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Selling Your Business Part IV - Closing the Buyer & the Deal

Selling Your Business Part IV - Closing the Buyer & the Deal

| February 03, 2020

Now that you have identified the type of buyer you would like to sell to, you want to attract them to your business and close the deal, right? 

Below we have identified a few helpful tips to attracting the type of buyer you have decided is best for your business  and closing that deal!

Hints for Attracting and Closing a Buyer

1) Be Open and Honest

Potential buyers and their financiers want to see transparency in your financial statements and in the information you present. You don’t want a sudden surprise to a buyer to come rushing at you like a train and derail the entire deal.

Often, they are relying on your information to line up a loan or other type of financing. If they start digging and turn up a few skeletons, more than likely they will back away from the bargaining table or they will significantly lower the asking price.

2) Have Your Financial Statements Reviewed

Especially for large deals, companies looking for an acquisition will give you a higher price if your statements are audited by a major accounting firm. By using a reputable firm, it is like getting a stamp of approval that you are clean with your accounting records and are being held to a higher standard.

This will not be cheap, but if it increases the value of your practice by $100,000 and if it costs you $25,000, it is well worth the effort.

3) Discuss Items Not Mentioned Within the Financial Statements

It is a very common practice not to include certain assets or liabilities within your financial statements. These “off-balance sheet” items can add or detract significant value from your practice.

For example, if you are a pharmaceutical business, do you have a patent on a specific kind of medication or process? If you are a manufacturer, have you depreciated the plant, property, and equipment to lower your taxes at a rate far quicker than they have actually depreciated? These changes can add significant value to your sales price.

4) Set a Tentative Plan Before Finding a Buyer

Now that you have done a valuation of your practice and know what kind of buyer you are looking for, it is almost time to start finding them. We cannot emphasize enough that you and your team of mentors need to set a plan before moving forward.

Get their opinion as to what is realistic. How long have various steps in the process usually taken? What are the longest as well as the shortest timelines that these events can take place? Make sure to set your expectations to “under perform” and “over deliver.” This means you should make your assumptions over a longer time period and if it happens in a shorter time frame, great.

We suggest you make this a company mantra not only for selling your business, but for how to treat customers. Setting expectations is incredibly important no matter what industry you are involved in.

The Documents, Pitfalls, and Hints for Closing the Deal

First, before the closing documents are signed, let’s explore the issue of the letter of interest versus letter of intent.

A letter of interest is simply expressing the desire of the buyer to buy and the seller to sell. It is a very small commitment with no strings attached. You can have several buyers sign letters of interest.

Meanwhile, the letter of intent is a more binding document. When you reach this point, you have identified the one and only buyer you want to purchase your business. You have done most of your due diligence on the buyer and want to move forward. The buyer will also have done a significant amount of due diligence and will want to really dig into your books after signing the letter of intent.

They will also be putting down earnest money to bind the letter. However, this is not closing because the buyer can still back out of the deal or you can still back out of the deal if aspects of the closing and final negotiations are not agreeable to either party.

By this time, the two parties will have agreed in principle to a price as well as the basics of the other terms such as assets and liabilities to be assumed and how the deal would be structured in terms of debt versus down-payment versus earn-out.

As the seller, you want a higher down payment in cash. You don’t know if the counterparty is going to be financially solvent down the road. Generally, the higher the cash up-front, the lower the price will be. By taking more cash, this will significantly lower your risk. A high down payment is especially valued by sellers who are stepping away from the business altogether.

On the other hand, if you are going to continue to work in the business and will have a heavy hand in guidance going forward, you could negotiate a higher earn-out provision. An earn-out provision is an override on revenue earned, very much like a continued fluctuating salary.

So let’s say you sell a business for $3 million. The earn-out is estimated to be a $1 million payment over 5 years. Your annual revenues are $1.5 million. You calculate the earn-out to be 30 percent over that time frame. If the buyer generates revenues of $1 million the year after the deal, you would get paid $300,000 over that period. If instead the buyer generates revenues of $2 million, you would get paid $600,000. 

As you can see, the amount you will be compensated will be dependent upon the quality of the revenues you are handing over and you can be very well compensated as long as the business engine continues to chug along. You can choose to have the payments monthly, quarterly, or annually. We usually suggest monthly.

Lastly, there is the debt payment. Rather than getting bank financing, it is common practice for the debt to be seller financed. As the seller, you become subject to the sometimes volatile credit risk of the buyer.

The buyer and seller agree to an acceptable interest rate and set an amortization schedule as to how the debt is to be repaid. The longer the term, the easier the seller will be able to afford the payment, but you will still be subject to the seller’s credit risk. 

There is no cut and dry answer as to what should be done – each deal must be looked at on a case-by-case basis. It is common practice to split equally among the three components.

The next major area to be addressed is the tax consequences of the deal. Just because you are compensated one way or the other (i.e. earn-out versus down payment), this does not mean that your taxes have to be structured in the same route.

Below is a sample table on how tax allocation might be structured for a $3 million deal in a financial firm. We’ll go into the specifics after the table is presented.

In the case of a financial firm, most of the value is in the revenue, not in plant, property, and equipment. So, you’ll see most of the tax allocation distributed between revenue and the consulting agreement.

The revenue line (#1) will be taxed as a capital gain to the seller whereas consulting agreement (#2) will be taxed as ordinary income to the seller. From the buyer’s perspective, the consulting agreement (#2) is preferred because they can write it off as a business expense right after the first year. 

Additionally, for the buyer, revenue (#1) as well the rest of the line items (#3 to 7) will usually get amortized over a long time frame – well over 15 years with current tax law. Ideally, as a seller, you want to lower the consulting agreement and increase the rest. However, if taxes are a sticking point, you can certainly negotiate the price or earn-out or down payment to make up for the difference in taxes.

We strongly suggest working closely with your CPA to hammer out the details of what will best fit your tax situation.

As a vital component to closing the deal, we emphasize that a Uniform Commercial Code (UCC) search should be done on both the buyer (if a business) and the seller. A UCC search looks for tax liens, judgments, and pending lawsuits. They will search state and county records.

This covers the basics on the subject. However, there are many other components to think as discussed regarding the documents including personal guarantees, security agreements, non-compete-agreements, and more. 

Above all else, it is extremely important to have each qualified member of your mentorship team to review over the documents and act as a check and balance to challenge you on your thinking and to make sure that you are getting the best possible deal.

However, now that you’ve signed all these closing documents and then escrow closes, congratulations – you’ve sold your business!

So what’s next? Check back for our fifth and final installment of this series where we discuss the next steps after you successfully sell your business!

Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation. Please consult with your accountant or tax advisor for specific guidance.