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There are many reasons to sell a business and hopefully it is the attainment of goals and the realisation of a positive financial outcome for the founders and shareholders.
Common questions, issues & challenges:
Selling a business is often the pinnacle of a business owner’s journey. Having invested a lot of time, cash and heartache into your business, you want to make sure it was all worth it but there are things that will undermine the value of a business if you don’t get them right early.
What is my business worth:
There are just a couple of ways to value a business. You are either selling your assets and an amount for good will or you are selling the future earnings of your business. Most businesses we support are assessing your past, current and future earnings and then applying a multiple based on current market conditions.
Simple valuation example based on EBIT multiple
The actual multiplier your business may achieve will be based on many factors, but the most common starting point of any Due Diligence will include;
Vendor’s assessment of how well the business is run,
how big are the synergies are with thepurchaser’s own business
how much risk there is in the deal (key driver of the EBITDA mulitplier.
For the purposes of this example, we assume a mid point of 6 times.
Valuation of the business is $1.5m x 6 = $9m
Now let’s look at a counter example:
What if earnings looked like this:
- Last year $1.5m
- This year $1.2m
- Next year $1.7m
And when the purchaser took a look at the business, they found the following:
In this instance, the purchaser might make the following assumptions:
In this example, the valuation of the business is $3.6m which is a significant difference from the $9m valuation, even though the 3 year earnings are the same.
Hopefully from this example, you’ll see the value of getting your business ready for sale ahead of the time when you actually want to sell it. This is one the major areas a board can add value to your business, by optimising those parts of your business which will add value in the purchasers’ eyes.
Who will buy my business & how long will it take?
There are generally 3 types of purchaser:
- A competitor or other existing industry player who wants to buy your marketshare, team & capabilities.
- A private equity group who is looking for investment opportunities for their investors. They may for example be looking to combine your business with others.
- A management buyout where the company is sold to members of your staff.
How long does it take to sell a business?
The sale process involves a number of steps from marketing your business to the final exchange of documents. It’s not unusual for this entire process to take 6-12 months, though there are rare examples of it happening faster than this. The message to take away though is that once you decide to sell, there’s a process to follow which is almost another full time job in addition to the running of the business.
What is the sale process?
There are 6 steps in the process of selling a business:
- Preparing the information memorandum (IM)
- This involves pulling together your sales pitch. What has been the company’s performance, what are the future opportunities and why is this a good business to buy.
- Getting help with preparing this document is crucial for three reasons:
- Firstly, it needs to be presented from the purchasers view point. This is very hard to do for most owners who are too close to their business and the vendor’s perspective.
- Secondly, the professionalism of this first document sets the tone of how professionally the business is run (and therefore sets early valuation expectations).
- Finally, all businesses have some rough edges and how these are disclosed and explained in the document is critical to maintaining a good valuation.
- Marketing the business to potential purchasers
- In many cases, you will know the other industry players who could benefit from owning your business and this is a good place to start.
- You may choose to engage an M&A advisor who proactively markets your business to these and other private equity or high net wealth individuals.
- Negotiating a term sheet
- Once you have one or more firms interested in your business, the next stage is to negotiate a term sheet. This is a document that essentially spells out the price and terms, assuming everything found in due diligence is the same as has been represented in the IM.
- Having an experienced advisor on your team or even better, leading this part of the negotiation can add a lot of value to the end result.
- Conducting Due Diligence
- Once the term sheet has been signed, the purchaser will then want access to your documents, staff and potentially key customers. The DD process can be quite exhausting and take one or more months to complete. It also includes a review of your contracts and tax affairs to make sure there are no unexpected liabilities that the purchaser will be liable for after the sale.
- Negotiating the Share Purchase Agreement
- Having completed the DD process, the share purchase agreement is then negotiated. This should broadly reflect the Term Sheet, though there may be adjustments based on what’s found during DD.
- Finalising the sale
- Having concluded all negotiations, final settlement takes place. For many owners though, the job continues as they then enter the earn out period.
Will I have to work for the new owners and if so, for how long?
When selling your business, you see the potential in the years ahead and you want this to be factored into the sale price. The purchaser may agree with this logic, but needs to manage the risk of the business not performing as promised. The way they do this is to set an earn out period where you will work in the business and a portion of the sale proceeds will be withheld, to be paid at a later date. It’s not uncommon for an earn out period to be 1 or 2 years from the date of sale and for the contingent component to be up to 25% of the agreed price.
Take the example above, of the $9m agreed purchase price. The purchaser may only pay $6m at the date of sale and the balance may be paid in part after 1 year and the balance at the end of the 2nd year. These terms are set during the Term Sheet negotiation and it’s at this point you’re able to put forward your preferences. You may for example, not want to work in the business after the sale, in which case, the purchaser may take a more conservative view of maintainable earnings and what they are prepared to pay.
They key takeaways from this should be that selling your business is a job in and of itself. If you lean into it and do it properly, with good advice, you will maximise your return. Ideally, the journey toward a sale should start 3-5 years before you want to exit. The value of a board during the process is to identify the things that need to be fixed or strengthened so as to maximise both your maintainable earnings and the multiple that someone will pay for them.
If you’re starting to think about selling your business and would like to discuss the process in more detail, contact us to arrange a chat with one of our experienced M&A advisors.