Episode 20 - Preparing a Company for Sale
Episode 20 – Preparing a Company for Sale provides insights for any business owner who intends or is considering placing their company up for sale. What are the crucial steps in the process of selling a business? What are the reasons for selling and how does the seller wish to position themselves for the future?
In this substantive podcast transcription of Episode 20 – Preparing a Company for Sale Jan goes step-by-step through an overview of the process. What are the issues the seller should be considering? How will you prepare your organization for sale while maximizing the value of the company? Is this going to be an asset purchase or stock purchase?
What do you need to know as an owner if you are thinking about selling your company?
Jan
Welcome to AB Cast, integrating Legal Tax, accounting and Business Solutions. I’m Janathan Allen. Welcome to our podcast Preparing a Company for Sale.
Neil
Jan, when we talk about putting a company up for sale, what do you find is the most surprising thing that most business owners miss when they start considering putting their company up for sale?
Jan
Well, I think the thing that surprises most company owners is when they get about halfway through the sale and they realize that they were totally unprepared. Most company owners, when they think about selling their companies, don’t realize the extent that preparation will ease that transition, make it easier to negotiate and make it faster to close the deal. But the process of due diligence covers all of the substantive areas in a business, and that includes accounting, tax, and corporate governance. And the preparation requirement for each one of those substantive areas demands a lot of attention prior to asking anyone to come in and buy your company.
Neil
So what are some of the most important questions that a business owner should be asking themselves when they’re thinking about putting their company up for sale?
Jan
Well, I think the most important question that someone needs to ask themselves is why do you want to sell? And who are you going to sell your company to? The why is generally because an owner is feeling stressed or something untoward is happening and they feel it necessary to sell. Most of the time, it could be a financial burden, it could be, or a financial issue. But most individuals, I haven’t planned well enough or far enough in advance to be in a really good place that when they make the determination that they’re going to sell their company, that they’re going to sell it because it’s the right time to sell. The second question is, who are you going to sell it to? Who would be interested in your business, and why would they be interested in your business? What is it that you’ve done that is above and beyond what your competitor has done?
And what is it that is unique that you bring to the market that would entice someone to come in and make you an offer that you would accept for your business? The other thing that I think most people don’t think about, and I’ve had this conversation with several individuals that have attempted to sell their company and a couple that have actually achieved it, and the question is, what are you going to do after you sell the company? Most of the time when I talk to individuals who are entrepreneurs, they reach a certain pinnacle, and they believe that they’ve reached that pinnacle. And ergo, it’s now time to sell the company. But the issue is what are you going to do after you sell the company? Is there a financial plan that you’ve put forward or that you’ve thought about other than just getting to the point where the company’s sold and you have a pocket full of cash? What is it that you intend to do with that pocket full of cash? And I can tell you that most owners are quite surprised that once they get to the point where they’ve gotten to the pinnacle, they’ve sold the business and they find themselves at the other end of the sale, the question that haunts them the most is what Now?
Neil
Do you think most business owners understand how a business is valued and have they thought through, or have they given consideration to what they want out of it?
Jan
Well, I think most owners have thought long and hard about what they want out of it. Mm-hmm. <affirmative>, I don’t think most of them have thought about how it is that the company is run, how it is that it’s prepared for sale, how those steps will go back and enhance that valuation in order to get to the number that they’re looking for.
Neil
Yeah. And the more organized they are, and the better the business is organized, the more it’s going to be worth.
Jan
Well, that’s true of most businesses. I mean the more efficient a business runs, the more processes it has in place, the less that it relies on the owner, the more value it has.
.
Neil
Yes. And then there are of course tax ramifications.
Jan
Oh, absolutely. I think the one thing that most people don’t realize, particularly if they have a corporation or if they have even an LLC, is there are two types of, of business transfers. And one is the sale of the membership or the stock interest in a company or the other is the sale of the assets. And I’ll tell you that most attorneys will prefer to do the asset sale because they believe it eliminates the potential for hidden liabilities later on. So most of the deals that I see presented are asset sales, but those types of sales are probably the most expensive for the seller because oftentimes the assets that are being held in the company may be operational assets. And so any gain from the sale price that’s attached to those assets less their basis is going to be taxed at ordinary income tax rates. It’s only when you get into things that are the capital gains type assets, which would be intellectual property. It could be goodwill, but things like accounts receivable, operational equipment, all that is really deemed operational in terms of the assessment of the types of assets that are sold. And that will be taxed at a much higher rate than the capital gains rates that most people have come to understand that are associated with the stock sale or a membership sale.
Neil
And the tax interest alone of the buyer and the seller are completely, almost opposed, are they not?
