Preparing Your Small Business for a Sale

By Jarrod Melson Monday, February 17, 2020

steps to selling a small businessThe first part of the six-part series on Selling Your Small Business provides an overview of the steps a small business owner should take to best prepare and position the business for sale once he or she has determined to sell. The subsequent five installments will discuss related steps to be taken during or after positioning such as: fiduciary considerations for controlling shareholders (in the case of a corporation), and key terms and concepts in typical term sheets and sale agreements, among other things.

In this overview, we assume that: (i) the business is closely-held, meaning that its shares or interests have no ready market for sale and that there are a small number of shareholders, (ii) the controlling shareholder controls the board of directors if the business is a corporation or that he or she is the manager or managing member if the business is an LLC, and (iii) the owner holds a majority of the shares or interests, as well as the attendant majority voting power.

Step 1: Review Governing Documents, Loan Terms and Significant Contracts.

If there is more than one shareholder or member and any shareholder or member opposes a sale, a business owner should consider consulting an attorney to assist in reviewing the governing documents, including any liquidation preference or other right given to specific investors or classes of shares or interests. The owner should also review any key loan agreements or other key contracts for provisions dealing with any required advance notice, acceleration of loan repayments, or termination rights in the event of a sale transaction and change of control. 

Step 2: Clean-Up and Present Financials.

  1. Review Completeness and Accuracy. The business owner should make sure that the financial statements are in good order and kept in accordance with proper accounting standards. The owner should consult an accountant to ensure this is the case, and also to determine what metrics and financial information would be most useful and appropriate in reviewing the company’s financial health and determining an appropriate sale price.
  2. Backing-Out Personal Amounts. It is particularly important that any personal items be removed from the financial statements. Regardless of whether such personal items should be included, it is an undeniable fact that they often are included, and should be backed-out to present a more accurate picture of the business’s results. Such personal items may include, for example, amounts representing lease payments for cars used by family members that are not entirely for business use, amounts spent on health insurance for family members that are only nominally employees, or amounts included in expenses that represent personal expenditures for the owner.

Step 3: Clean-Up Documentation.

The owner should go through all corporate documents, minutes, reports, incentive plan drafts, option grants, certificates, employment agreements, contract and other materials to determine that final, signed copies of all documents are available, and that corporate actions have been duly authorized and papered. In many cases, officers can go back and create paper transactions that were taken without disagreement or discussion, provided that there is no attempt to post-date any document or agreement involving a third party where the post-dating would constitute a fraud or material misrepresentation.

Step 4: Consider Exit Options.

  1. Purchase Type – Insider Purchase or Third Party. The owner should consider likely sale options to evaluate the most likely buyer and consider the pros and cons of each potential type of purchaser.  For example, a sale to a key manager or group of managers may make sense, particularly as they would already be familiar with significant portions of the company’s business and, potentially, its financial statements and financial presentation. A group of insiders may have trouble obtaining financing, however, compared to a strategic buyer or other third-party purchaser.
  2. Business Broker. The owner may need help in finding a buyer, among other tasks, and may want to consult a business broker. A business broker generally specializes in brokering the purchase and sale of small to mid-sized businesses. The broker is well-connected with service providers (attorneys, accountants, valuation agents etc.), assists the owner in preparing the business for the sale and creating marketing materials, and also locates and assists in pitching the transaction to potential purchasers. The business broker will be very familiar with the process, terms and concepts in the sale, and can advise the owner during the process.

Step 5: Prepare for the Post-Sale.

  1. Planning for Proceeds. The owner should begin to consider early in the process the most advantageous means of receiving the purchase consideration for the business. For example, there may be tax-advantageous methods of structuring a buyer’s purchase of the business or transferring the purchase price. The owner should consult his or her financial adviser or accountant to plan the structure of the transaction with the owner’s specific needs and tax considerations in mind from the earliest point.

    The owner should also remember that most purchase agreements in the context of the sale of a business include certain indemnification provisions, meaning that, in certain circumstances and for a limited time period after the transaction, there may be certain costs and expenses that the new owner incurs which must be paid by the former owner(s). As a result, the owner should retain an amount determined by the provisions of the purchase agreement to cover such costs and expenses, should they arise.
  2. Post-Sale Time as Management. A purchaser may require that the owner continue in management for a period of time, given that he or she knows the business best and can aid in the transition of management to the new owner. Also, the owner often is the public face of the business, and continuity of the relationship between the business and its clients/customers is often a key portion of the value of the business. The owner should consider how long he or she would be willing to stay on in a management, board member or advisory role with the company after the sale. The owner should also consider how long he or she is willing to wait for the full payment of the purchase price, as in the case of an earn-out where a sizeable portion of the purchase price is paid out over a period of years based on certain financial or other milestones.
  3. Restrictive Covenants. A buyer will frequently require that the owner enter into restrictive covenants that would take effect for a period after the sale, such as a non-compete, non-solicitation, or other provisions. In a non-compete, for instance, the owner is prohibited from forming a competing business or working in the same industry for a period of time in a given geographic area. A non-solicit prohibits the owner from attempting to bring clients or customers to another business. The owner should have a sense of what he or she would find acceptable in this context, particularly in the context of a non-compete.

Step 6: Prepare a Solid Confidentiality Agreement.

The owner will eventually need to provide a potential buyer with a great deal of information about the business’s inner workings: including proprietary methods, products, clients, service providers, and financials of the business. The potential buyer may not be willing to enter into a confidentiality agreement at first, prior to reviewing at least a basic set of financial statements and other materials, but the owner should hold back truly important information until the buyer executes such an agreement either separately or as part of a term sheet. A confidentiality agreement must be carefully drafted to ensure that it is comprehensive in the information it covers; as a result, the owner will want to create a strong form to ensure he or she enters into consistent agreements and knows what information is protected and how it is handled and maintained.

Conclusion

Selling a business is a major step and it is often a very personal process, as the sale places a price on the time, emotional energy, hard work and self-sacrifice that the founder has put into the enterprise. A sale must be carefully considered and each step planned, as it represents the owners’ last chance to recognize value from the business, and even minor missteps can have significant consequences. For this reason, a business owner should consider consulting legal counsel or another professional early in the process.

Notably, certain consultants offer business sale consulting services on a fixed fee basis, helping business owners to consider all aspects of a sale or other exit and, if desired, serving as a point person for the various service providers involved in an ultimate sale (e.g., lawyers, accountants, business broker, financial advisor, etc.).

Preparation and positioning of your business at an early stage can save significant time and money and can prevent mistakes later in the process. In addition, the preparation outlined above can help to show the business in its best light, and ultimately could result in a higher initial offering price.

*Disclaimer*: Harvard Business Services, Inc. is neither a law firm nor an accounting firm and, even in cases where the author is an attorney, or a tax professional, nothing in this article constitutes legal or tax advice. This article provides general commentary on, and analysis of, the subject addressed. We strongly advise that you consult an attorney or tax professional to receive legal or tax guidance tailored to your specific circumstances. Any action taken or not taken based on this article is at your own risk. If an article cites or provides a link to third-party sources or websites, Harvard Business Services, Inc. is not responsible for and makes no representations regarding such source’s content or accuracy. Opinions expressed in this article do not necessarily reflect those of Harvard Business Services, Inc.

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