Interview By: Dennis Zink
July 22, 2019
My interview continues with Peter Gruits and Matthew LaPointe on the 10-step sale process for a successful small business exit. At the same time, this process leads to a successful beginning for the person who wants to Buy an Existing Business.
Where should a seller list their business for sale?
If they’re going to sell the business on their own, they can go to BizBuySell.com and buy a listing for three months.
Matt, what if a broker is involved? If they hire a broker, then the broker’s going to accommodate that listing arrangement. Often, brokers will put ads (listing their business) in trade magazines. You don’t want the ad to disclose the name of the company, but to you want to give enough flavor of the company that buyers will have enough information to take that second step, make an inquiry. There are other people who are probably very likely buyers that a good broker would reach out to, such as competitors in the industry or sometimes a supplier or vendor, above or below the chain of that particular company in that industry. Those are often good prospects as purchasers. Reaching out to CPAs and business lawyers like myself is often a good idea. CPAs and business lawyers often know of companies that are on an acquisition mode and are looking for target companies. All of those outlets are good places to look. A good business broker or investment banker will also have their own list of people who they know are in the market or looking for investments. There’s really many options.
Matt, you alluded to confidentiality, why is that important? You certainly don’t want your advertising of your business for sale to be so easily recognizable that people in your company know that the company is for sale. In only very rare cases would you want your staff and employees to know that you’re selling the company. It’s best not to make that known until far along in the process. It maybe necessary to tell your CFO, for example, and your top salesperson, perhaps, but you certainly don’t want it to be common knowledge.
Peter, How much might a seller expect to pay in commissions for the brokerage transaction? Commissions are negotiable and there is no fixed commission. In general, for a business that’s under a million dollars, or the transactions is under a million dollars, it’s not atypical to see a 10% commission charge.
It’s important to know who your buyers are for a lot of reasons. One, you want to make sure it’s not just somebody out kicking the tires. You don’t want to waste your time with somebody who doesn’t have the ability to buy or isn’t serious. Second, often, particularly in smaller deals, the seller will hold some paper and will make part of the loan to the buyer in order to acquire the business. If the seller is holding a note from that buyer, you want to make sure that the buyer is going to be able to pay and has the financial wherewithal to handle the note. Those are the two main reasons.
Peter, receiving an offer is exciting, isn’t it? Few things are as exciting as getting an offer. You’re excited because you put all this hard work into the business. Now someone recognizes that what you’re offering is worth buying. There’s a great tendency to shortcut everything because of that offer. It’s very easy to forget in the excitement of it all, that you’re really getting someone to apply for a job to work your business. You need to ask questions about the availability of cash. How is the buyer going to pay for the business? Do they have proof to indicate if they are qualified? What have they done that would qualify them to take over this business? And how is their experience going to help make this business grow? Those are some fundamental questions to be asked either by your broker or by the seller. That’s part of the qualifying process.
If someone walks into your business indicating that they want to buy your business. You may be tempted to tell them everything about your business, but you haven’t signed a nondisclosure agreement and you don’t have anything in writing. Suddenly you’re negotiating against yourself without knowing if you have a qualified buyer.
According to Business brokers, nine out of 10 respondents to ‘for sale ads’ aren’t qualified to make a purchase. A lot of your time is going to be wasted unless you can figure out how to qualify them.
Matt, should you do a background check on the buyer? I would say it depends on the industry, but that’s certainly not a bad idea. If your industry is any kind of regulated industry, for example, if it’s a restaurant and you have a liquor license, someone with a felony on their record cannot have a liquor license. So, it’s a disqualifier right there. Depending upon the type of business, yes, a background check might be a good idea.
In a transaction like this, time is of the essence. To close a business deal is going to take a minimum 90 days, and sometimes it could take a year. If you are fooling around with somebody who doesn’t know what they’re doing or expects you to finance the whole transaction because they don’t have to put any money down, your time is being wasted. You may be locking up your business and wasting time for an extended period, and you’re taking yourself off the market. Don’t talk to them until you have a nondisclosure agreement in place. Insist that any offer you’re going to get is in writing.
Sometimes you want to add that the buyers not allowed to speak to your vendors, or that they’re not allowed to speak to your employees. Sometimes a buyer will want a lock up an agreement on the part of the seller that they won’t continue to try to find other buyers. That they’ll negotiate with this buyer exclusively. Those kinds of things need to be covered right up front in that very early non-disclosure talk.
Matt, is that referred to as a no shop clause? Yes, a no shop clause is what it’s called.
