Depending on the nature of your business and industry, other specialists may be employed during the process. Their level of involvement will impact the scope of negotiations. In some cases, retaining experts in advance can mitigate risk for the buyer. Here are some examples:

Other Specialists:

Your investment banker, attorney, and accountant form the core of your deal team. In addition, you may also hire other specialists, such as:

• Environmental: You may want to consider hiring an environmental consultant if your business handles hazardous materials or is subject to environmental regulations. Buyers often hire environmental experts if they’re purchasing land or buildings and suspect the property may be contaminated. Many jurisdictions impose strict liability for all past owners of real estate when environmental issues arise. Such issues represent the highest exposure levels for the parties. Retaining a consultant in advance gives you time to discover and address problems before they arise with the buyer. 
• Employee Benefits: Employee benefits are the next-largest area of risk exposure for buyers. If you have a pension plan, consult with experts in this area well in advance of the sale to ensure assets exceed liabilities and that a smooth transition of benefits can occur in the case of other benefits, such as deferred compensation, profit-sharing, stock options, employee stock ownership, health insurance, and life insurance. In most cases, the plans will be terminated and you’ll be obligated to fulfill the termination requirements.
• Code Audit: When purchasing a software company, most buyers retain a third party to perform a code audit to ensure the software code is clean and well documented. A wise seller will hire a third party to perform the audit and clean up the code before the company is put on the market. The results of the audit and resulting cleanup can then be used as negotiating leverage with buyers to provide the buyers with some level of comfort regarding the documentation, accuracy, and organization of the code.
• Insurance Advisor: Your insurance advisor will play a limited role in the transaction. Most insurance isn’t transferable in an asset sale. But your insurance agent should be available to gather information regarding your existing policies and assist the buyer with obtaining new policies by communicating your coverage limits to the buyer. You should also make sure your current coverage is adequate. If it isn’t, the buyer will deduct the cost to upgrade your insurance when calculating SDE or EBITDA.
• Commercial Real Estate Agent or Attorney: I recommend hiring a commercial real estate agent if you own the real estate and plan on selling it. The agent can assist with marketing the property for sale or determining an appropriate rental rate. Once you determine an appropriate rental rate based on current market conditions, be sure to pay your business this rate.

There are dozens of additional experts that could become involved in the sale, but their roles are usually minimal.

Conclusion

Just as you wouldn’t knowingly board an airplane piloted by a novice who’s only read the manual, you shouldn’t entrust the sale of your most important asset to an advisor who’s never actually sold a company.

As in aviation and almost every endeavor, real-world experience is key. When you’re in the market for a professional advisor to help sell your business, go with someone who’s been there and done that. Preferably multiple times. An experienced advisor will know how best to market your company for sale and who best to market it to. An experienced advisor will work effectively with your attorney and other members of your deal team to help ensure a smooth sales process and maximal outcome. Bonus points if your business broker or M&A advisor can help you plan your exit by showing you how to improve your company over time.

Just as important when it comes to the need for real-world experience is the attorney you choose to negotiate the key agreements and advise you of any legal matters that may need to be resolved before you even put your business on the market. For the most reliable results, go with an M&A attorney who’s been involved in dozens of real-life M&A negotiations and sales. A specialist may charge more up front than, say, your personal or general business attorney, but chances are you’ll more than recoup that cost in the end – especially when it comes to negotiating the purchase agreement and dealing with other M&A idiosyncrasies along the way.

Rounding out the core of your deal team is your accountant. This is the role-player who will review your financials to ensure there are no inaccuracies before turning them over to a potential buyer. Your accountant will also play the lead role in financial due diligence and can advise you of the tax implications of the sale. If you’re needing to hire a CPA, bring someone on board who’s had experience in those matters.

What’s left? You may want to consider consulting with a benefits expert, especially if you offer a pension plan to employees, to ensure you’ll be able to meet your obligations in the event of a sale. And if your business involves chemicals or other hazardous materials, it’s a good idea to have an environmental consultant at the ready.

As you’ve already seen, it can take a village to properly sell a business. Following the suggestions discussed in this chapter will go a long way into transforming a routine deal team into a high-powered dream team. 

Experience

When hiring a professional advisor, the number one thing you should look for is real-world experience buying and selling companies. Ask how many M&A transactions they have worked on in the last three years and their role in each transaction. The more, the better. An “affordable” advisor lacking real-world experience will prove to be much more costly than the most “expensive” experienced advisors. 

For example, it’s common for CPAs to kill deals by offering their unsolicited opinion on a business’s value. They may attempt to use logic that only applies to publicly traded companies or they may use valuation methods such as discounted cash flow (DCF) that don’t apply to small to mid-sized companies. I have heard CPAs claim that an appropriate multiple for a business was seven to nine times EBITDA when, in reality, multiples were in the range of three to four times. The CPA on the opposing side claimed that multiples for the same business were three to four times EBITDA. Such opinions are common among CPAs. If a CPA or other advisor opines on your company’s value, respond by asking how many transactions they have personally been involved in.

The best advisors have deep, relevant experience. They understand their client’s business and industry and are willing to be flexible to meet the needs of both parties. Negotiating the deal involves making numerous tradeoffs. Both you and your advisor must be prepared to be flexible and make concessions if you want to get a deal done. By the same token, your advisor should have the experience necessary to know when a buyer is being unreasonable and when it’s sensible to advise you to stand your ground.

This understanding is required if they’re going to offer their opinion on the transaction structure, as opposed to simply accommodating your requests. The most valuable advisors play a technical role and have the requisite experience to add more value than that for which they were retained. This is particularly important when a transaction structure involves an earnout, one of the most complicated deal mechanisms to design. Don’t pay your advisor to learn on the job – ensure you have retained advisors who have significant relevant experience drafting and negotiating earnouts. As a business owner, you likely have no practical experience negotiating an earnout. You must, therefore, solely rely on the advice of professionals. Close collaboration with your deal team will be essential to creating a deal structure that minimizes your risks and maximizes your purchase price. 

Negotiating the agreements for the sale of a middle-market business is a complex undertaking. Don’t be shy when inquiring about qualifications. Ask what role your advisors envision themselves playing in your situation – some prefer to be in the background while others prefer to be on the firing line.

The reps and warranties in the purchase agreement can have significant implications for several years following the closing. In some instances, the liability you may incur in reps and warranties can be perpetual, such as in the case of environmental issues, the payment of taxes, or for employment-related matters. One word in the agreement can make the difference between a million-dollar recovery of damages and no recovery at all. 

Experienced accountants and attorneys know what’s customary and reasonable and what isn’t. The American Bar Association (ABA) compiles surveys of attorneys in the trenches based on what’s currently considered reasonable in an industry. For example, the ABA study might indicate that 34% of M&A transactions under $10 million in purchase price include an earnout, or that the average escrow is for 11% of the purchase price. The ABA’s studies are highly detailed and contain specifics on every critical element of a purchase agreement. An experienced advisor can spot when the opposing party is making an unreasonable request and will be able to couple your objectives with current standards of reasonableness. A good advisor will tell you when to fight and when to acquiesce. 

The more experienced the professional, the more cost-effective they will be. For example, an attorney charging $500 per hour may be cheaper in the long run than your general business attorney with little M&A experience that only charges $200 per hour. 

While your general business attorney may be sufficient for advising you regarding general business matters, M&A is not a general business matter. Your attorney should have significant experience negotiating M&A transactions. For example, an inexperienced attorney may miss that your reps and warranties should include a basket (deductible) and a cap (maximum). On a $50 million transaction with prevailing norms regarding the reps and warranties (10% holdback with a 1% basket), this could cost you $500,000 if problems arise after the closing. What if a problem arises after the closing with potential damages estimated at $600,000? With the inexperienced attorney and no cap, you would potentially be liable for up to $600,000. With an experienced M&A attorney and a $500,000 cap, you would potentially be liable for only $100,000. In this scenario, you saved $10,000 in attorney fees but this cost you $500,000. 

If your attorney forgot to include a cap, or the maximum amount of your indemnity, this one seemingly small oversight could cost you millions of dollars – $45 million (or more) in this case if something terrible goes wrong.

If your business may be sold to a corporate buyer, such as a competitor or private equity firm, you can count on the fact that they will bring dozens of specialized experts to the negotiating table. Their team will run circles around you if your advisors are inexperienced. To be sure, this isn’t the place to be cutting corners. 

Of all the specialists you hire, your investment banker (or M&A advisor) and your M&A attorney are the most critical, and therefore should have deep experience.

You should only hire an M&A advisor that specializes in M&A. If they’re attempting to do multiple other things, there’s probably a reason for that.

An “affordable” advisor lacking real-world experience will prove to be much more costly than the most “expensive” experienced advisors. 

Knowledge of Your Business

Selling a business involves juggling numerous tradeoffs. Price is relative to the ratio of risk vs. reward. If the perceived risk is high, either a buyer will offer a lower purchase price or seek to mitigate the risk through transaction structuring, such as earnouts or stronger reps and warranties. It’s critical that your advisor understands your business from an operational standpoint so they can see how the deal mechanisms a buyer proposes fit into your overall deal structure. 

Your advisors should understand the risks inherent in your business, particularly the risks a buyer will perceive. The perception of risks will vary from buyer to buyer. Understanding this enables your advisor to get a handle on how a buyer’s proposals relate to the overall transaction structure and their perception of risk. Your advisor will then be able to propose alternative deal structures that meet both parties’ needs.

Help your advisors understand your business from both an operational and a financial standpoint. Tell your accountant or attorney what your primary concerns are and work with your advisor to meet your needs before burying yourself in legal or financial jargon. Don’t lose sight of your objectives. Once your advisor understands your business and aspirations, you can work together to create package proposals that meet the buyer’s needs while also addressing the needs of your business.

Role

Allow your own experience to dictate the roles of your accountant and attorney. If you have never sold a business, be prepared for your advisors to play an instrumental role in the process. If you’re a serial entrepreneur who has sold dozens of companies, your advisors may play a more limited role. Ask what role your advisors envision themselves playing in your situation based on your experience level. If you’re hands-off, you will want an advisor who can take charge and lead the transaction.

Appetite for Risk

Attorneys and accountants are conservative by nature. Find an advisor whose appetite for risk matches your own. Some advisors are excessively risk-averse. Likewise, some business owners are also risk-averse. You should employ an advisor whose risk profile matches your own.

Pre-Sale Due Diligence

Ask your attorney and especially your accountant to conduct pre-sale due diligence. This involves conducting due diligence before you put your business on the market and will allow you to identify and resolve potential problems before you begin the sale process. If your accountant lacks M&A experience, it may be wise to hire an accountant who specializes in this. Conducting pre-sale due diligence may also lessen the scope of the reps and warranties.

Ask your attorney and especially your accountant to conduct pre-sale due diligence. 

The purpose of external advisors is to make you – the owner – and your entire management team look as credible as possible by anticipating issues and preparing disclosure in a professional manner. And who doesn’t want that?

Your Accountant’s Role

Your attorney will play a key role in negotiating the purchase agreement. But it’s your accountant who will take the lead in financial due diligence and examining the financial and tax implications of the purchase agreement and negotiating any reps and warranties, including representations that relate to:

• Capitalization
• Financial statements (accuracy of, in accordance with GAAP, and so forth)
• Taxes and tax returns
• Books and records
• Accounts receivable
• Inventory
• Employee benefits
• Employee compensation

Review Your Financials

I recommend you ask your accountant to review your financial statements, tax returns, and bank statements, and correct any inaccuracies before you begin the sales process. They should also reconcile your financial statements, tax returns, and bank statements to ensure they match.

Tax Advice

An accountant also can advise you on the tax implications of the sale. If so, I recommend involving your accountant as soon as possible in the process because you will have much more flexibility in tax planning and maximizing after-tax transaction proceeds the earlier you involve them in your plans. 