Jan
Oh yes, they’re absolutely opposed. And they’re opposite because when an individual comes in to buy a company, if they can assess more of the assets into an operational range or an operational category, that means they can depreciate or amortize those assets that gives them a deduction right off the bat on their p and l. It doesn’t give anything to the owner of the company. So there is a direct opposition. What’s best for the seller is not necessarily best for the buyer and vice versa.
Neil
So Jan, what’s another type of issue or other issues that you think that they should be going through in their mind before they put their company up for sale?
Jan
Well, I think one of the most important ones is whether or not, depending on how the sale is structured, whether or not the owner will be required to stay on in some form or capacity for a period of time in order to ensure that the transfer is successful. I don’t think a lot of owners who are used to being their own bosses take the transition into being an employee for someone else. Well, <laugh>, and that would be an understatement. And so I think when you put together the idea that you’re going to sell your company, the largest question, the most important question is, am I so much an integral part of this company that I’m going to be required to stay on in order to ensure the transition? And how am I going to feel and how am I going to react about that? Because I’ve seen a lot of perfectly good sales go down in flames because the seller and the buyer don’t get along after the culmination of the sale.
Neil
So Jan, that thought extension probably includes key employees and then important customers as well, doesn’t it?
Jan
Absolutely. And that’s the reason most sales are not made public until just before they’re culminated. So in order to maintain key employees, there’s going to be a process where you’ll have to ensure that the, the employees are enticed to stay on in order to ensure the ongoing success of the business if they’re part and parcel of that progress and process. The other thing, our customers as well, what you don’t want to do is transfer a company and then find out that your customers don’t like the new buyer and suddenly sales fail because that customer doesn’t want to do business with the company any longer.
Neil
Jan, how far in advance of an actual sale do you think the planning process and preparation should begin?
Jan
I think a business owner should give themselves 18 months. And while that may seem like a long period of time, I don’t think that most business owners are, are readily appreciate the degree of research and planning and fixing that will have to be done in order to get the company ready for sale.
Neil
If we’re looking at it from a big picture point of view, just a general overview of the process, what are the steps to getting a company ready for sale, Jan?
Jan
So the steps really follow in tandem with one another. And the first thing is to go back and review the financial statements to ensure that the books are maintained in accordance with gap. If it’s possible, an audit always helps in terms of easing the transition, particularly for the buyer, because once a company has undergone an audit, then they have a third party source that says, yes, these books and records are maintained in accordance with gap and that they represent fairly the financial position of the company.
When you don’t have audited financial statements, the due diligence is generally far more and invasive. Far more document requests are, will be required delving into accounts receivable, accounts payable, and the mountains of information that is exchanged can be quite voluminous. And it takes time. It’s one thing to be able to hand off, for example, a listing of accounts receivable for the last 18 months, but it takes time for the buyer to be able to go through and assess what it is that that means. So I think the first step is make sure that the financial statements are in order. And if it’s possible, I would have the financial statements of the company audited.
Neil
And then the next step that is kind of very closely associated, that is the structure of the company itself to get your corporate house in order.
Jan
Absolutely. I think one of the areas where most companies fall down is in corporate governance. Once a company’s set up, most company owners don’t think about what it is that it takes to maintain the corporate governance. And that’s above and beyond the annual Secretary of State filing that’s required. It’s really the minutes of, let’s say the directors or the shareholder and the shareholders or the members in order to accurately record what it is the company’s gone through and what it is that it’s been doing in, for example, the past 36 months. So the corporate governance documents are very important in terms of ensuring that the company is validly legal entity within the state in which it was created.
Neil
And then they’re going to have to organize a bunch of information, tax returns, a list of assets and their obligations. What are all the informational pieces that need to be brought together and organized?
Jan
Well, the information that’s required really comes from a really thorough investigation of the financial statements. So yes, one of the transactional requests could be a list of the assets and then a, a review of those assets. There’s a lot of emphasis that’s placed on any long-term payables or loans, things that may go back and impact a company over a period of time after the sale. And then of course, there’s a review of the tax returns in order to ensure that the tax returns were accurately prepared based on the financial statements and the financial statement review. So the list of documents and the types of documents that are exchanged, as I said, can be quite voluminous when I put together a due diligence checklist for legal, tax and accounting. It’s approximately 14 pages long.
Neil
Jan, you’ve talked a lot about the financials. There’s also the recast financials. Can you tell us a little bit about what those are and how they help?
Jan
Sure. Recast financials are really a restatement of the financials of an organization that takes out the expenses that are solely associated with the owner. So for example, if the business is paying for the car for the owner, or if they’re paying for any other types of personal expenses, those types of expenses are then taken out of the financial statement and the profit and losses then recast without those expenses so that a prospective buyer can see what a financial statement would look like without the expenses that are really associated with the then current owner.
Neil
And technically speaking, removing expenses increases valuation does it not?
