Selling a Business & Exit Planning
Selling a business may at first glance seem a simple matter of getting as much money as possible from a buyer and figuring out what the business-owner will do next. In reality, selling is the final step in the exit-planning process that all business owners should, at a minimum, begin thinking about when they start or buy the business. Ideally, the business-owner should start planning their exit long before they’re ready to leave the business.
With this in mind, it’s useful to review some basic exit-planning considerations. There are only four ways for a business owner to exit. Each method has its own pros and cons and strategic planning considerations.
Knowing which exit plan the business-owner will eventually execute allows for the proper long-term planning and action steps leading up to the exit. The ideal scenario is for the business-owner to evaluate these exit options early-on, decide which is the best fit and start laying the foundation for that day to come.
The first way to exit a business is a sale to outsiders. This means the owner will find a buyer who’s not involved in their business or related to the owner. To sell to an outsider, the business-owner would put the business on the market, evaluate offers and negotiate the terms of the deal.
It’s critical to get sound legal, business, financial and tax guidance from your trusted team of advisors leading up to and through the outsider sale. How you sell the business and receive the sale proceeds will have certain legal and tax implications. You may collect a lump-sum one-time cash payment for the business assets, shares of a corporation or membership interest in an LLC. In the alternative, you could collect a down-payment and receive installment payments for the balance. Selling the company itself or only its assets while keeping the company carries its own considerations also.
The second way to exit your business is a sale to insiders. This means identifying employees or partners already in your business who will someday take over and buy it. As with all the exit strategies, the insider sale is best-executed and most beneficial to all the stake-holders when carefully thought out and planned in over a long period of time.
The business-owner should carefully consider the qualities their successor should have to maximize the potential for a successful insider sale. The potential buyer needs to have the right qualities to succeed, including the entrepreneurial vision, drive, financial means, appropriate age and knowledge for running the business, among other qualities.
The method of financing the insider purchase is one of the most important factors. It’s rare for salaried people in any industry to accumulate enough savings to buy a business outright for cash. More commonly, a combination of methods including seller-financing, bank-financing, cash and other methods are used.
Leading up to the sale to an insider, many business-owners pave the way through some kind of a “shadow equity” arrangement. This can take many forms, but essentially, it’s a way to incentivize and reward employees through profit-sharing before they actually own equity in the business. Quite often, the next step is an actual sale or transfer of equity for employees to become minority interest-owners along the way to full ownership.
There have been many studies published on human behavior and motivation. The results are often counter-intuitive in concluding that there’s much more to getting the most out of people in business or other settings than paying them more money. That said, a shadow-equity arrangement can be a very effective lead-in to an actual sale of the business. Among other benefits, it may help get employees thinking and acting like business-owners.
The third way to exit a business is to transfer it to your family. Most often, this happens in a family business when the older generation passes the torch to their successors.
Of all the exit plans, this one comes with the most intangible, emotional and potentially, explosive considerations. For example, it’s common for family strife to result from a variety of situations, including the resentment between siblings when some have contributed to and worked in the business far more than others but all of them end up receiving shares of the business.
The insider sale also intersects greatly with estate planning considerations and tax-planning strategies. Certain types of trusts may be used to hold title to business shares or assets and achieve goals such as reducing tax burdens and asset-protection. Owners of family businesses should also take great care to make sure their estate plans include direction on what happens to the business in the event of death or disability before they’re ready to pass the torch.
On the tax-planning side, much can be done to pave the way for the softest impact to the owner transferring the business to their family. Generally, you’ll want the business to be assessed at the “lowest-defensible value.” The advice of a good CPA will be helpful in this area.
The fourth, and final, way to exit your business is through liquidation. This means simply winding it down and closing out the accounts payable and receivable. For businesses that are systemized and scaled and depend solely on the individual owner(s), this may be the only viable option. Professional services or consulting businesses commonly fit in this category. Without the individual owner running it and providing the products or services, there is effectively no business.
Though any business, including those described above, can be scaled and systemized so that it has resale value, the majority are not. Consider professional service providers such as lawyers, doctors, dentists, CPAs and others. If they never build transferrable systems and operations and lack a team of producers under them, there will never be a market value to the business (other than hard assets than can be sold) because the owner is the business and when they’re gone, so goes the business.
It’s very common for small business-owners to agree to seller-finance part of the transaction. In the right circumstances, this can be a strong, win-win arrangement. The seller will often want a new source of income that would come from a promissory note to replace the lost business income. Buyers often cannot completely finance the purchase with cash and bank loans and thus, welcome the chance to sign a note with the seller.
The way it works is simple. The seller will collect some percentage of the purchase price at the closing and finance the balance through a seller-held promissory note. In theory, a seller could finance the entire purchase, but it’s very unlikely this would make economic sense. Virtually all sellers should insist on the buyer having some “skin in the game” by paying a portion of the purchase price up front.
That win-win allure sometimes makes sellers regret the deal. The main concern to consider is what will happen if the buyer defaults on the payments. In residential or commercial mortgage lending, real property will secure the debt with foreclosure as the remedy for default. In the sale of a business, it may not be so easy to identify collateral to secure the debt. Also, the seller may be in second place and holding a junior-lien to a bank lender, often holding a note secured by the Small Business Administration. As such, it may be difficult to find sufficient collateral to secure a seller-held note.
Many disappointed sellers have been dragged back into the business by having to take it over following the buyer’s payment default. Just no couples expect to get divorced when they marry, nobody going into a business deal expects it to go bad. That’s why CPC Law helps business people “expect the unexpected” and get answers to all those “what ifs?”
Another common contract term in a business sale is for the seller to stay onboard to help as a consultant or employee for some transitional period following the closing. The main thing is for expectations and duties to be very clear and well-understood for all parties. We’ll help you design a very clear and thorough staying-on agreement to benefit everyone involved in the deal. It’s h helpful to remember that if there is seller-financing, the seller has a vested interest in the continued success of the business.
For expert, sound legal advice and trusted-advisor guidance in selling your business, call CPC Law to schedule your attorney consultation.