Your accountant can also estimate the federal and state tax consequences of selling your business under varying scenarios, such as whether you’re selling your assets only or your entire entity, whether you’ll be paid in one lump sum versus installments over time, and to what extent your estate plan should be considered. They can also prepare tax returns associated with the sale, such as the income tax return of a corporation that sells its assets or the tax return of an individual who sells their shares or corporate stock. 

Allocation of Purchase Price

Your accountant can also assist in allocating the sale price among the various assets being sold by completing IRS Form 8594, the “Asset Acquisition Statement,” which is required when selling your business. Your accountant can help review the financial aspects of the deal, including structuring earnouts, seller financing, or other contingent payments.

Working Capital Calculations

Most middle-market transactions include working capital. As a result, working capital and balance worksheets must be prepared for the closing and then re-examined after the closing to calculate any differences in working capital between the periods. Your accountant can assist with these calculations. If you’re selling a small business, these calculations usually aren’t necessary because working capital isn’t customarily included in the purchase of a small business.

Ask your accountant to review your financial statements, tax returns, and bank statements, and correct any inaccuracies before you begin the sales process.

Tips for Hiring an Accountant

Find out if your accountant has experience in the purchase and sale of businesses. Ideally, your accountant should have experience both on the buy-side and the sell-side in a range of different-sized transactions. But a word of caution – not all CPAs are sufficiently qualified to provide all of the small-business sale services suggested above. That’s because many CPAs specialize in preparing individual tax returns but don’t routinely assist in business sales. 

When selling your business, retaining an attorney to represent you is necessary unless your business is small – less than $1 million in purchase price. While an attorney isn’t always a requirement in smaller transactions, they can be tremendously helpful. While many small transactions successfully conclude without an attorney, all sellers should hire an attorney and have them prepared to become involved in the transaction at a moment’s notice. If the purchaser of your business is a corporate or financial buyer, your attorney will need to be intricately involved in the transaction, regardless of the size of your transaction.

For middle-market transactions, the buyer often brings a team of dozens of experts and other advisors to due diligence. As a result of the imbalance, you should aim to at least achieve negotiating parity by hiring the best advisors you can afford – that’s especially true for your attorney. Unfortunately, your standard commercial attorney is less than ideal. Rather, you should hire an attorney whose sole expertise is handling mergers and acquisitions transactions.

It’s also important to bear in mind that no contract can provide complete protection for both parties. There are too many variables to anticipate and address. As a result, it’s critical that your attorney remains flexible, is capable of balancing tradeoffs, and that you trust the buyer. 

You should hire an attorney whose sole expertise is handling mergers and acquisitions transactions.

Roles

Here are the common roles your attorney will play in the sale of your business:

Non-Disclosure Agreement

While a standard non-disclosure agreement (NDA) works in most cases, I recommend your attorney draft a custom NDA if the sale is particularly sensitive and you’re approaching or negotiating with your competitors or anyone else in your industry.

Letter of Intent

Your broker may often prepare the letter of intent if the buyer is an individual. However, the buyer’s legal team usually prepares the LOI if the purchaser is a corporate buyer, private equity firm, or a competitor. If so, you will often need to heavily involve your attorney in the process. In such cases, your attorney should be on standby and available to respond quickly when you receive an offer or LOI.

Due Diligence

The extent to which your attorney is involved in due diligence depends on how thoroughly the buyer conducts their due diligence. Your broker can often anticipate how thoroughly the buyer will perform their due diligence based on their preliminary conversations with them. Often, they can let you know in advance if they feel your attorney will need to play a more involved role.

Purchase Agreement

• Small Businesses: As noted above, your broker may often prepare the purchase agreement and closing documents using their templates if the buyer is an individual or smaller competitor with less than $5 million in revenue, which tends to be more common for smaller businesses. If so, you may optionally have your attorney review them. 
• Mid-Sized Businesses: The buyer’s legal team customarily prepares the purchase agreement if the buyer is a corporate buyer, private equity firm, or competitor, which is common for mid-sized companies. If that’s the case, your attorney will need to be intimately involved in the negotiations of the key agreements. The purchase agreement is often prepared simultaneously while due diligence is being conducted, which gives the parties plenty of time to negotiate the agreement. On the other hand, the negotiations surrounding the LOI tend to be more time-sensitive so you should have your attorney on standby for when you receive a letter of intent.

Closing Process

Your attorney can also facilitate the closing process and wiring of funds if the buyer’s attorney or escrow is unavailable to do so.

Other Roles

Your lawyer can also prepare or review the necessary transfer documents if you’re selling a building or land. 

Tips for Hiring an M&A Attorney

When hiring an attorney, you should look for the following:

Experience: Your attorney should have acted in dozens of transactions and should dedicate a substantial portion of their time to M&A – the more, the better. Ideally, your attorney should spend more than half of their time specializing in M&A transactions.

Negotiating Skills: Your legal advisor should also be an excellent negotiator. Often the negotiations on representations and warranties (reps and warranties) is tougher and more challenging than negotiating the price. 

Other Soft Skills: Find a lawyer who doesn’t feel compelled to participate in or influence the commercial aspects of the deal unless you specifically request them to do so. Your advisor should also be capable of offering solutions in risk management, such as creative deal structuring. 

Fees: Most professional advisors charge by the hour, while a minority charge a flat fee. Most of those that charge a flat fee understand the process enough to be comfortable quoting a flat fee. Fees can range from $150 per hour to more than $1,000 per hour and are discussed in more detail below.

You will spend 6 to 18 months with your M&A advisor. It goes without saying that your M&A advisor’s style should complement your own. For example, my style is straightforward and no-nonsense. I’m usually straight to the point, matter of fact, and waste little time in small talk. If you’re looking for a talkative, salesy-type advisor, I’m not your man. If you’re selling a business whose valuation is based on projections and hype, an M&A advisor who takes a more sales-based approach will be a better fit for you. Otherwise, look for an M&A advisor or investment banker whose style complements your own.

One of the primary advantages of hiring an M&A advisor lies in their role as an intermediary. Retaining an intermediary to negotiate on your behalf enables you to maintain goodwill with the buyer and minimize any potential conflicts. This is valuable when you and the buyer will maintain an ongoing relationship after the closing. 

Negotiations regarding price can become contentious. An experienced M&A advisor can keep their cool during these discussions and insulate you from the stress of the high-stakes negotiations. This can help you maintain your focus on your business and minimize interpersonal conflicts with the buyer. This is especially important if your transaction includes an earnout, which is a promise of additional compensation in the future if your business achieves specific financial goals. 

Your M&A advisor will be instrumental in providing a preliminary range of value for your company and preliminary transaction structuring. They will also negotiate with the buyer regarding the high-level elements of the transaction and how the various components of the transaction work together to form the overall deal structure. This could include estimating the possibility and degree of an earnout that may be included in offers from buyers. 

Experienced investment bankers treat negotiations as a win-win proposition as opposed to stating a position and firmly holding one’s ground. An experienced intermediary can be invaluable in uncovering a buyer’s true concerns and creatively structuring a transaction to meet both parties’ needs.

They can also identify risk factors a buyer is likely to perceive in your business, then outline a strategy for mitigating those factors. Ideally, you should build a relationship with your M&A advisor several years in advance so they can strategically advise you on actions you can take to maximize the value of your business. 

An experienced M&A advisor can keep their cool during negotiations and insulate you from the stress of the high-stakes negotiations.

Industry Overview

Before we discuss fees that your business broker, M&A advisor, or investment banker may charge, allow me to provide an overview of the individuals operating within the industry. There is a diverse array of people who sell businesses, and they can be broken down into several categories.

Business Brokers

Business brokers sell the majority of small businesses, or those priced under $5 million. There are anywhere from 5,000 to 10,000 full-time business brokers in the United States from a variety of backgrounds, from sales to marketing and finance. According to the International Business Brokers Association, many business brokers are former entrepreneurs, with an average age in the mid-50s. The more experienced and knowledgeable a business broker is, the more likely they are to sell mid-market businesses, thereby effectively becoming an M&A advisor. Most business brokers are generalists and don’t focus on one specific industry.

Most business brokers work on straight commission. However, the more experienced they are, the more likely they are to charge up-front fees. Many business brokers operate both in the Main Street market and in the middle markets.

Most solo brokers and office owners are full-time brokers, although there are a number of part-time agents who work in offices. It takes a significant amount of knowledge to sell a business, and there are few formal training programs available. Due to the low barriers to entry to become a business broker, many people enter the industry expecting to make quick money but underestimate the amount of expertise that’s required. As a result, many brokers quit within the first few years, so the turnover in the industry is high.

M&A Advisors

M&A advisors specialize in selling mid-sized businesses, or those generally priced from $5 million to $50 million – there is no universally agreed-upon range. There are a few thousand M&A advisors in the United States. Although the majority of M&A advisors represent sellers, there are some who work with buyers. 

Most M&A advisors work solo or as part of a boutique firm. There are a few larger firms that specialize in the lower middle market, but they are in the minority. Some M&A firms focus on specific industries, though the majority are generalists. Many firms offer additional services, such as financing, recapitalizations, and management buyouts, but these constitute ancillary services for most firms.

Most M&A advisors charge an up-front fee, sometimes called a retainer, in addition to a success fee. Some also charge a monthly retainer fee. Typical success fees range between 2% and 8%. Common fee arrangements include the Lehman and Double Lehman formulas, which command a higher percentage on the first million – let’s say 8% – and a lower percentage on successive amounts, such as 6% on the second million, 4% on the third million, and so forth.

As a general rule, most M&A advisors are much more knowledgeable than business brokers because a higher level of knowledge is required to sell a middle-market business than a small business.

Exit Planners

Interestingly enough, there’s a large divide between those who sell businesses and those who prepare businesses for sale. The world of exit planners is a fragmented collection of professionals. There is little crossover between those who prepare businesses for sale and those who sell businesses. In other words, those who help entrepreneurs prepare their business for sale don’t normally help them sell the business, and vice versa. As a result, there’s often a disconnect between exit planning and the actual exit for most entrepreneurs. Also, how can an exit planner advise you on preparing your business for sale if they aren’t actively engaged in the marketplace and aren’t familiar with the buyer’s preferences?

Few business brokers and M&A advisors assist entrepreneurs in preparing their businesses for sale. Our hypothesis is that doing so requires a different mindset, a different set of skills, and different processes. Processes and tools need to be created to advise owners. We go into detail later about how most advisors simply don’t have the manpower to create the processes due to how most offices are structured. 

Investment Bankers

Investment bankers specialize in selling larger businesses, typically those generating more than $100 million per year in revenue. You should be aware that the term “investment banker” is regularly and loosely used by M&A advisors to identify themselves due to the lack of a catchy moniker for those specializing in the middle market – “M&A advisor” sounds clunky. 

Many of the larger investment banking firm’s clients include publicly traded companies. Investment banking firms also offer many other services, such as asset management, trading, equity research, raising debt financing, IPOs, and banking.

There are fewer investment banking offices than M&A firms. Most investment banking firms are larger and have more support staff, though there are some boutique firms in the lower end of the market with between $100 million and $250 million in revenue.

Commercial Real Estate Agents

Many commercial real estate agents sell businesses with a real estate component, such as hotels, motels, or storage units. Some commercial real estate offices are active in the business marketplace, though the majority consider this a minor segment of their business. Most commercial real estate agents charge a 4% to 6% commission, with declining amounts as the purchase price increases. Most work on straight commission, though there are a few who charge up-front fees.

I find it’s best to hire a commercial agent if you have a business with a substantial real estate component. For example, if you own a hotel, hire a hotel broker. There are many agents who specialize in hotels, motels, storage units, gas stations, and car washes. However, it may be difficult if you’re located in a smaller state, as every state requires a real estate license to sell real estate. You may need to hire an out-of-state broker who can cooperate with a local broker. Most states’ real estate departments allow an out-of-state broker to cooperate with a local broker if they’re not licensed in the state. 