Matt, when should you meet with a prospective buyer and where should you meet with them? Peter’s right, before you share any information with that buyer, you need to have a good nondisclosure agreement. No offense, but please don’t just take one off the internet and change the names around, please talk to a lawyer about the non-disclosure and get one that’s tailored to your business.
You should meet with them after you’ve qualified them and after they’ve signed a nondisclosure confidentiality agreement. The meeting should probably take place not at your business and not at your office. Anywhere else. Have it at your CPA’s office, or at your lawyer’s office, your business broker’s office, but I wouldn’t recommend having it at your business. We talked earlier about the need to keep the fact that the business is for sale quiet. Bringing someone into the office who’s not someone anyone has seen before, who is looking around, it’s very easy to tip off.
People often learn before you want them to learn. It’s amazing. Somehow the employees figure out that the business is for sale. But you don’t have to help them by bringing the potential buyer right into the company.
Ideally, you want to have a bidding war, but that’s easier said than done. Peter, how can you get a bidding war going where you have several people expressing an interest in buying your business?
A good listing and a good executive summary. Something that points out where this business is going to go, and why. You’ve got to target who your buyer is going to be. You have to have an idea of who you’re going to sell to and why you would sell it to them. This is something that the SCORE Exit Strategy team excels at, trying to focus sellers about what they are going to say yes and no to. You will also have to find out what the experience of the buyer is. The buyer could be a tire kicker who’s going to waste your time and is not going to do anything. Have they ever bought a business before and why is this business appealing to them? You need to find out what their triggers are for buying the business.
This is where the rubber meets the road. This is it. The buyer obviously wants to get the best deal that he can get, the seller wants to get the most money that she can get. It’s a matter of negotiation. Who has the power in the negotiation, well, that depends upon how badly the buyer wants your business, and whether you’ve got a bidding war. If you do, then the seller’s really in the driver’s seat and they can dictate terms, so to speak. I can help compare and contrast the two (or more) offers from the buyers and pick the one that’s better for them. In that negotiation, the business owner needs to do a lot of listening and needs to rely on their experts, the broker and the CPA primarily on the financial aspects. The lawyer at this stage–not so much. In the negotiation, it is usually mostly financial, although there can be some legal issues as well. Deal structure varies significantly. Sometimes a buyer will want the seller to stay on in an employment capacity or in an independent contractor capacity for a period of time. Will that be compensated or uncompensated? At what rate would that be compensated? Sometimes the buyer wants the seller out of the business immediately. That’s fine too. But those are the sorts of things that need to be negotiated.
That first meeting is not let’s make a deal. That first meeting is an opportunity for you to qualify the buyer, and an opportunity for you to say I like you, I’m interested in you, and I have to get back to you on this. Because you don’t want to make a decision the first time that you meet them. You have to do some investigation. Your qualifying process is that first, second or third meeting. A good deal is a good deal, a bad deal, you don’t want to enter. You want to walk away from a deal that’s going to hurt you.
Matt, obviously, the cash in the business is yours, and accounts receivable is negotiable. What would be some advantages and disadvantages of retaining the accounts receivable or having the buyer collect and maybe pay you a percentage?
As you say, it can be done either way. We’re talking primarily about an asset sale. In an asset sale, the company, the LLC, or the corporation, sells what it owns, which has all the equipment and the customer lists and whatever value it has. That can include accounts receivable. The question is, when is it good to sell accounts receivable, when is it good to keep it? Buyers will not purchase accounts receivable on a dollar for dollar basis, they will always want to discount the price that they’re going to pay for the accounts receivable. If you have $100,000 in AR, they will perhaps offer 80% or 75%. Why? For one thing, they don’t know the collectability of these accounts. They don’t know whether these accounts are strong or weak. When I’m representing a buyer, we ask for an aging of the accounts receivable. We want to know how much of that is net 30 days, how much is net 90, which is 120. Anything over 90, we discount pretty heavily.
There is some negotiation here, if you’re going to sell the accounts receivable at what discount are you going to sell it? Now, you may decide not to sell it all, and to keep it. A factor there is will you have the wherewithal to collect it? Most companies have somebody or in big companies, they have a staff whose responsibility it is to collect the accounts receivable, to send out the reminder notices and pick up the phone.
Once you sell your company, you no longer have that person or that staff. So, you’re probably going to have to do it yourself. Is that something you want to bother with or be bothered with, or is that something you want to do? Is it better to take the 80% of it and go home? It’s a matter of judging those factors and deciding what makes the most sense for you.
Matt, please explain what an earn out is and how that plays into a transaction?