Jan
It can increase the valuation, but generally what it does is it gives the buyer a better indication of what will fall to the bottom line without these personal expenditures.
Neil
Okay, Jan, let’s presume we’ve gotten the house in order. We’ve polished the apple. What happens next?
Jan
Well, then you’re ready to go to market, and there are several ways to do that. There are rep companies that will go out and find buyers for your type of company. You may have individuals that you’ve spoken to that could be interested in your company, or there could be a competitor that might be interested in the purchase of your company. But what it all leads up to is essentially what’s known in the trades as a letter of intent with a potential buyer. And that letter of intent outlines at 50,000 foot level what it is that you agree upon, at least initially. So for example, if you have someone that comes in and says, I want to buy your company, then the terms of the agreement could include whether or not it’s going to be an asset sale or whether or not it’s going to be a stock or membership sale. What are the length of the terms? How long will due diligence be? Will there be a cap? And the length of time that due diligence will occur? And then what will end up happening at the end of the due diligence period, and what type of agreement or arrangement and who’s going to create the contract that will facilitate the sale of the company?
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Neil
So, okay, we’ve got a letter of intent in place. We’ve got a potential buyer on the line. What’s the next step?
Jan
Well, the next step is the actual due diligence that’s performed in the company by the buyer. And so while we’ve spent 18 months preparing for this moment, what will now happen is there will be an outside source that will go through all of the records that you have so cleanly accumulated over the last 18 months in preparation for the sale. That takes quite a bit of time, actually. It can take anywhere from six to eight to 10 weeks depending on the size of the company. But once you get through the due diligence period, then what begins to occur is the negotiation of things that are found within the due diligence itself. The letter of intent is really a frame. It’s not a negotiated agreement.
The contract that follows the contract for sale is what will dot the i’s and cross the T’s regarding all aspects of the sale of the company, including whether or not the owner operator will continue on in the company, whether or not there will be any sort of remuneration for staying on, or if staying on is a matter of ensuring that the company continues as a success. What will the purchase price be? What will the down payment be? How will it be paid? All of those terms are then discussed following the due diligence in getting to the contract for the sale of the company.
Neil
So Jan, we’ve had a discussion about preparing to put your company up for sale. There are several things that a buyer is going to want to achieve, but from the position of the seller, they really need to think about where they are, where they want to go, and what happens after this is ultimately accomplished.
Jan
That’s essentially what drives the contract for the sale of the company, because there can be, there’s so many different types of terms that can be negotiated that it’s very important that an owner go into the process understanding what it is that they want, because I’ve seen a lot of negotiations between a buyer and seller continue for months and then suddenly fall apart at the end because of what was clearly a misunderstanding that could have been deflected and cleared up earlier in the process. So it’s important that when your company is being sold, that you understand as an individual what it is that your terms are, what it is that you want for the company, how you want that money paid, and whether or not you are willing to stay on in the capacity of a successor employee for someone else.
Neil
And how do the integrated services that we bring to the table affect a client? And what’s the value that Allen Barron delivers?
Jan
Well, when you go through a due diligence process, essentially you’re looking for is you’re looking for individuals that have the capacity to opine on the legal, the tax, and the accounting. And generally, you can find tax and accounting in a traditional C p a firm, but you won’t find the legal piece. So by coordinating our efforts with the integrated services we provide here at Allen Barron Inc, we can cover all of those substantive areas, the tax, the accounting, and the legal. And that includes, of course, the negotiation and the creation of the contract for the purchase of the sale of the company.
Neil
And then there’s an estate planning element to this as well, isn’t there?
Jan
Well, there’s an estate planning element, but prior to that, there really is the structuring of how it is the sale will impact the owner, and how you can minimize taxes coming out of the chute with the negotiation. It’s like I’ve always said, when you write a contract, you can accelerate income, you can de-accelerate income, you can time it as to when it is, you want it paid or you want it held off. So these terms are really, really critically important, particularly to the owner of the company and putting together their post sale life.
Neil
So Jan, if I’m a business owner and I’m thinking of selling my business, what’s the first step I should actually take?
Jan
Well, I think the, the first step is to talk to someone that understands how it is that selling a business is accomplished. And you’ll have to find someone that does, we call it in the trades, a merger and or acquisition. And you have to have someone that has been through the processes well enough or long enough and with enough experience to make the process that the owner will go through a far smoother and less stressful event than it normally is.
Neil
And if they contact us, it begins with a free discussion.
Jan
Absolutely. We love to talk to business owners about the sales of their company and how it is that we might be able to assist in all aspects of that sale.
Neil
Thank you Jan.
Jan
Learn more about our integrated legal tax, accounting, and business solutions, and visit https://allenbarron.com or call (866) 631-3470 to schedule a free consultation.
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