SELLING YOUR SMALL BUSINESS? START HERE
Take these steps before meeting with a broker.
Whether you are ready to retire, step down or prepare for the next adventure — selling your small business* is more manageable if you understand the process, timing and factors that affect the sale. Most companies can be put up for sale, but to ensure a higher likelihood of getting what you want, preparation and understanding is key.
Although there’s an array of information online on how to sell your business, there isn’t a lot of great information available to help you understand what your expectations should be, in terms of its sale price. During my career at 21st Century Bank, I have advised business owners on how to start, buy, grow, repair and sell businesses. One thing I always encourage my customers to do is start every significant business decision with sound advice.
I am not talking about advice from your broker or another person financially invested in the sale — they can be important to involve, just not for this purpose. I am talking about open, honest information from two or more third parties (perhaps a banker, CPA or business consultant), whose sole concern is what is best for you. Ideally, this advice should be sought at least two to three years before putting your business up for sale. To help get you started, I have outlined a process and points to consider. I welcome you to contact me with any questions you may have.
A couple of quick definitions before we begin:
- Sale Price of a Business = Cash Flow of the Selling Business x Multiple
- Cash Flow of the Selling Business = Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA). This can also be Adjusted EBITDA when it adds back certain expenses that are deemed discretionary, or not necessary to produce cash flow, and deducts foreseen expenses that a new buyer will bear in operating the business.
- Multiple = This is a number (usually between 2 and 5 for businesses that this article targets, of under $3,000,000 purchase price) that the Cash Flow of the Selling Business is multiplied by to produce the Sale Price of the Business. The Multiple begins with researching comparable sales that have occurred in comparable industries and sizes. It should be adjusted for factors like strength of management team and/or corporate structure, breakdown of sales (diversification assessment), structure of transaction (seller carryback involvement and specific terms) and more. Essentially, it identifies the future consistency of the cash flow stream of the business.
Preparation: This requires you to take time to work through some of the more complex aspects of selling your business. Ask yourself these questions:
- What does my management team look like without me? Can someone step in and fill my role?
This is an essential part of understanding what price you may get for your business. If you are an actively involved owner, the cash flow you believe the business makes may be adjusted downwards by a new buyer, as they may need to hire multiple people to fill your shoes. That means more expense for the buyer. Or, without you in the company, the organizational chart may appear weak to potential buyers, which may decrease the amount that a buyer is willing to pay. Begin by assessing your management team and their positions, and perhaps start shifting your responsibilities and knowledge to others in your organization. This requires a time investment, but bettering this situation can help you to achieve a higher sales price.
- Am I willing to stay on with the company post-sale, and if so, for how long?
At times, a company may require that you stay on board to help with the transition.
- What does my customer/client base look like? How diverse is it? Most buyers expect to lose some clients or customers during the transition to a new owner. It is riskier for them to buy a business with only one customer than a company is with 20 customers.
- What’s the direction of the industry I work in?
What is your business position in the marketplace, who are your competitors and to what extent is there volatility in the industry? This and other related factors could affect your asking price.
- What is the optimal time of year to sell my business?
For example, attempting to sell a construction business at the beginning of winter will most likely not net your desired price.
- Am I prepared to make changes to how I have handled business expenses in the past?
Prospective buyers will look closely at all your expenses, especially those that could be considered discretionary. For example, let’s say you make an annual donation to non-profits that don’t play a direct role in producing sales and thus, could be considered discretionary. As the seller, you’ll want to add this expense back to your cash flow, so it can potentially increase your final sale price. That means it’s open to negotiation, and the potential buyer may not accept it.
With preparation, decisions about those discretionary items can be made beforehand to decrease potential complications during negotiations. Essentially, the cleaner the financials and the less adjustments you make, the more likely you are to speed through negotiations and net the final sale price you’re seeking.
- Have I researched to see what other business are for sale?
Check out broker sites to see what other companies are for sale and review their marketing pitches. We suggest you consider those sites, but stay away from contacting a broker until you are more prepared. If you are in the Twin Cities, a Google search of “business for sale in MN” will get you multiple options to review. This can help you gain perspective by identifying who is selling, what they are asking, how long listings have been out there and more.
- How much can I sell my business for?