Business Appraisers

Most business appraisers only value businesses for tax or other legal reasons. They rarely sell businesses, but most will appraise a business for any owner, for any purpose, including for exit-planning purposes. In my opinion, it’s best to hire someone active in the marketplace, or someone who sells businesses, as they will be able to best advise you on how to increase the value of your business, and their knowledge won’t be purely theoretical. Appraisals can cost $1,000 at the very low end for a verbal opinion of value up to $5,000 to $10,000 for a company with revenue of $5 million per year, and up to $20,000, or more, for larger companies.

Fees

Here is an overview of typical fees charged for selling a business based on its size:

Small Businesses Priced Under $5 Million (Main Street)

• This market is primarily handled by business brokers.
• Most brokers charge a flat commission between 8% and 12% if the business is under $1 million and charge a lower fee for businesses priced from $1 million to $5 million. Most follow the Double Lehman or Modern Lehman formula, or some version thereof:
  • 10%-12% on the first million, plus
  • 8% on the second million, plus
  • 6% on the third million, plus
  • 4% on the fourth million, plus
  • 2% after that.
• If a business sells at $5 million, then the fee would be: $100k + $80k + $60k + $40k + $20k = $300k.
• Most business brokers charge a minimum fee of $10,000 to $25,000, regardless of the sale price for the business. For example, if a business sells for $50,000, the broker’s fee would be $25,000.
• Most business brokers work on straight commission. A minority of brokers charge an up-front fee, but the more experienced the broker is, the more likely they are to charge up-front fees as a general rule.
• Most business brokers have no incentive to improve the value of your business due to their fee structure. A straight commission model incentivizes the broker to sell your business as fast as possible with minimal effort.

Mid-Sized Businesses Priced From $5 Million to $100 Million (M&A)

• Most M&A advisors charge up-front fees, in addition to a success fee. The up-front fee, usually called a retainer, varies from as small as a few thousand dollars to more than $50,000. Most advisors have a minimum fee in the range of $50,000 to $250,000.
• The most common fee structures are the Lehman and Double Lehman formulas.
  • Lehman Formula:
    • 5% on the first million, plus
    • 4% on the second million, plus
    • 3% on the third million, plus
    • 2% on the fourth million, plus
    • 1% after that.
  • Double Lehman Formula:
    • 10% on the first million, plus
    • 8% on the second million, plus
    • 6% on the third million, plus
    • 4% on the fourth million, plus
    • 2% after that.
• There are other variations on the Lehman and Double Lehman models. For example, some M&A advisors may begin at 8% on the first million and level out at 4%.

Business owners with businesses that sell from $100,000 to $1 million can expect to pay a higher percentage rate than business owners with businesses that sell for more than $1 million. Businesses that sell for more than $1 million often pay a commission that is less than 10% of the purchase price.

Factors To Consider When Hiring a Business Broker or M&A Advisor

You should consider the following questions before retaining an intermediary.

Do they work solely on commission?

Intermediaries who work solely on commission are disincentivized from spending time. A flat commission model incentivizes them to sell your business as quickly as possible with the least amount of effort expended. If you don’t want to be rushed, you may be more suited to work with a firm that charges up-front fees in addition to a success fee.

Firms who work on straight commission must pad their fees to account for the businesses they take on but do not sell. For example, if they have a 40% success rate, they must find a way to receive compensation on the 60% of the businesses they don’t get paid on.

A straight commission structure can also cause bias and misalignment. The more time the broker invests in selling your business, the more they will feel the need to recoup their investment. A broker who charges an up-front fee for services will feel this pressure to a lesser extent, and your interests are more likely to be closely aligned with the broker’s interests.

Does the advisor charge up-front fees?

Most professionals are fee-based, but due to the nature of an M&A transaction, few business owners would be willing to pay tens or hundreds of thousands of dollars in fees only to have a transaction fail at the last minute. As a result, most M&A advisors charge fees for services along with a success fee on the back end. Up-front fees shouldn’t be charged if no service is being provided. For example, if a broker requires a $5,000 retainer fee and doesn’t provide any specific service for this fee, I recommend you keep looking. 

The more experienced the broker, the higher the likelihood they will charge up-front fees, especially if they invest a significant amount of time preparing and packaging a business for sale. Most M&A advisors devote significant time preparing a business, which they are reluctant to do without being paid up front for their expertise. 

Does the advisor have support staff? 

The more professional offices have support staff and rely on a team of both internal and external experts. Selling a business is a difficult multi-disciplinary task that requires an enormous amount of skills in disparate areas. The most efficiently operated offices have developed scalable systems for the repeatable elements in the sale process, such as financial analysis, valuation, marketing, packaging, screening buyers, and closing, with each element handled by an expert in that process. The best operations I’ve seen operate like a surgeon’s office, where the most experienced advisors handle the most complex tasks, while a variety of other staff members deftly execute well-documented and defined processes within a flexible framework.

The size of support staff can have an impact on the level of professionalism demonstrated by the firm and the quality and efficiency of your transaction. Generally speaking, the more support staff the office has, the higher the skill level of everyone involved. In this instance, it’s better to specialize in specific areas than to be a “Jack or Jill of all trades.”

Are they able to customize their services?

Every business is unique and should be handled as such. Ideally, your advisor should work within a customizable framework, but if all services are 100% customized the process will become too inefficient. The ideal scenario is hiring a boutique office that exclusively focuses on selling businesses, has an experienced support staff, and also has a customizable framework.

Can they help with exit planning?

Only a minority of business brokers and M&A advisors help business owners plan their exits. Exit planning primarily consists of helping the owner improve the value of their business over time. Some prepare a formal exit strategy and valuation, while others help on an ad hoc basis. It’s a bonus if they can assist you in preparing your business for sale.

Is the firm local or national?

Most business brokers work on a local basis, while many M&A advisors work on a national basis. Ask yourself if their physical presence is necessary. In most cases, it isn’t. Most business brokers only work locally because they feel it’s necessary to physically meet with buyers. Many do this to protect their commission. If you don’t need the broker to physically meet with buyers, you don’t need to hire a local broker.

Do they work full-time or part-time?

It goes without saying that you should only hire a broker or advisor who works full-time.

What are the terms of their agreement?

Here are some key additional terms and conditions you should consider:

• Length of Agreement: Most brokers and M&A intermediaries require a one-year exclusive agreement, but you can sometimes negotiate a shorter term. On average, the process of selling a business takes 6 to 12 months. However, it can sometimes take much longer. The length of the agreement tends to coincide with the length of time it takes to sell a business.
• The Tail: Regardless of how long the exclusive agreement is, at the end of the contract your broker or M&A advisor should provide you with a list of potential buyers acquired throughout the contract. You will then be obligated to pay a fee if you sell your business to one of those buyers following a specified amount of time after the expiration date of the agreement – called a “tail.”
• Cancellation of the Agreement: Discuss contract cancellation rights with the person or firm you hire. Some agreements allow you to cancel at any time, while others do not. 

The more experienced the broker, the higher the likelihood they will charge up-front fees, especially if they invest a significant amount of time preparing and packaging a business for sale. 

The Bottom Line When Hiring a Broker

You need someone you can trust. Whether you choose an exclusive or open agreement, your business sale depends on reaching the right buyer – that’s really the bottom line. Interview as many brokers as you can and go with the firm you feel most comfortable with that also possesses the most experience. 

Most small transactions are financed using an SBA loan, a bank, or the seller. One additional source of financing to acquire small businesses includes rollovers of retirement funds and seller financing. The buyer can avoid a small business loan altogether and use their retirement funds to finance the purchase of a business. Because the buyer is buying stock as an investment in their own company, the buyer doesn’t have to take a taxable distribution. 

A buyer can invest in a business or franchise through this process by utilizing existing retirement funds without taking a taxable distribution or getting a loan. This arrangement allows an individual to invest up to 100% of their eligible assets to finance their venture debt-free.

Advantages of using retirement funds to buy a business include:

• Easy Access: Retirement funds are easy to access. For the buyer, retirement funds can be accessed quickly and with a high success rate, whereas bank financing is often difficult to access. Many offers are contingent on the buyer receiving bank financing to purchase a business. Most sellers are reluctant to accept these offers because of the traditionally high failure rate of obtaining a bank loan to purchase a business.
• High Success Rate: Once an initial screening takes place, the likelihood of accessing retirement funds to purchase a business is well above 90%. 
• Cash at Closing: Using retirement funds creates a win-win situation for the buyer and the seller. The buyer can easily access funds to purchase the business, and the seller can receive cash at the closing.
• Streamlines Process: The process of accessing a 401(k), IRA, or other retirement funds to purchase a business is quick and easy. Contrast this to the process of obtaining a bank loan, such as an SBA 7(a) loan, which is time-consuming for the buyer and seller. These strict requirements are not present when a buyer accesses funds from their retirement kitty to purchase a business. 
• Creative Deal Structures: The use of retirement funds allows for creative deal structuring. This structure can be combined with other sources of financing, such as traditional or SBA bank loans, without causing complications. Because the retirement funds are treated as the buyer’s own money, there is no issue with subordination.
• No Credit Score: The buyer’s credit score doesn’t matter when accessing retirement funds. It is the buyer’s money. The buyer isn’t borrowing money from a bank, and therefore no minimum credit score is required.
• Maximizes Cash Flow: Less interest to pay equates to higher cash flow for the buyer. This can help justify a higher purchase price if cash flow is strained when preparing financial models that incorporate some form of bank financing.

Requirements and Other Criteria:

• Individuals Only: This source of financing is available only to individuals. Companies must use alternative sources of financing.
• Costs: If the buyer has less than $50,000 in their retirement funds, it’s often more practical to simply take the distribution, and then pay the associated taxes and penalties.
• Qualifications: While numerous qualifications exist, plans should be fully accessible and be enabled to roll over into another plan.
• Penalties: If done correctly, there are no penalties when using a 401(k) or IRA to buy a business.

How the Process Works

The buyer creates a new entity, typically a C Corporation. The C Corporation creates, but doesn’t issue, stock. The corporation then forms a profit-sharing plan, and the buyer rolls over the retirement funds into the new retirement account. Next, the funds are exchanged for the newly issued shares in the new entity. The cash in the corporation can then be used to purchase a business or other corporate assets. 

Warning: Do not do this alone. Always use the advice of a professional when setting up this type of account. ERISA and IRS penalties apply if you don’t comply with all of the rules.

Why should sellers love this strategy? 

It’s a win-win situation for both the buyer and you. There are many benefits for the buyer, including ease of access and low fees. For you, it creates a simplified and streamlined process with a high success rate. This means a buyer can make an offer without worrying about the ability to obtain financing.

Who can use a rollover plan, and what are the limitations? 

Most retirement plans qualify for this type of funding structure; however, Roth IRAs don’t.

Is there a minimum amount that can be rolled over? 

There is no set minimum amount. But I suggest entrepreneurs use a rollover plan only if accessing at least $50,000 from their retirement funds unless there are extenuating circumstances, such as needing the funds to secure additional funding. Other than extenuating circumstances, if a buyer needs to access less than $50,000, it may make sense to withdraw the money and pay whatever taxes or penalties are tied to the transaction.

Are most accountants and attorneys familiar with this type of rollover plan? 

Yes and no, and that is the problem. Those who are aware of it typically support it, but there are those who have no idea it exists. The problem arises when it is dismissed as a prohibited transaction, rather than learning about this specific structure. The IRS permits the rollover of funds to qualified plans without taxes or penalties.

Conclusion

Many a solid deal has lived and died by financing. Knowing what you can get away with, what buyers are looking for, and what is best for your business, will be a huge boon during negotiations. That understanding will allow you to get the best price and incentivize your buyer to continue to grow your business. What sellers often get wrong is digging in their heels at the wrong time, turning away good buyers because they want all cash, or shying away from SBA loans because of a single rejection from a local bank. Understanding the financing process will help you know when to compromise and when to hold your ground. 

Financing the purchase of your business is a critical aspect of the negotiation process. It’s healthy to have skepticism about your buyer early on. But keep in mind that how the deal is financed is, in fact, a point to be negotiated. That means the end result will probably be different from your ideal payment. And that’s alright. 

Note: This section applies only to loans of $5 million or less. That’s the maximum size of loans from the Small Business Administration (SBA). In larger transactions, companies use alternative sources of financing.