An earn out, I would call it a contingent part of the purchase price. What the buyer is trying to accomplish with an earn out is confirmation that the customers that it’s paying for, the goodwill that it’s paying for materializes after the deal. An earn out is an incentive to the seller to do what’s necessary to make sure that those customers remain with the company and that that goodwill is passed along. Often, it’s done in a way that the seller might stay on as an independent contractor or as an employee of the new buyer to ensure the transition of those customers.
There are often certain milestones that have to be met, certain numbers that have to be met for the seller to get that extra money on the sale price.
Peter, what about installment sales and how that affects taxes?
In an installment sale, you consider the present value of the dollars and this is an opportunity for a seller to get a greater benefit. It’s important that the seller has a strong level of confidence as to what the business can produce. Some installment notes can run as much as five or 10 years. It really depends on the nature of the business and the credit worthiness of the buyer. Tax deferment generally mirrors the receipt of cash.
Matt, at this point, we’ve agreed on the deals terms, is the letter of intent ready to be created? Yes, I would say a letter of intent would happen after you’ve got the outline of your deal. The basic business structure is set, and oftentimes the broker will draft the letter of intent. I would recommend you have the lawyer take a look at that letter of intent before it’s signed. Because there are some things that should be covered that aren’t always covered. Yes, the letter of intent would be the next step and then after that, the actual drafting of the purchase and sale agreement.
Peter, when does due diligence come into play? It comes after you have a deal. Now you’re going to have to check out what elements of the deal are valid and what are the flaws in the deal. The letter of intent is not something that you just accept because somebody wrote a letter of intent. Your advisors, your attorney, your accountant, your SCORE mentors have got to look at that letter of intent and see if it captures your point of view, in reference to the spirit of the deal. Whether it’s a good deal or not. A letter of intent, will have some element of good faith money. But that good faith money is not like a deposit on a house. If you don’t come through on the house, I get to keep the money. A letter of intent that usually is not the case.
After the letter of intent, you get to what we call the definitive agreement. It’s usually in the case of a smaller business, an asset sale, an asset purchase and sale agreement. That’s the primary document. Oftentimes attached as exhibits to that document are other documents that are going to be signed at the closing.
If I could just analogize it to a house, when you go to buy a house, you sign a purchase and sale agreement. That’s not the actual purchase of the house, that’s the promise to buy the house 30 days from now, or whatever it is. At the closing, the seller delivers to you a deed. That deed is what physically and legally transfers ownership of that house. In the business context, the asset purchase agreement is the purchase and sale agreement. At the closing however, there are a number of documents, including the equivalent of the deed, which is called the Bill of Sale.
But there are other documents that need to be delivered at the time of closing. A lot of lawyers will prepare the asset purchase agreement and then put as exhibits to the asset purchase agreement, those documents that will be expected to be signed at the closing so that both parties know exactly what those documents are going to be.
Now, what are those other documents? Well, I’ve already talked about the Bill of Sale. There’s also often a non-competition agreement. If I’m a buyer, I’m insisting that there’s a non-competition agreement because I want to make sure that that seller doesn’t sell me the business and then go and start a new one five miles away, to compete with me. Another important document is the promissory note. If the seller is going to be loaning some of the purchase money to the buyer, a promissory note documents that. Now, the promissory note should also be secured by something. Oftentimes, we’ll use a security agreement in an asset sale. That is usually a second position on the part of the seller because the bank has financed the primary amount of the purchase price, and often we’ll ask for a personal guarantee from the buyer as well to guarantee that note. Those are basic documents.
What can a seller do to help things go smoothly?
You need to get good experienced advice as you go along. And then you need to be careful that you pay attention to all of the details. Every detail in the deal can come back and bite you. If you miss one element, it could be something that you face for two or three years in the future. Once again, don’t sign anything unless you really know what you’re signing. Don’t sign anything unless you really have thought it through, and you have planned for it.
Matt, what can go wrong with the deal at the end especially as it relates to leases and landlords?
Peter is absolutely right, it’s the details. I always make a checklist of all the items that I need to make sure I’ve covered before we get to that closing table. One of the big ones as your intimating is the lease, the situation where the business is located? Well ahead of time and well ahead of the closing. Do not wait until the day before the closing. The buyer needs to start talking to that landlord about either an assignment of the lease from the current owner to the new owner, or a new lease to take over once the new buyer gets in. That’s one of the things that will often throw off a closing is if they haven’t gotten a relationship with the landlord set up. Another thing that throws off the closing is when you don’t have your financing lined up. This is very frustrating sometimes. The banks usually will give the buyer a long list of all the items that they need. If you don’t get them everything on that list, they will not give you the money, they will not close the deal.
If I may be of help to you whether you are buying or selling a business, please reach out to me at [email protected]