There are a lot of factors that go into answering this question, but the general definition and some explanation is listed at the beginning of this article. Buyers consider your EBITDA and if applicable, adjusted EBITDA. Also, further adjustments can occur for the following: the condition of your equipment, replacement of key staff, desired accounts payable and accounts receivable cut-off dates, the time of year of the sale and the recent industry growth trends.
Once some range of a cash flow figure is known, then one needs to understand Multiples that businesses in your industry sell for. We call this “comparables.” Just like the case with comparables in terms of real estate sales, adjustments need to be made to reflect the comparison of your business to the businesses that sold.
The combination of your Cash Flow and the Multiple will give you a range of a value that you should anticipate as a Sale Price.
Consider Potential Buyers and Assess Your Financial Outcome: Once you’ve prepared and answered the questions above, consider who you may sell to. Here are some options:
- Public Company:
If a public company is interested in absorbing your business, this may be the best-case scenario for you – depending on your industry. Public companies often have the most resources, expertise to manage the process, and, in most circumstances, are likely to offer the highest purchase price.
- Larger Private Company:
Odds are, there are private companies, more substantial financially than yours, who may be interested in absorbing your company to take out the competition. Or, your business may fit in to their strategic growth strategy. This type of transaction is called a “bolt-on,” where the private company takes your business and “bolts it on” to theirs. The sale transaction with private companies will usually involve cash payment or a conventional bank loan, and it will usually be at a price-point that is between a higher-cost public company purchase and a lower-cost private, individual buyer purchase.
- Private, Individual Buyer (including Employee or Relative):
In most cases, private buyers have less capital and are more risk-averse than the public companies or private companies described above. This type of buyer usually pays a lower price. In this scenario, a private buyer may be looking at acquiring a business like yours, or there may be an employee or relative who may be an option.
In most cases a private buyer will seek a loan through a financial institution for a large portion of the purchase price. They will couple this bank loan with their own personal cash and potentially, a “seller carryback note” to complete the purchase. “Seller carryback” means that, if the buyer defaults on the bank loan, you will likely have a difficult time receiving the loan balance that still remains on your “seller carryback note” at the time of default. The bank holds a priority position on your business. If you wanted to find another buyer, or reassume operational control, you will need to pay off the bank loan’s priority lien to “own” your business again, before operating it or selling it to another buyer.
It’s important to clarify that all sellers would likely sell to a public company if they had the choice. However, there isn’t always a public company that would be interested in absorbing your business. Then you move to another target — a larger, private company. This is most likely the second-best option for you. If you have exhausted all your options with these two targets, you move onto your third option. Understanding this progression is important because what multiple you receive for your business could be a six multiple if it is sold to a public company, a five multiple if it is sold to a large private company, and a four multiple if sold to a private, individual buyer. This price difference can be large, so this is an important point to understand when talking business Sale Prices.
The Sale Process:
Managing the sale of your business can lead you to choose to list your business on a broker website. As mentioned, I strongly encourage you to seek the advice of a non-benefitting advisor first, who has experienced the business sales process before and understands sale prices, multiples and adjustments. It’s essential to have the proper knowledge base before proceeding with listing your business on a broker sight.
Our Advisory Role:
At 21st Century Bank, our outcome for the sale of a business is to help obtain reasonable, fair and realistic results for both the seller and the buyer. We are here to guide you through the process.
Do we want your business? Sure, we would love to have you as a bank customer, but we instead want to start by being of service and leave it up to you to jump on board if you are pleased with our help. We do not get a commission for helping you sell your business. We simply want to provide thorough advice, possible assistance with connecting you with potential buyers and share any loan program options that could assist the financial sales transaction.
If you have any additional questions, or you are ready to start making plans to sell your business, I would welcome the opportunity to talk with you further.
*(Note: the process outlined in this article refers to small businesses under $3 million, and would not apply to ‘Shark Tank,’ technology (application based), or medical device companies. This article primarily applies to manufacturing, professional/service based, retail merchandise and construction industries).
Jonathan Dolphin, President: Over 20 years of banking experience, with a demonstrated history of building a successful organization through thoughtful planning and a focus on talent acquisition and development. Highly skilled in assisting Small Businesses with their unique lending and strategic planning needs. Proficient in the use of the SBA 504 and 7a loan programs, as well as utilization of Conventional Bank lending programs.
17 Washington Avenue North, Suite 200
Minneapolis, MN. 55401