Many buyers attempt to secure financing on their own, but the reality is that 84% of those loans are denied. 

So what’s a cash-strapped buyer to do? Many buyers, and sellers too, start by calling 1-800-827-5722. That’s the number for the Small Business Administration, which is involved in funding nearly 95% of bank loans for the acquisition of small businesses. 

It’s important to understand that the SBA does not loan money – rather, it guarantees loans made through banks. The SBA, via its 7(a) Loan Program, helps small businesses access credit by guaranteeing loans made by banks. This limits risk for banks offering such loans, which encourages them to lend money to small businesses. As a result, SBA financing can offer buyers attractive loan terms and interest rates while eliminating, or reducing, the need for you, as the seller, to carry a note. 

The availability of SBA financing translates into a potentially bigger pond of buyers in which to fish. But you’re not off the hook. You see, not only must the buyer qualify, but so must your business. After all, it’s your business that needs to generate ample cash flow to cover the monthly loan payments. 

In this section, I go into detail about the SBA loan process and how it can benefit both buyer and seller. I also dispel some popular myths about working with the SBA and offer suggestions about what to do if an SBA loan is denied. 

In other words, what you are about to read is kind of a big deal. 

SBA Loan Types and Overview

SBA loans are guaranteed by the Small Business Administration. There are many programs available under the SBA. However, there are two main loans that are used for business acquisitions: the 7(a) loan and the 504 loan. The 7(a) loan is used to acquire the business only and is the most popular SBA loan used to acquire small businesses. The second type of loan, the 504 loan program, offers long-term financing used to acquire real estate. In this section, we discuss the 7(a) loan.

Isn’t it the buyer’s responsibility to get a loan? 

Why do you need to get your business pre-qualified for an SBA loan when selling your business? Isn’t that the buyer’s responsibility? 

Your business must get pre-qualified for an SBA loan because your business must produce enough cash flow to cover the monthly loan payments. SBA loans are pre-approved based on the cash flow available to support the debt service. The cash flow to repay the loan is generated from your business, so the pre-approval process is dependent on the cash flow from your business.

While the buyer has some burden of responsibility, the principal responsibility lies with you, the seller. Don’t take the attitude that, “The buyer wants to buy my business, so it’s their responsibility to find the money.” Remember, it’s your business that is repaying the debt service. Most denials for SBA financing are related to issues regarding the business, not the buyer.

If your business does receive pre-approval, I recommend that the buyer also get pre-approved as early in the process as possible. The lender will review the buyer’s financial position, credit, management experience, and several other criteria.

If both your business and the buyer have been pre-approved, you have a favorable chance of obtaining financing for the sale of your business.

Here’s an example:

Cash Flow

Annual cash flow = $300,000

Less buyer’s salary = $200,000

Annual cash flow after buyer’s salary = $100,000

Price and Terms

Asking price = $1,000,000

Down payment = $200,000

Amount financed = $800,000

Debt Service

Annual payment = $109,008 (10-year term @ 6.5% interest)

Plus 25% debt coverage ratio (DCR) = $27,252

Annual payment + DCR = $132,260

Cash Flow After Debt Service

Annual cash flow after buyer’s salary = $100,000

Less annual payment + DCR = $132,260

This business would not qualify because the “annual cash flow after buyer’s salary” of $100,000 is not enough to support the “annual payment” + “cushion” (debt coverage ratio) of $132,260.

When pre-approving your business for an SBA loan, the lender may also review additional criteria. 

For example, if revenue has consistently declined in your business in recent years, your business may not be approved. Additionally, the lender will require an appraisal of your business. If the appraised amount doesn’t meet the lender’s requirements, they may deny your loan. In summary, there are several reasons your business may not be pre-approved for an SBA loan. 

If both your business and the buyer have been pre-approved, you know that a buyer has a high probability of obtaining financing to purchase your business. 

If your business can’t get approved for SBA financing, you still have options, which I will discuss in the “Next Step if You are Denied a Loan” section. 

Most denials for SBA financing are related to issues regarding the business, not the buyer.

Why should you use an SBA loan intermediary?

A loan intermediary is a specialist in SBA financing. Loan intermediaries know which banks are aggressively dedicated to committing to SBA loans, and most charge either no upfront fees or nominal ones.

A loan intermediary offers many advantages to buyers and sellers because they:

• Help with pre-screening buyers to determine their ability to obtain financing.
• Have success rates of 90% to 95%, for most intermediaries.
• Are the buyer’s advocate in the process and work to get the best deal and the most options for the buyer. 
• Work with multiple lenders and can offer a variety of finance options.
• Don’t simply “pass” off a loan application and hope for the best.
• Are not bankers – they are business people. Intermediaries need results in order to be compensated. 
• Add working capital and closing costs to a loan to reduce the impact of capital needs for the business. 
• Assist in pulling together all necessary documents, critiquing the loan application, and speed up the process from loan application to commitment, improving the chances of securing a loan.
• Review and critique the business plan, professionally prepare loan documents, develop realistic revenue projections, and help select a lender with guidelines capable of approving the loan.
• Provide ongoing status reports, relieving frustration and concerns through the difficult and time-consuming loan process.
• Speed up the process for faster loan commitment and closing.
• Improve the success rate by utilizing creativity in deal structuring and their relationships with aggressive national lenders.

Obtaining an SBA Pre-Approval

Part of the screening process is verifying the financial stability and funding liquidity of the buyer. Below is a list of items most banks or loan intermediaries require to qualify the buyer:

• Personal financial statement
• Bank statements
• Credit report
• Current resume or CV
• Personal cash flow analysis

SBA Loan Myths

Many sellers and buyers are hesitant to apply for an SBA loan because of certain common myths. The following distortions are addressed with real-world information and examples from Diamond Financial, an SBA loan intermediary that I often work with.

Myth 1: It takes nine to 10 months to get a loan through the SBA.

Not true. At Diamond Financial, we have a high volume of SBA loans, and our average deal takes between 48 and 52 days. So, when we are asked about time frames, we usually quote between 45 and 60 days. Some loans get approved in 2 to 3 weeks, but that’s not the norm. Our overall national average is around 48 days from start to finish. If a buyer produces the documentation that we require, it’s a relatively painless process.

Myth 2: Because the SBA guarantees the loan, the lender doesn’t care if it’s a good deal.

That is absolutely false. The SBA monitors lender’s fault rates, and no one wants to put in a bad loan. Just because the SBA loan has a guarantee behind it does not mean that any lender is going to approve the deal. It boils down to finding and choosing the correct lender because every lender has a different set of criteria. For example, if you are trying to buy a car wash and this lender has never financed a car wash, it is going to be a long and tedious process. Why? Because lenders do care if it’s a good deal – no one wants defaulted loans on their portfolio.

Myth 3: The SBA application is over 100 pages.

This is actually not true. The average SBA application is about 23 pages. Much of the documentation needed for an SBA application has already been produced, whether it comes from the broker, the seller, or whoever is involved in the transaction. Unfortunately, this is where most people fail. Buyers don’t understand this part of the application process, and over 84% of applications are declined because of poor presentation. Being approved for an SBA loan is all about systematically compiling the application and presenting it correctly.

Myth 4: You must have a detailed business plan to get an SBA loan.

You do not need a detailed business plan. What we are really looking for is the answer to this basic question: who is going to handle daily operations? And we want it answered in just a couple of pages, never a 50-page business plan. We provide our clients with a detailed questionnaire that asks them to answer questions such as the anticipated hours of operation, who is going to be opening the store, who is going to be closing the store, who are the management and staff, and who is going to be taking this business forward? It is more of how the operation is going to continue under your supervision. Lenders want to know that you have the ability to run the business they will be financing.

Myth 5: No bank will do this loan. You’ve already asked them all.

This myth stems from exhausted entrepreneurs who once eagerly walked into every local bank asking for a loan and were denied by every local bank they walked into. What buyers need to realize is that your local community bank is not going to put your $800,000 uncollateralized loan in its portfolio. For some reason, everyone automatically thinks, “I need a loan. I should go to my local bank.” This is because the world insists that when you need a loan, you go to where your checking account is or where you got your mortgage. But the truth is, those banks have no appetite for the transaction loans that we provide, and that true SBA lenders provide. If you look at the list of the top 10 SBA lenders in the country, they are not going to be your local community banks. Uncollateralized loans devalue the bank. What buyers will soon discover is they have been asking the wrong people. Rather than blindly walking into all local banks, a buyer should strategically choose where to apply for a loan.

Next Step if You Are Denied a Loan

What’s the next step if your buyer is denied an SBA loan?

Don’t give up. I’ve seen lots of deals get turned down by one bank only to get accepted by another bank. Aside from the objective requirements, SBA loans have subjective requirements that vary from bank to bank.

There may be some niche lenders out there that are more aggressive than the first bank. Loan intermediaries are likely to know who these banks are. As the seller, you need to know if an SBA loan is possible in order to avoid wasting your time on future deals if an SBA loan is not possible. 

Also, it would make sense to run your draft tax returns by a loan intermediary before filing them with the IRS. A loan intermediary can recommend certain adjustments to your federal income tax returns to increase the likelihood of obtaining SBA financing.

Some situations are tricky. For example, deducting the cost of that trip to Hawaii last year that cost you $5,000 may reduce the tax burden of your company. But in the lender’s eyes, this reduces your company’s profitability, which reduces the amount of cash flow available to pay the loan.

Although we make adjustments when normalizing financial statements, banks are conservative in the adjustments they allow. Running your tax returns by a loan intermediary may result in changes that could improve the chances of obtaining bank financing.

If your business is not approved for SBA financing, you have two options:

1. Offer seller financing.
2. Sell your business for all cash and reduce the purchase price by 20% to 30% to account for the fact that you are asking for all cash.

Frequently Asked Questions About SBA Loans

Let’s look at a few more common questions about the SBA loan process.

Should you reduce the asking price if your loan wasn’t approved? 

A bank’s denial of a loan often has little to do with the fairness of your asking price. Lenders are, by nature, conservative, especially when granting an SBA loan, so don’t let this dampen your enthusiasm. Loans are often denied based on subjective requirements that do not have a bearing on the value of a business. I did a deal recently for around $700,000, and the bank performed an appraisal that came in at about $100,000 less than what we had accepted for the business. I had our internal appraiser at Morgan & Westfield critique the bank’s appraisal, which contained several errors, and I was able to get the loan restructured. Never take the first no – there are always other lenders that are more aggressive. Keep persisting and keep the revenue stable, and you will get a transaction done eventually.

What is a pre-approval? 

A pre-approval means that a lender has analyzed the business, its financials, and federal tax returns and determined there is a high chance they would finance the acquisition. They estimate their chances of approval are 85% to 90% with a strong buyer. 

What are the costs to the seller for an SBA loan? 

There are no fees assessed to the seller as a result of the buyer seeking SBA-guaranteed financing.

What are the different types of SBA-approved lenders? 

Lenders are either General Program (GP) or Preferred Lending Program (PLP) originators. The difference between the two is that while GP lenders must obtain certain approvals from the SBA through the transaction, PLP lenders have been granted full delegated underwriting and closing authorization on behalf of the SBA. The process is faster when working through a PLP lender.

What credit score is required? 

Most loans require a credit score of at least 640, though some buyers may be approved with a lower credit score. But far more important than the credit score are the underlying details of a borrower’s credit history.

Will lenders review your tax returns when they consider financing? 

Yes, lenders will review your tax returns when they consider financing for your business. There are some exceptions, such as medical practices; however, in the majority of loan applications, the lender will primarily base their decision on the cash flows shown on the business’s federal income tax returns. If the income reported on your tax returns isn’t high enough to cover the debt service, the buyer’s salary, and a debt cushion, it’s unlikely your business will qualify for a bank loan.

Can working capital and inventory be financed? 

Yes, working capital is routinely included in a loan in the form of permanent working capital or a line of credit. Loan funds can also be used to finance inventory as well as other business assets. Funds can be applied to building and leasehold improvements, equipment, debt restructuring, working capital, and franchise fees, all as part of an acquisition package.

