You could be running your business for years with no thought of selling your business, and then you get a call out of the blue from someone who wants to buy your company. If the call interests you, you’ll want to: Display your business in a fashion that maximizes value; negotiate the terms that minimize taxes; and make sure you can replace your business cash flow with a new income stream.
Let’s first acknowledge that we’re not using that word correctly — you didn’t receive an offer. You received a solicitation to hand over your confidential information to an acquirer, who might make an offer.
According to a study printed in the Journal of Applied Social Psychology, when you ask people if they are better than average drivers, eight out of 10 say that they are. The majority believe they are exceptional drivers. Similarly, most business owners believe their “baby” is worth more than average — even valued at an exceptional premium. Many business owners are insulted at most offers (if they even receive one).
You need to display your intangibles, such as operational efficiency and human capital, in a way that maximizes the offer. Your instinct may be to negotiate the deal yourself. However, negotiating a multimillion-dollar deal is like going to court — you could represent yourself. But it’s prudent to engage a professional. Studies have shown that an adviser can add up to 20 percent to the selling price of a company.
You will begin discussions by signing a nondisclosure agreement (NDA). You will then provide the potential buyer with confidential information. After signing the NDA, you might wonder why your confidential information becomes nonconfidential in one year? Why are only the items marked “confidential” considered confidential? And data should be aggregated or blind, not specific. You want to protect customer names and contact information. You also don’t want to provide employee pay and benefits information. If the deal doesn’t go through, that information will make it easier for competing firms to poach your workers.
You may sign an NDA with an exclusivity clause that doesn’t allow you to shop around for other buyers. If so, you should ask for reciprocation so that the acquirer doesn’t simultaneously court your local competitors. However, be cautious about agreeing to that. One buyer is nearly the same as having zero buyers; you have no competitive bid on price or terms. Suppose a buyer knows that an advisor is reviewing the deal and competing bids. In that case, the acquirer is more likely to offer a better price and terms to sweeten the deal.
Many owners sign an NDA and move forward with a letter of intent (LOI) that sneaks in a no-competition feature. This is called a propriety deal. An LOI represents due diligence commitments from both parties, which are used to draft purchase agreements reflecting the conditions that both parties had agreed to.
A professional review of the LOI is critical because it gives you strength in the final negotiation. The LOI should describe the acquirer’s metrics to formulate the valuation. After an LOI is signed, the purchase price and terms rarely improve as the buyer scrutinizes all aspects of your business throughout the due diligence period. The acquirer will try to justify lowering the price or altering the terms during this process.
The biggest question is, if you sell your business, can you maintain the lifestyle you’ve become accustomed to? What will your post-close life look like? Will you remain with the firm for some time? Will your company be combined with the acquirer’s current operations? Are there earnout payments depending upon future performance? Are those earnouts based on profits or revenue? How much control do you have over those once you make the sale?
Is the deal all cash, or will you retain equity in your or the acquirer’s company? Will the new buyers be a good steward of your legacy? Will they maintain the quality of your products and services, provide financial opportunities for your employees, and support your community?
Many business owners are comfortable with the reliability of the steady stream of income the company produces. However, they are less expert in converting the business sale proceeds to an income-producing investment portfolio. Although owners often have a value in mind for what their company is worth, it’s always inflated. Whatever you think your company is worth, it’s worth less to the acquirer.
There are risks to running your business. An outside force could upset operations. You could lose key personnel due to health or retirement. There is increased competition. These risks represent a reduced probability of attaining a return on their investment to the acquirer.
Also, the tax implications are often misunderstood. Stock sale versus an asset sale. Promissory note versus earnout. Payments, stated somewhere in the fine print, for consulting and taxed at the higher ordinary income rate instead of the lower capital gains rate. If you sell your business for $30 million, for example, it’s easy to unnecessarily lose an extra $5 million to taxes if you don’t structure the deal correctly.
Selling your business won’t make you rich; it will make you liquid. Being liquid brings a different set of risks. One thing you wouldn’t do with your proceeds is invest all your new cash into one single microcap stock. However, when you own your own business, that’s kinda what you’re doing. Despite all the risks of owning our own companies, we feel more confident in what we’re doing than how someone, or something, else might perform. It can be unsettling to shift from the perceived long-term reliability of your company’s income to something less familiar.
The unknown can be scary and dangerous. Business owners often don’t know how much income they’ll need to replace. Oh, they think they do. But they don’t.
Kayla owns a limousine and transportation company in Leominster. In 2021, she received an unsolicited offer from a competitor. In her late 50s, Kayla wanted to determine how much she would need to clear after taxes to convert the proceeds to a $650,000 after-tax income stream without having to touch the principal. That part is easy ($20 million should do it; $10 million would be OK if they didn’t mind eating into the principal). However, calculating that income proved deceiving.
Kayla leased her personal cars through the business. She put dinner on the company card, asking facetiously, “We talked about business, right?” She had a personal assistant on the payroll. Some of her vacations were extended conference stays. Her family’s life and health insurance were expensed through the business. Owner perquisites add up. Kayla’s adviser determined that she was expensing about $75,000 of personal services through the company annually. That amount would have to be added to her $650,000 target.
Getting an unsolicited offer can be flattering. But there’s a lot of work to be done between getting that call and receiving the best possible offer.
Allen Harris is the owner and founder of Berkshire Money Management and 10,001 Hours in Dalton. He can be reached at email@example.com.
This column appeared originally in The Berkshire Eagle on January 27, 2022.