05.15.2002
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Updates
This update is designed to help the owners of a "closely held" business facilitate its sale and increase the price they receive from its sale. By a "closely held" business, we mean a business owned by a relatively small number of people – often members of an extended family.
Be Prepared
We advise business owners to begin planning a sale up to five years ahead of time. This update outlines several simple steps that business owners may take to maximize the value of a business before it is sold and to smooth the path of the sale.
Even if the business is not to be sold at this time, consider holding regular meetings of all of the owners to discuss the operations and prospects of the business. A decision to sell should be preceded by a consensus-building exercise.
Keep Up on Housekeeping
Examine the business' dealings with third parties. Formalize contracts, especially with major customers and suppliers. Long-term customer/suppler contracts can add considerable value. Ensure that contracts allow assignment.
Examine standard terms and conditions to ensure that they give adequate protection from liability.
Are the business' stock records and minutes in order? Are all contracts in one place? Is there a system for renewing contracts, leases, licenses and permits? Is there a record of all claims, whether or not they result in formal litigation? Is there a system for terminating UCC filings when debts have been paid or leased equipment returned (similarly, liens on real estate)? These might seem like insignificant details, but they routinely hold up transactions.
By being organized, business owners can make it easy for a potential purchaser to do its "due diligence." This is particularly important if the business owners have been successful in interesting more than one potential purchaser. In addition, poor organization can cause a potential purchaser or its lawyers to label the business as poorly managed and prompt them to start looking for problems. This may result in downward pressure on the purchase price and will cause the sale to be more difficult to close.
We can help by reviewing the business' existing agreements and records, conducting UCC and other searches, and suggesting appropriate remedial action.
Skeletons in the Closet
In the process of addressing housekeeping, a business owner may find a "skeleton in the closet." The adverse impact of a "skeleton in the closet" can often be limited if it is fully disclosed early in a controlled manner, as opposed to the case where it is uncovered by the purchaser at a late stage of the transaction.
We can help identify a business' "skeletons" and plan for disclosure (i.e., think creatively as to what the business owners or the purchaser, or both, may do to address the issue).
Intellectual Property
Of the factors that affect the value and marketability of a business, arguably the most important is the existence of proprietary products or services. If the business has proprietary products or services, protect them by filing copyrights, trademarks or patents. A corporate name alone is insufficient to protect a brand. We can help with copyright, trademark and patent filings, and maintenance.
If the business involves technological innovations or trade secrets, make sure that each employee is party to an agreement covering confidential and proprietary information and inventions. We can help draft such agreements.
Employees and Management Team
Many business owners will say that their most valuable asset is their people. Are the employee benefits offered sufficient to incentivise employees? Are there appropriate benefits for each level of employee? Will news of a planned sale unsettle senior management, or is there a mechanism for them to participate in the sale? An experienced management team that is willing to stay after a sale is an asset for which business owners can realize value.
We can help address these issues with a wide variety of employee benefit plans, including stock option plans, or – for business owners that wish to limit share ownership – "phantom" stock plans.
Tax and Estate Planning
Federal, state and local taxes are extremely important in planning for a sale of a business and is too large a topic for this update. We can help with estate planning and planning for federal, state and local taxes.
Financial Statements
Most closely held businesses manage their finances to minimize taxes as opposed to increase earnings. Speak to the business' accountant about ways to reflect the true value of the business in its financial statements (e.g., consider "expensing" less aggressively – perhaps by capitalizing equipment purchases and repairs to buildings or equipment, consider capitalizing loans from shareholders, and, if the business is a "C" corporation and the owners can afford to, consider reducing salaries to the owners). Examine the true value of each asset that has been depreciated – the business owners may have to substantiate it during the negotiations for a sale. Similarly, try to identify and value the business' intangible assets (e.g., proprietary products, distribution network, name recognition and uniqueness of market niche).
Identify Potential Purchasers and Sale Price
Take time to identify potential purchasers. Help potential purchasers identify the business by raising its profile. A network of contacts established while participating in local business associations and community organizations may help identify potential purchasers, but try to think more broadly than the business' immediate competitors, customers and suppliers. Professional advisers such as business brokers or investment bankers may also help identify potential purchasers. Consider using a public relations consultant to raise the profile of the business and to compile high quality brochures and other marketing materials.
The ideal situation is to attract a number of potential purchasers and initiate an auction.
Think realistically about what the business is worth. A variety of equations and formulas for valuing a business exist, and valuations may vary. A business broker or investment banker can help with valuations. Try to identify the lowest amount that the business owners will accept. Are the business owners prepared to seller finance or take stock in a purchaser?
Before hiring a business broker, investment banker or public relations consultant, ask for and actually contact references in a similar size and line of business to the one to be sold. Ask a business broker or investment banker to quote a fee payable on a successful sale as opposed to a retainer. We can help with referrals to such professionals.
Timing Is Everything – Don't Be Rushed
Business owners can almost always increase the price paid for their business with careful preparation and by choosing the right time to sell.
A purchaser is paying for the future of a target business. Consequently, if the business is expanding at the time of the sale, the business owners are likely to get a better price than if it has reached a plateau or is declining. Keep up on local business news by actively participating in local business associations and community organizations. An early warning about market entry by a competitor or an adverse change to zoning regulations may be vital.
Business owners who resist the temptation to become emotionally invested in a particular sale before it is actually negotiated and closed will obtain a better deal, not only relative to price but also with respect to matters such as indemnification and escrow of purchase price.
Conclusion
- Communicate with all of the business' owners with respect to the business' operations and prospects. Involve everyone in a decision to sell.
- Start planning for a sale early.
- Make the effort to keep up on housekeeping. It is a chore now that will pay dividends later.
- Address potential obstacles to a sale early. Do not wait for the purchaser to raise them.
- Identify and protect proprietary products and services.
- Build employee/management loyalty.
- Undertake estate planning, and plan for federal, state and local taxes.
- Reexamine accounting practices.
- Identify potential purchasers and raise the business' profile.
- Control the process – do not be rushed.