What fees are charged? 

With the exception of a loan packaging fee, which can be no more than $2,500, all costs and fees charged to a borrower are actual out-of-pocket costs borne by the lender in the process of providing the loan. This can include the lender’s legal fees, business valuation costs, credit reports, and a variety of other expenses. Most often, the largest fee is the SBA Guaranty Fee, which is calculated based upon the amount of the portion of the loan guaranteed by the SBA.

What are the terms? 

Terms are usually 10 years for business acquisition loans, but if the commercial real estate housing the business is also being acquired, the term can be as long as 25 years.

What is the interest rate? 

The maximum, and typical, interest rate is prime + 2.75%, normally adjusted on a quarterly basis.

What happens if the buyer sells the business? 

SBA loans are fully assumable under certain conditions, but most often, they are paid off upon the sale of the business.

Does the seller have to carry a note? 

There is no SBA rule requiring the seller to hold a note. That determination is made by the transaction’s parties and the lender during the process of structuring the deal.

Is a business appraisal necessary? 

Business valuations are required if the loan is $200,000 or more.

How is real estate handled? 

The real estate associated with the business can be acquired and financed as part of the business acquisition and financing process.

Why is bank financing for a small business so hard to get? 

There’s one main reason why bank financing is rarely involved in small business sales. In an effort to boost profits, business owners reduce income taxes by not reporting all their income or by deducting as many expenses as possible. This lowers the income that is reported on the business’s tax returns, which in effect reduces the cash flow available to repay the debt service. Banks are, by nature, conservative and must follow guidelines and procedures when granting a loan. Banks have a specific process when pre-qualifying a small business loan. They start by reviewing the federal income tax returns. Then they add back a minimum number of adjustments, which may include interest, depreciation, amortization, and the owner’s salary. This resulting number is normally lower than the seller’s discretionary earnings (SDE). This number is used to determine the maximum amount of debt service available to repay a loan. Banks are conservative in the adjustments they make to your financial statements. They do not add back other perks you may be running through your business, such as personal travel expenses, meal and entertainment expenses, and other discretionary or personal expenses.

Are there other options besides SBA loans? 

Yes, but they are rare. Buyers can often access their retirement funds tax-free to buy a small business. If the buyer is a veteran, they may qualify for a VA loan. It is estimated that over 95% of the loans to purchase a small business are 7(a) SBA loans. For this reason, I recommend first exploring if the business would qualify for an SBA loan. If it does not, you may explore other options.

The vast majority of small business sales – 80%, according to industry statistics – include some form of seller financing. Most M&A transactions in the middle market contain some component of seller financing but the amounts are low – often 10% to 40% of the transaction size. 

Seller financing is often the most suitable option if SBA financing can’t be obtained. Seller financing is also faster to arrange and requires less paperwork than traditional financing sources. 

One of the first questions buyers have is whether you will finance a portion of the sale.

Deciding To Offer Seller Financing

Decide early in the process of marketing your business whether you will offer seller financing. This is because one of the most important components of the business sale is how the buyer plans to finance the transaction. One of the first questions buyers have is whether you will finance a portion of the sale. With seller financing, you receive a down payment and then periodic, usually monthly, payments until the buyer pays you in full.

For example, if the purchase price is $5 million and you’re willing to finance 50% of the purchase price, the buyer puts down $2.5 million and makes monthly payments on the remainder until the balance of the seller note is paid in full.

Because you are functioning as a bank, you should ask your accountant to assist you in pre-qualifying the buyer before committing to financing the sale. You may pre-qualify the buyer by obtaining a copy of their credit report, a resume detailing the buyer’s previous business experience, and, in some cases, even hiring a private investigator. The buyer may also offer their personal assets as collateral, in addition to the assets of the business.

Most sellers of small businesses want a minimum down payment of 50%, and most sellers offer terms ranging from three to five years; but, the terms must make sense financially for both parties involved.

For middle-market businesses, these deal structures usually include a seller note amounting to 10% to 40% of the purchase price with an amortization period from two to four years.

You should consider the following to protect yourself:

• Require that the buyer meet certain specifications or financial benchmarks after closing, such as maintaining a minimum amount of working capital or inventory. 
• Request access to financial statements during the term of the loan so you can identify and address problems early on.
• Remain on the lease during the duration of the note.

Benefits of Financing the Sale

For small businesses, it’s best to offer specific terms when marketing your business for sale. This sends the message to the buyer that you have given the sale careful consideration, and are serious and realistic in terms of the sale. Buyers like to deal with realistic and prepared sellers. You will also receive more responses if you market your business for sale with some form of financing versus for all cash.

For mid-sized businesses, it’s common to market a business without a price and without offering specific terms. Here are a few additional benefits to financing the sale:

• Higher Selling Price: Businesses that include seller financing sell for 20% to 30% more than businesses that sell for all cash.
• Lower Taxes: You generally don’t pay taxes until you receive the money, but there are always exceptions when it comes to tax law. Be sure that the note is structured so it’s “non-negotiable” to avoid having to pay income taxes until you receive the money.
• Faster Sale: Businesses offered with seller financing are easier to sell than a business offered for all cash.

What if you will finance the right buyer?

In this case, I recommend mentioning that financing is negotiable. Don’t specify the exact terms under which you would finance the sale. This doesn’t commit you to financing the sale; however, the mention of possible financing invites buyers who are only looking at businesses in which the seller would finance a portion of the deal.

Can you sell the note if you need cash?

You can often sell the note after it has matured for 6 to 12 months. There are many investors who purchase these notes, which effectively cashes you out. Unfortunately, it’s often at a steep discount, but there are few alternatives other than selling your note. If you would like to leave this option open, it’s important to ensure that the note can be transferred or assigned to a third party.

Terms

What interest rate is fair to charge?

The rate depends on the amount of risk involved and less on the current cost of money. Over the past 10 years, the interest rates charged on promissory notes have ranged from 6% to 8%. 

Some buyers state that current interest rates on residential real estate mortgages are much lower and that the rate should be competitive with these. As I explain to buyers, such a loan is risky for the seller and little collateral is available, other than the undervalued assets of the business. If you default on your mortgage, the bank simply takes your house. However, if you default on a loan used to buy a small business, there often isn’t anything to take back other than a struggling business.

Other factors that should be considered in determining the interest rate to charge include the total price of your business, the buyer’s credit score, the buyer’s experience, the buyer’s financial position, and perhaps most important, the amount of the down payment. The interest rate is more a function of the risk than the current cost of money.

How do you determine how much to finance?

Your decision regarding how much to finance must make sense from a cash-flow standpoint – if your business makes a profit of $100,000 per month, then a note of $90,000 per month won’t make sense. The profit from your business must cover the amount of the note and also pay the buyer a living wage. If it can’t, then it won’t work.

The following information is based on statistics from more than 10,000 business sales:

• Average Interest Rate: Ranges from 6% to 8%, but there’s a slight variance. This is based on risk, not prevailing interest rates. Financing a business is risky, leading to relatively high rates compared with interest rates on other assets.
• Average Length of Note: Five years, but it varies from three to seven years. 
• Average Down Payment: Usually 50%, but it varies from 30% to 80%. 
• All Cash Deals: Less than 10% of businesses sell for all cash.

How many years should the note be for? 

Most notes range from three to five years. But common sense is the rule of thumb here. The cash flow from the business should cover the debt service. 

Let’s look at a simple case that doesn’t work because the debt service is too high:

This scenario won’t work because the payment is 94% of the annual profit of the business. A more realistic scenario would be a four-to-five-year term. Note that the term has a bigger impact on the amount of the payments than the interest rate. The payment should be less than a third of the annual cash flow of the business. If the cash flow of the business is stable from year to year, then it can be higher. If the cash flow is inconsistent, you should build in a cushion and structure the note so the payment is lower.

Should you hire a private investigator?

If you are considering financing a significant portion of the purchase price and doubt the buyer’s credibility, you need to protect yourself. Money spent on an investigation could save you hundreds of thousands of dollars down the line if you find out that your prospective buyer is a bad credit risk.

A private investigator can reveal information about individuals who want to purchase your business, such as aliases and undisclosed addresses. This information can help you determine the character of your buyer’s past and their creditworthiness.

In addition, a private investigator can help you learn if the potential buyer has any current or previous litigation, debts, or claims that could predict whether they would default on the loan to you. An investigation of their public records could help identify any undisclosed arrest records, bankruptcies, corporate records, court records, criminal records, deeds, or divorce filings.

It’s important to note that a signed release may be required by law to obtain this information. The buyer has a right to refuse the release, though they should understand your need to protect yourself if they’re asking you to finance the loan. Explain to the potential buyer that it’s a necessary action, considering the financial risk you are taking. They would have to do the same thing with a bank or financial institution. You should also consult your attorney for more advice.

Documenting and Managing the Note

There are specific documents involved in seller financing that need to be drafted. You will need a promissory note and security agreement that address the key terms of the seller note. When you are financing the sale of your business, your note is secured with a Uniform Commercial Code (UCC) lien on the assets of the business. This UCC-1 lien should be filed post-closing with your local county or state. 

The UCC lien prevents the buyer from selling the business or the assets during the term of the note. It’s also protected with a promissory note and a personal guarantee. If you hire a broker to sell your business, the broker will usually draft these documents.

Why should you use a third-party loan processor?

I recommend using a third party to service the loan for a number of reasons. A loan processor handles all aspects of collecting, crediting, and disbursing monthly loan payments. As a neutral third party, they simplify the day-to-day management and process of managing loan payments. Using a third party to administer the payments simplifies recordkeeping.

Using a third party also removes your obligation to handle late payments, freeing you up to focus on more important matters. It also allows you to maintain a good working relationship with the buyer by having an independent third party serve as a buffer if payments arrive late.

Preventing and Resolving a Default 

Because you are financing a portion of the sale, you need to think and act like a bank, and qualify the buyer before committing to financing the sale. I recommend obtaining a detailed financial statement, credit report, resume, and any other pertinent information you can get from the buyer as early as possible in the process. You should also select a buyer you think will succeed in your business from an operational standpoint.

If the buyer of your business is another company, ask the buyer about their previous acquisitions. Talking to the owners of companies they have acquired in the past may also be helpful. Depending on the size of the company, it may be prudent to perform due diligence on the principals of the company that wants to acquire your business.

Most of the problems I see related to seller financing originate from the seller accepting a low down payment, which would be anything less than 30%. I suggest asking for a down payment of at least 30% to 50% of the asking price. Why? Few buyers will walk away from such a large down payment.

If the buyer is an individual, you may also be able to negotiate to collateralize the buyer’s personal assets in addition to the assets of the business; but doing so can sometimes signal to the buyer that you don’t have faith in your business. 

Additionally, you can require the buyer to maintain specific financial benchmarks post-closing, such as maintaining a minimum level of inventory or working capital. I also recommend that you have access to monthly or quarterly financial statements. This should enable you to spot and help correct any problems early on if they do arise.

The vast majority of small business sales – 80%, according to industry statistics – include some form of seller financing.

How common is a default?

I estimate default rates for seller notes to range from 2% to 5%. While no verifiable statistics exist on default rates for seller notes, I believe my estimate to be accurate. The default rates for SBA loans have ranged from approximately 2% to 5% over the previous 10 years. Default rates tend to be the highest for the riskiest industries, such as restaurants and retail. If you think and act like a bank, then you can expect a success rate of 95% to 98%.

If you are concerned that the buyer is going to default, you should first attempt to come to a mutual agreement with the buyer. In many instances, a default by the buyer can be simply and easily dealt with by talking with them. It’s also important to maintain a working relationship with the buyer throughout the transaction. If an excellent working relationship is maintained, most buyers will cooperate if they default, making it possible to work out a peaceful solution quickly and inexpensively. In my experience, most buyers will be willing to work out a peaceful solution, whether by surrendering control of the business, working out another payment plan, or providing additional collateral.

