPA they were working with was not well-versed in the various options available and the changes that could have been made, and the owner did not want to change CPAs since they had built a trusted relationship over time. In this instance, as well as most, it’s critical for an owner to educate themselves and not be afraid to ask questions, because it could cost you thousands, or hundreds of thousands, of dollars.
Misconceptions in equity implications
It is very important to have a good, strong equity position when selling your business, but there is a common misconception that we have seen when owners try to build equity in their company. Jami shares that some business owners think that in order to sell it at a higher price, they should not take a distribution or pay themselves, and keep all the money in the business. This can turn out badly for an owner because it can impact the valuation of your company, cash flow, and lending abilities, etc.
Once again, it’s important to have a strong advisory team in place to help navigate any of those negative implications. As we mentioned in our first podcast episode of the series, you have to be able to look at the sale from a buyer’s point of view, and if the buyer sees that the owner has not paid themselves very much over the past 20 years or so, it could be a red flag for the buyer.
The buyer won’t be very interested in any emotional attachment the seller has to a business they are interested in buying, and will not pay for sweat equity in building the business. The sacrifices you, as an owner, may have made in missing your child’s games every Saturday for the past 20 years, is not what will increase the value in your business. A buyer is not going to pay an owner for their hard work, but pay what the business is worth and the opportunity and the potential that they see in their future position as the owner.
Multiple bumps in the road
The situations we discussed today are about what can happen when you have a bump in the road when selling your business, but what if you encounter multiple bumps in the road along the way? The answer actually comes down to having the solid foundation in your business that we’ve talked about throughout this three-part episode series. Putting yourself in the best possible position for a sale and being able to get over multiple bumps that you may encounter includes knowing all the factors that will help minimize any risks. You should know your financial position is solid, have a good advisory team and know where you stand, know your market and the value of your business, be all on the same page if partners are involved, know your limitations, and be able to walk away from a deal if necessary. You will need this strong foundation to overcome bumps in the road. In order to put yourself in the best position for a positive outcome in the sale of your business, you have to know that the preparation process is part of the selling process.
The return on investment that an owner can get in preparing for the unexpected that may come up in the sale of their business can be invaluable. Being prepared will put you in an offensive position during a sale, allow you to stand tall, minimize stress, and navigate any unanticipated situations that may arise. Remember that this process is a marathon, not a sprint, and think of the old Boy Scout motto of “Be Prepared.” If you are planning to go through this process in the future, know that we here at PJS & Co CPAs are available for a free discovery call, and you can speak to our virtual CFOs and get some real-world advice.