If you can’t voluntarily work out a solution, then you must follow the dispute resolution options in your purchase agreement, which could be mediation, arbitration, or litigation. 

In my experience, there are two ways you can prevent a default: 

1. Perform careful due diligence on the buyer 
2. Maintain a cordial relationship with the buyer after the closing 

Don’t underestimate the value of your face-to-face assessment of the buyer’s trustworthiness. There have been many instances where sellers felt something was “off” about a buyer’s body language or negotiation methods but continued with the transaction anyway in their eagerness to close a deal – much to their regret later.

With respect to cordiality, common courtesy will go a long way toward allowing each party to communicate clearly and effectively in an environment unclouded by emotion. When both sides can clearly articulate their needs, an amicable solution can be achieved much more quickly most of the time.

Should you remain on the lease?

As the seller, make sure you remain on the lease during the entire period of the note. If the buyer defaults, you will need to take the business back and repossess the lease. 

Alternatively, you can negotiate to take back the lease if the buyer defaults without you remaining on the lease. In this scenario, you would not remain on the lease; however, you would retain the ability to take back the lease only in the event of a default by the buyer. Again, this should be addressed by an experienced broker or real estate attorney.

Can you take the business back if the buyer defaults?

You can’t take the business back without the buyer’s explicit permission or without first resorting to any dispute resolution process. Remember, when the bill of sale is signed, ownership of the business transfers to the buyer. From that point, even if the buyer is behind in their payments, the buyer has the exclusive right to the business. Without the involvement of the authorities, you can’t force the buyer to return the business no matter how legally justified you believe yourself to be.

Key Points

• For Small Businesses: If you aren’t willing to finance the sale of your business, there’s probably another seller with a reasonably priced business similar to yours who will. Sellers must consider financing the sale of the business if they’re serious about selling, especially if the business is not pre-approved for bank financing.
• For Mid-Sized Businesses: Most M&A transactions in the middle market include s0me component of seller financing, though the amounts are low, often 10% to 30% of the transaction size. 

Many business owners want all cash when selling their businesses. No muss, no fuss. But, there are still a number of questions you may be asking yourself, such as: 

• When selling my business, can I cash out at closing? 
• Is it possible to sell my business for all cash? 
• Do I need to finance a portion of the purchase price? 

Let’s look at some answers to these questions.

Can you sell your business for all cash? 

The short answer is “Yes.” That’s the long answer, too, but your chances of selling your business decrease and your timeline for selling your business increases. Here’s what I mean:

When you ask for all cash, the chances of selling your business significantly decrease because buyers always consider multiple options. It’s unlikely the buyer is looking only at your business. It’s more often the case that the buyer is considering businesses for sale where the owner is willing to offer financing or businesses that have been pre-approved for SBA financing. If the buyer is a company, they may be considering other corporate development options for growing their business.

If your business has been pre-approved for SBA financing, I don’t think you need to offer seller financing as a second alternative. You can limit your search to buyers who are interested in purchasing your business only with SBA financing. This means you will effectively “cash out” when you sell your business, with the exception of a small note you may be required to carry, which is typically less than 10% of the purchase price.

So, again, yes, you can ask for all cash for your business, but there could be consequences. 

The information in this chapter primarily applies only if the buyer of your business is likely to be an individual or small competitor. It does not apply if the likely buyer is a mid-to-large-sized competitor, another company, or a financial buyer, such as a private equity group. These buyers often pay cash or put down up to 90% cash at closing.

Small Business Buyers and Cash Offers 

There may be several reasons why buyers won’t pay all cash for the purchase of a business, so let’s look at a few of the biggest.

Buyers Look at Lots of Options for Businesses to Buy

Individual buyers of small businesses are usually industry agnostic and have multiple options. About 95% of the time, individual buyers of small businesses priced at less than $5 million are not looking to buy one specific type of business. They are usually considering businesses in a variety of industries, such as service-based, retail, manufacturing, or others. 

It is rare for small-business buyers to limit their search to one particular type of industry, unless the buyer is a corporate buyer, such as a competitor or private equity group. The primary exception is highly specialized businesses, such as professional service firms and other niche businesses that require a unique set of knowledge or skills.

Buyers are often looking at hundreds of businesses for sale. As a result, they have a wide variety to choose from and tend to migrate toward businesses that can be financed, either through the seller or the SBA. 

Buyers tend to dismiss business owners who are asking for all cash unless the business has been pre-approved for SBA financing.

Sellers Who Are Asking for All Cash are Considered Unrealistic

Buyers are wary of sellers who want to take the cash and run, figuratively speaking. They see this as a lack of faith in the business and as a warning sign that something may be wrong.

Buyers Maximize Their Returns Through Leverage

For example, a buyer who has $1.2 million cash to invest in a business is more likely to buy a business for $2.4 million as opposed to a business for only $1.2 million. Why? Let’s examine the numbers behind the logic:

Would you rather buy Business A or Business B?

Both businesses require the same down payment, but Business B is offering 50% financing. Business B also has a higher cash flow, which means the buyer will put more money in their pocket, even after paying the debt service. 

Most buyers prefer Business B because it offers higher returns, both as a return on investment and cash-on-cash return.

In other words, they are buying a business that will put more money in their pockets – but for the same down payment of $1.2 million. Also, because Business B offers financing, this implies that the seller of Business B has more faith in their business, which is likely to make the buyer more comfortable.

Business B also builds more equity in the long term.

One additional principle to consider when calculating ROI is equity building.

Let’s assume that both owners sell their business after 10 years. The owner of Business A would receive $1.2 million for their business, and the owner of Business B would receive $2.4 million for their business excluding any growth in value. Essentially, the owner of Business B used the cash flow of the business to pay for itself.

You have heard it before, but terms are often more important than purchase price.

Exceptions to the Rule

As with everything in life, there are exceptions, and in business sales, there is one principal exception. Americans love financing just about anything they purchase. 

However, some cultures prefer to pay cash as they are philosophically, culturally, or religiously opposed to the idea of paying interest and being burdened by debt, even though the ROI may be higher. Additionally, some religions forbid charging or paying interest.

Several years ago, I was selling a gas station for a couple of million dollars. In a conversation I had with the seller, who happened to be from Lebanon, we discussed structuring the promissory note. I asked the seller his preferences regarding the interest rate. He told me 0%. I thought the seller misheard me, so I asked him again. He again told me 0% and that he was forbidden from charging or receiving interest payments. I later learned that Islam prohibits charging interest, even at low interest rates.

This is most common in culturally-diverse cities, such as Los Angeles, Seattle, or Miami, in which a buyer may be open to paying all cash, though they often expect a discount.

For these types of businesses, we recommend two prices: an all-cash price and a seller-financed price. The price difference usually needs to be about 20% to make sense. For example, you can ask $1 million all cash or $1.2 million with 50% down.

Isn’t it the buyer’s responsibility to obtain financing? 

Yes, the buyer must also meet the requirements for approval, but your business must be able to generate sufficient cash flow to repay the debt service.

A valuable criterion for any buyer is the availability of financing. Assets that can be financed are more easily bought and sold, and the markets tend to be more liquid for them than for assets where no financing is available.

How many cars could Ford Motor Company sell if no banks would finance them?

If you own a business and are willing to offer financing or if SBA financing is available, you can expect to sell more quickly and more easily than if you are asking for all cash.

If you still want to ask for all cash, what are your options?

If you still want to ask for all cash, you have two options:

1. Pre-Approval: Have your business pre-approved for SBA financing. Remember, the maximum loan amount is $5.5 million.
2. Discount Price: Ask for all cash, but discount the asking price by approximately 20%. I have analyzed over 10,000 transactions and through my analysis, I have calculated businesses that sell for all cash receive approximately 30% less. But you can start with a lower discount, perhaps 20%, and negotiate from there.

The buyer’s personal equity is a key element in the acquisition of small and mid-sized businesses. Anywhere from 10% to 100% of the capital necessary to purchase a business comes from the buyer’s own cash injection. Most individual buyers of small businesses prefer to leverage their down payment – as a result, they prefer not to pay all cash. Some corporate acquirers put down larger amounts than individual buyers, although this varies significantly from company to company. So, where does the remainder of the cash come from?

There are three major components of deal structure: 

1. Seller Financing
2. Bank or SBA Financing
3. 401(k) Rollovers

Source 1: Seller Financing

The simplest way to finance the acquisition of a small business is for the buyer to work closely with the seller to negotiate a “seller note.” 

Seller financing is faster to arrange and requires less paperwork than traditional financing sources. Seller financing is often the most suitable option if SBA financing can’t be obtained. 

How does seller financing work? If the price of a business is $5 million and the seller is offering 50% financing, then the buyer would put down $2.5 million and make payments on the remainder until the note is paid in full. Nearly 85% of small business purchases involve seller financing. 

Sellers typically offer terms of three to five years and interest rates of 5% to 8%.

Advantages of Seller Financing:

• Less paperwork
• Less stringent requirements for buyers regarding things like their experience and credit
• Minimal closing costs
• Fast closing time
• Motivation to ensure the buyer is successful, which can make your business easier to sell

Disadvantages of Seller Financing:

• Risk of default
• Less cash at closing

Source 2: Bank or SBA Financing

Nearly 95% of bank loans for the acquisition of businesses under $5 million are Small Business Administration (SBA) loans. The maximum loan size for an SBA 7(a) loan is $5 million. Loans above $5 million are primarily conventional loans. If a corporate buyer is purchasing your business and the loan size is likely to exceed $5 million, the buyer will pursue traditional sources of financing other than an SBA loan. The SBA 7(a) loan is the number one source of financing for acquisitions of businesses under $5 million, other than seller financing.

To be clear, the SBA does not actually loan money. The SBA, through its 7(a) Loan Program, helps small businesses access credit by guaranteeing loans made by banks. This limits risk for banks offering such loans, which encourages them to lend money to small businesses. By doing this, SBA financing can offer buyers attractive loan terms and interest rates while eliminating, or reducing, the need for the seller to carry a note. 

For the buyer, this means a lower down payment, lower debt service, and higher net income. Because this is a government-sponsored program, there are strict guidelines that any bank must follow when offering an SBA loan.

SBA financing can also sometimes be combined with seller financing.

Advantages of SBA Financing:

• There is a lower down payment requirement for buyers, typically 10% to 20% cash. This can improve the chances of selling your business because there are more buyers with 10% to 20% cash down than buyers with 50% or more cash down.
• An SBA loan will have a longer amortization period – typically 10 years. This results in lower monthly payments, which increases cash flow for the buyer and makes your business easier to sell.
• SBA financing can be combined with other forms of financing, such as seller financing and 401(k) rollovers.
• As the seller, you receive cash at closing, which reduces your risk.

Disadvantages of SBA Financing:

• There is more loan paperwork required.
• There is a longer approval and closing time frame.
• There is a lower success rate of obtaining SBA financing vs. seller financing.
• There are more stringent requirements and guidelines, which reduce the likelihood of SBA approval.
• Most SBA loans require a business appraisal. The loan may be denied if the appraised value is less than your asking price.
• There are higher closing costs for the buyer, typically 3.5% to 4%, which is regulated by the SBA. This may reduce the total purchase price the buyer can pay for your business.
• There is normally a variable interest rate for the buyer, which increases risk for the buyer and therefore the price they can pay you for the business.

Source 3: 401(k) Rollovers

A buyer can also avoid taking out a small business loan altogether and use their retirement funds to finance a new business purchase. Since buying stock will be an investment in the buyer’s own company, they won’t have to take a taxable distribution. Creative use of this form of financing has allowed us to finance million-dollar transactions with as little as $20,000 cash down. While numerous qualifications exist, retirement plans should be fully accessible and should be enabled to be rolled over into another plan. 

If done right, there are no penalties for the buyer when using a 401(k) or IRA to buy a business.

Advantages of 401(k) Rollovers:

• You receive cash at closing, which reduces your risk.
• There is a high success rate of obtaining funding, which reduces your risk of a buyer not obtaining financing.
• Interest on the debt is tax-deductible for the buyer, making the transaction more attractive.

Disadvantages of 401(k) Rollovers:

• Using retirement funds results in a longer time frame to work out the details.
• An annual appraisal may be required, which would be paid by the buyer.
• There may be ongoing maintenance fees, which are paid by the buyer.

Common Transaction Structures

A buyer can combine all three forms of financing to purchase your business. I have outlined a few common transaction structures below and broken these down into three broad categories: all cash, seller financing, and bank (SBA) financing. A 401(k) rollover is included as cash in these example transaction structures and counts as the buyer’s personal equity, and can also be used in combination with seller or bank financing.

The following are the most common transaction structures for businesses sold to individuals and priced under $5 million:

• All Cash
  • Buyer pays 100% cash at closing 
• Seller Financing
  • Buyer puts 50% cash down 
  • You finance 50% of the purchase price 
• Bank or SBA Financing
  • The buyer puts 20% cash down 
  • The buyer obtains an SBA loan for 80% of the purchase price
• Hybrid
  • Buyer puts 10% cash down 
  • Seller finances 10% of the purchase price
  • The buyer obtains an SBA loan for 80% of the purchase price

I recommend considering your financing options in the following order:

1. SBA Financing: First, consider SBA financing, which offers the most lenient terms, including the lowest down payment and the longest amortization period.
2. Seller Financing: Consider seller financing if SBA financing is not available or if you prefer to offer seller financing due to other reasons such as tax benefits.

If your business is priced from $5 million to $10 million, it will most likely be sold to a corporate buyer who will typically put down 70% to 90% of the purchase price and you will finance the remaining 10% to 30%. The buyer will obtain their own financing and in most cases will require that 10% of the purchase price be held in escrow for a period of 12 to 18 months before it is released to you. These buyers also sometimes propose an earnout as part of the transaction structure. Earnouts will be covered in later chapters.

There are nine critical valuation concepts you should understand before valuing your business:

1. Fair Market Value vs. Strategic Value 
2. Small Market vs. Middle Market
3. Business Valuation Is a Range Concept 
4. The M&A Market Is Inefficient
5. Buyers Don’t Always Follow Valuations 
6. Terms Affect the Value 
7. Your Personal Needs Affect Value 
8. Comparable Sales Are Rarely Comparable 
9. Value is Determined Upon a Sale

Let’s take a deeper look at each of these concepts …

Concept 1: Fair Market Value vs. Strategic Value

Fair Market Value

Most business appraisals use fair market value (FMV) as the standard of value.

The real-world understanding of “fair market value” is as follows:

The highest price a business might reasonably be expected to bring if sold by using the normal methods and in the ordinary course of business in a market not exposed to any undue stresses. That market is composed of willing buyers and sellers dealing at arm’s length and under no compulsion to buy or sell, and both parties having reasonable knowledge of relevant facts.

Explicit in the definition of fair market value is the following:

• Amount (Price): The prevailing standard in business transactions is the highest price, whereas in real estate transactions the standard is the “most probable price.”
• Willing: The definition implies that the parties are willing and able, have sufficient motivation, and are acting in their best interests.
• Compulsion: FMV assumes the parties are “under no compulsion” to complete a transaction, and that they are dealing with one another at arm’s length, not influenced by special motivations.
• Knowledge: Fair market value assumes the parties are well-informed and possess reasonable knowledge of the industry, marketplace, and the opportunities and weaknesses of the subject business.

Strategic Value

Strategic value, also called investment value, is the value of a business to a specific buyer. It can represent a value in excess of FMV to a specific buyer of a business, usually a strategic buyer. The primary downside to strategic value is that you can’t measure strategic value until you know who the buyer is. That’s because every buyer is able to extract a different amount of value from the business based on the synergies they bring to the table.

For companies likely to be sold to a strategic buyer, a valuation will only serve to establish a “floor,” or a minimum price, or fair market value at which the company may sell. It’s possible that your business may sell for more if it’s purchased by a strategic buyer. 

It’s impossible to quantify the synergies until you identify the buyer, and many times you can never quantify the synergies, as most buyers hold these in confidence throughout the process to maintain their negotiating leverage. For mid-sized businesses, the purpose of the valuation is only to establish a minimum floor price or fair market value. The true value, or strategic value, can only be determined in the actual marketplace by establishing a competitive auction process among buyers.

The riskier your business is, the higher the rate of return your buyer will require to compensate for the risk.

Concept 2: Small Market vs. Middle Market

The methods used to value a small business are different from those used to value a mid-sized business.

Multiples

Mid-market companies with annual revenues between $1 million and $50 million commonly sell for three to six times their EBITDA. However, companies with less than $1 million in annual revenue typically sell for a multiple of two or three. This is because a smaller business is riskier. The business may not have a diversified customer base or produce enough cash flow to withstand a downturn in its market. Small businesses are more prone to failure than middle-market businesses, so they sell at lower multiples.

ROI vs. Multiples

The riskier your business is, the higher the rate of return your buyer will require to compensate for the risk, and the lower your multiple will be. It’s a simple formula – if your business is larger and less risky, an investor might decide they need only a 20% return, or a 5.0 multiple, to justify the risk. If your business is smaller, a 40% return, or 2.5 multiple may be required.

Middle-Market Businesses are Easier to Sell

You will receive more for your business if you are seen as a mid-market company, and not an owner-operated small business. There is another good reason to grow beyond that $1 million to $5 million mark: less competition for buyers. 

There are approximately 300,000 mid-market companies in the United States with annual revenues ranging from $5 million to $1 billion. But there are more than 10 times as many owner-operated small businesses with revenues of less than $5 million.

Concept 3: Business Valuation Is a Range Concept 

A Valuation Is Based on a Professional’s Opinion

When obtaining a business valuation, you are simply paying for a professional’s opinion. This is a subjective opinion from an independent professional and is going to change based on new information. This represents the professional’s opinion as to what a hypothetical person or company is likely to pay for your business, not necessarily what your company will actually sell for in the real marketplace. 

Valuation Is Essentially Mind Reading

In reality, the appraiser is attempting to predict how a diverse audience with different preferences, views, and perspectives will behave. Doing this is inherently difficult because the range of possible values for a business is wider than for other investments such as real estate. 

Identifying Value Drivers

Nonetheless, an appraiser’s opinion is valuable and can be a realistic starting point for planning your exit. One of the most important roles an appraiser will play is identifying the factors that will most heavily influence the value of your business. These are called value drivers. Knowing what these factors are will help you maximize your business’s value.

Concept 4: The M&A Market Is Inefficient

Lack of Comparable Transactions

Some markets, such as the real estate market, have a ready supply of highly comparable transactions. The market for businesses, on the other hand, is fragmented, making it difficult to obtain relevant comparable transactions.

Values Change Based on Markets

Because the marketplace for the sale of small and mid-sized businesses is inefficient, values vary widely. Current market conditions can therefore greatly affect the final selling price of your business.

Concept 5: Buyers Don’t Always Follow Valuations

Keep in mind that an appraiser is making an educated guess as to what a hypothetical buyer might pay for your business. That task is difficult, since buyers don’t always follow valuations, especially if there are potential buyers for your business who are unsophisticated. 

It is inherently difficult to predict how unsophisticated people behave, whereas it’s easier to predict how sophisticated people will behave. Sophisticated investors tend to enlist professionals who share the same training and education, and often share uniform perspectives regarding what makes an intelligent investment. Their behavior and perspectives fall along a more narrow band than those of unsophisticated buyers.

That’s why estimating the value of a small to mid-sized business is difficult – you are conjecturing how a diverse group of both sophisticated and unsophisticated investors will think and behave. This is an inherently onerous task, regardless of one’s expertise and knowledge.

Concept 6: Terms Affect the Value

In most transactions, some portion of the purchase price is contingent. It follows that the terms of the sale – such as the amount of the down payment, the repayment period, and the interest rate – can all affect how much a buyer will be willing to pay.

An installment sale may affect your sale price calculation in another important way. You may want to charge a higher interest rate if you will be paid over a longer period of time rather than a shorter period of time, since during the repayment period you will be exposed to more risk.

Lower Taxes

Keep in mind that selling your business on an installment basis can benefit you because it often puts you into a lower income tax bracket. This is due to progressive tax rates that would apply if you received the entire sale proceeds in one lump sum.

Minimum Cash Down

Regardless of the terms, you should walk away from any transaction in which the cash you will receive at closing doesn’t meet the minimum you are willing to accept for the business.

Concept 7: Your Personal Needs Affect Value

Poor health or financial pressures may force you to sell. If for these or other understandable reasons you need to sell quickly, you will probably have to accept less than the optimal sale price. Similarly, if you’re unable or unwilling to work for the buyer, even for a short time after the closing, that fact may diminish the value of the business in the buyer’s eyes. Many buyers prefer to have the seller stay on board during the entire transition period.

Concept 8: Comparable Sales Are Rarely Comparable

The ideal way to value your business is to determine what similar businesses have sold for. Unlike residential real estate transactions – where it’s not difficult to find recent sales of homes more or less like yours – in the business world, there may have been few, if any, recent sales of businesses similar to yours. 

All Businesses Are Unique

Additionally, businesses are unique. Even if you are able to find a somewhat similar comparable transaction in your industry, the business will not be the same as yours in terms of risk, growth rate, location, sales volume, number of employees, or a host of other important factors that can affect the price.

Availability of Accurate Information

Even in the unlikely event that you can find the recent sale of a company that closely resembles yours, you may not be able to access accurate numbers on the business and the transaction. Unlike sales of real estate, which often leave a public paper trail, reliable business sales numbers are private and access to accurate information can be hard to come by, especially because rumor and exaggeration often obscure the facts.

Beware of Incomplete Information

Watch out for incomplete sales information such as hearsay. Attend any business event with people in your field and you are sure to hear that so-and-so sold his business for such-and-such dollars. 

For example, at a business lunch, you may learn that Emma received $10 million for her business. Even assuming this number has some truth to it, and it may not, you may not be told other important details. For example, the reports of the sale price may not mention that Emma agreed to work for the buyer for three years, which was included in the purchase price, or that the price included the real estate, or that Emma received only 15% of the purchase price upfront with the rest to be paid over five years, or that 80% of the price was based on an earnout. 

Concept 9: Value is Determined Upon a Sale 

A key task in selling any business is deciding how much it’s worth. Price your business too high, and you will scare off potential buyers. Price it too low, and you will leave money on the table. 

No Valuation Is Exact

If you expect precision in pricing your business, you will be disappointed. No pricing formula or expert can accurately provide a sales figure that is exactly “right.” So, while you need to price your business sensibly, you won’t know how much it’s really worth until the day a buyer writes you a check.

Start High and Be Prepared To Negotiate

If you have a healthy business, you will probably pick an initial asking price toward the top of your range and then, if necessary, be prepared to back off a bit in negotiating the final price. You will also need to take into account the general economic climate and trends in your industry, whether positive or negative. And, of course, if you have to sell quickly, you may be required to settle for less than you might receive otherwise.

Conclusion

Valuing a business is a challenging task for even the most seasoned advisor. The best you can hope to do is to make an educated guess as to the future, which can be based on a limited amount of biased information. While such an opinion of value may be tenuous, it is nonetheless the starting point of the M&A process and a critical component of a successful exit strategy for any entrepreneur. A valuation of your business serves as a baseline from which to develop your exit strategy and the ultimate value can only be determined through a carefully executed sale.

Now that I’ve explained the difference between SDE and EBITDA, let’s dive into the two main methods used to value a small to mid-sized company.

Pricing a business is based primarily on its profitability which you can determine in the EBITDA or SDE. Profit is the number one criteria buyers look for when buying a business and the number one factor that buyers use to value a business. 

There are other variables that buyers may consider, but the majority exclusively look for one thing: profit. 

There are two primary methods to value a business:

1. Multiple of EBITDA or SDE: Multiply the EBITDA or SDE of the business by a multiple. Common multiples for mid-sized businesses are three to six times EBITDA. Common multiples for most small businesses are two to four times SDE. 
2. Comparable Sales Approach: This involves researching prices of similar businesses that have sold and then adjusting the value based on any differences between your company and the comparable company.

Profit is the number one criteria buyers look for when buying a business and the number one factor that buyers use to value a business. 

Method 1: Multiple of Earnings (EBITDA or SDE)

Here’s how you can value your business using the multiple of earnings method:

Step 1: Determine the EBITDA or SDE for the previous 12 months or your latest fiscal year. This is called “recasting” or “normalizing” the financial statements. It involves adding the following back to the net profit of your business: depreciation, amortization, owner’s salary, non-cash expenses, non-recurring expenses, and other perks.

Step 2: Multiply your business’s EBITDA or SDE by the multiple.

Example: $1 million EBITDA (Cash Flow) x 4.0 Multiple = $4 million Value of Business

Common Multiples

Here are common current multiples for businesses with less than $5 million in annual revenue:

• Retail Businesses: 2 to 3 times SDE
• Service Businesses: 2 to 3 times SDE
• Food Businesses: 2 to 3 times SDE
• Manufacturing businesses: 3 to 5 or more times SDE
• Wholesale Businesses: 2 to 4 times SDE

Here are common current multiples for businesses with $5 million to $100 million in annual revenue:

• Retail Businesses: 3 to 5 times EBITDA
• Service Businesses: 3 to 5 times EBITDA
• Food Businesses: 3 to 4 times EBITDA
• Manufacturing Businesses: 3 to 6 or more times EBITDA
• Wholesale Businesses: 2 to 5 times EBITDA

Multiples vary with the current economic climate and market conditions. How do you determine the appropriate multiple? Unfortunately, this can only come from experience; however, the guidelines above can be a helpful starting point.

Multiples for Larger Businesses

Most mid-sized businesses are priced at three to six times EBITDA. The multiple varies based primarily on the industry in which a business operates, in addition to several other factors. 

Larger businesses always sell at higher multiples. To demonstrate:

• Business A: SDE of $100,000 per year = 3.0 multiple, or an asking price of $300,000.
• Business B: EBITDA of $5 million per year = 5.0 multiple, or an asking price of $25 million.
• Business C: EBITDA of $100 million per year = 8.0 multiple, or an asking price of $800 million.

The relationship between EBITDA or SDE and multiples is direct. As the EBITDA or SDE of the business increases, so does the multiple. Larger businesses are seen as more valuable by sophisticated investors because they are viewed as more stable, have more professional management teams, and are less dependent on the owner for the business to operate. This is a simple, clear relationship between the size of a company and its multiple that’s demonstrated in the transactional databases and widely accepted by both intermediaries and buyers alike.

Method 2: Comparable Sales Approach

The comparable sales approach is a method for pricing your business based on the prices of similar businesses sold, then making adjustments to account for any differences between your company and the comparable company.

This approach is often difficult to use because the prices of businesses aren’t publicly available. The best source of comparable transactions is from a business broker, M&A intermediary, or business appraiser who has access to private databases. There are several databases sporting comparable business sales. However, the information is sparse or incomplete, so you can’t rely on this data entirely. Collectively, these databases contain approximately 100,000 transactions.

Other Factors to Consider

Value Enhancement

Remember, there are only two direct ways to increase the value of your business:

1. Increase the EBITDA or SDE: There are only two ways to increase the profitability of your business:
   • Reduce expenses.
   • Increase revenues.
2. Increase the Multiple: Multiples are based on several factors, including:
   • Risk: Your multiple is a reflection of how risky a buyer perceives your business to be. To increase your multiple – and your valuation – you should take steps to reduce the risks associated with your business. 
   • Recurring Revenue: Businesses with recurring revenue will attract higher multiples. 
   • Growth Strategy: Buyers will pay higher multiples for companies that have a realistic growth strategy. 

Accounting for Synergies

The valuation methods above do not take into account possible synergies that might be achieved. The value of synergies is impossible to calculate without knowing who the buyer is and having access to their financial statements. The value of synergies is also different for every buyer; therefore, the value of your business can differ substantially depending on who the buyer is.

There are five broad types of synergies: cost savings, revenue enhancement, process improvements, financial engineering such as cheaper access to debt, and tax benefits.

What’s Included in the Price

The price should include all tangible and intangible assets used in the business to generate the cash flow the business produces. This includes all of the equipment and assets required to operate the business on a daily basis. Working capital is generally excluded from the price if the buyer is an individual, while it is included in the price if the buyer is a corporate buyer.

Should inventory be included? This is a common debate among experts. If you have a small business, you can try to get paid for the inventory in addition to the price. It’s going to be negotiated anyway, so ask for it upfront and see what happens.

Pricing a business is based primarily on its profitability. There are other variables that buyers may consider when purchasing a business but the majority exclusively look for profit. When valuing your business, focus on the two methods most buyers use to value a business:

1. Multiple of SDE or EBITDA
2. Comparable Sales

To increase the value of your business, focus on increasing your EBITDA or increasing your multiple.

The value of your business can differ substantially depending on who the buyer is.

When should you use SDE versus EBITDA to value your business? There are many differences to consider, including the fact that numerous adjustments are made when calculating both SDE and EBITDA. But, the major difference is that EBITDA does not include the owner’s salary.

EBITDA is used to value mid-sized businesses that can be run by an outside manager. In a small business, an owner would keep the owner’s salary, but in a mid-sized business, the new owner would need to pay a salary to a manager to run the business. It makes sense to use EBITDA when valuing mid-sized businesses because the majority of businesses in the middle market are purchased by other companies that must hire and pay a manager or CEO to run the business post-closing.

SDE is used to value small businesses in which the owner actively works in the business. In most small businesses, it’s difficult to distinguish between the profits of the business and the owner’s compensation. SDE addresses this problem by blending the profits of the business and the owner’s compensation into the one number called the seller’s discretionary earnings. 

Let’s explore EBITDA and SDE in depth. I’ll explain which is more suitable for valuing your business, along with some other minor differences.

When To Use SDE

SDE is used to value small businesses in which the owner actively works in the business. Keep in mind that it’s often difficult to distinguish between the profits of the business and the owner’s compensation. Many business owners don’t pay themselves a salary and instead may take a “draw.” In other businesses, an owner may be paying themselves less than what they would have to pay an outside manager. 

For example, they may pay themselves a $40,000 annual salary when a more appropriate salary for their role, based on market demand, would be $150,000 per year. 

Additionally, many business owners deduct numerous personal expenses, or “perks,” through the business that would not be paid to an outside manager if they were running the business. 

For example, a business may be paying for an owner’s personal vehicle, health club membership, vacation home, and personal travel expenses. It’s unlikely a business would pay for these perks for an outside manager.

SDE addresses this problem by blending the profits of the business and the owner’s compensation into one number. This is the total compensation that would be available to a new owner-operator of the business. In other words, this is what a new owner could potentially put in their pocket, regardless of how they decide to characterize the income – whether via perks, a salary, a draw, or dividends. 

SDE makes sense when valuing a small owner-operated business because it’s difficult to distinguish business profits from the owner’s compensation in a small business. In most cases, distinguishing the two isn’t practical since most small business owners blur the line between “business” and “personal.” Calculating an appropriate manager’s salary for a small business is also more subjective than doing so for a mid-sized business.

SDE is normally used with businesses that have less than approximately $1 million in SDE. The SDE calculation is mainly used by business brokers since most business brokers sell businesses that are run by an owner-operator. 

When To Use EBITDA

EBITDA is used to value mid-sized businesses that typically have an EBITDA of greater than $1 million per year and that can be run by an outside manager. If an owner-operator currently runs the business, the owner’s compensation is normalized to market levels. 

For example, if the owner’s current salary is $500,000 per year, and the market rate is $200,000 per year, then the owner’s compensation is normalized to $200,000 per year. 

If the current owner isn’t paid a salary, then an appropriate market-rate salary is deducted when calculating EBITDA. The same is true if the current owner or manager is underpaid. A market-rate salary for a manager or CEO is deducted to arrive at EBITDA. Regardless of what the current owner pays themselves, the owner’s compensation is normalized to current market levels, which range from $150,000 to $300,000 for most businesses in the lower middle market.

If a private equity group or company bought your business, they would need to hire a manager to run it, which is why the owner’s compensation is not added back. In a small business, an owner would keep the owner’s compensation, but in a mid-sized business, the new owner would need to pay a salary to a manager to run the business. 

For example, if the SDE is $1 million, and a competitor bought the business and paid a manager $200,000 per year to run the business, their EBITDA would be $800,000 per year ($1,000,000 – $200,000 = $800,000). 

It makes sense to use EBITDA when valuing mid-sized businesses because the majority of businesses in the middle market are purchased by other companies that must hire and pay a manager or CEO to run the business post-closing.

EBITDA is normally used with businesses that have more than about $1 million in EBITDA. EBITDA is mainly used by M&A advisors and investment bankers who specialize in selling businesses to private equity groups, competitors, and other companies. EBITDA is also used as a metric for public companies, but earnings, or simply net income, is more commonly used by publicly held companies.

EBITDA vs. Adjusted EBITDA 

The term EBITDA is loosely used and often refers to “adjusted EBITDA.” Adjusted EBITDA includes additional adjustments that are not included when calculating EBITDA, similar to adjustments that are made to calculate SDE. Therefore, when discussing EBITDA, you need to clarify if you are referring to EBITDA or adjusted EBITDA. Most M&A advisors are referring to adjusted EBITDA when they mention EBITDA.

Some adjustments included in adjusted EBITDA but not standard EBITDA include:

• Non-operating income or expenses 
• Non-recurring income or expenses
• Unrealized gains or losses
• Owner perks

SDE vs. EBITDA

Here is a chart summarizing the differences among SDE, EBITDA, and Adjusted EBITDA:

Here is an example illustrating the differences:

Are multiples the same for SDE and EBITDA?

If the multiples for the business were the same, it would seem that it would make sense to always value the business based on SDE. This is because SDE includes the owner’s salary and is therefore higher, and this would result in the highest value. 

Unfortunately, this isn’t the case. Multiples of EBITDA are naturally higher than multiples of SDE for the simple reason that a business that’s run by a manager should sell for more than one in which the owner is working full-time. If the business is on the line, and either SDE or EBITDA could be used to value the business, the choice doesn’t usually impact value in the real world. 

What if the value based on SDE is higher than the value based on a multiple of EBITDA? Again, it might seem that it would make sense to value the business based on a multiple of SDE. But businesses sold based on a multiple of EBITDA usually include working capital such as cash, inventory, accounts receivable, and accounts payable in the purchase price. 

Let’s examine one final scenario that shows the difference of the multiple when it’s applied to EBITDA versus SDE. 

Obviously, the math doesn’t always work out this perfectly. However, this example illustrates that the value is usually similar regardless of whether you use SDE or EBITDA. 

Keep in mind that the two measures of cash flow concerning owner’s compensation represent the main difference between EBITDA and SDE. When valuing a business with less than $1 million in earnings, use SDE, where the owner’s compensation is included. When valuing a business with more than $1 million in earnings, use EBITDA, where the owner’s compensation is excluded. In each situation, you want to ensure that the value of the business is clearly laid out.

What should the valuation be based on?

In other words, which year’s EBITDA or SDE should I use? A valuation is normally based on the last full year’s EBITDA or SDE or the most recent twelve months – also called trailing twelve months, or TTM for short. In other cases, a weighted average may be used if results are inconsistent from year to year and business cycles are longer and unpredictable. Some value may also be placed on projected current-year EBITDA or SDE, if the growth rate is consistent and predictable. Some buyers may attempt to use an average of the last three years’ EBITDA or SDE, which can pull down the valuation if the business is growing from year to year.

How do you increase the value of your business?

While you shouldn’t ignore other factors, one of your most important objectives should be on increasing EBITDA or SDE. Every dollar increase in EBITDA or SDE increases the value of your business by its multiple. 

For example, let’s say your business is likely to sell at a 4.0 multiple. If you increase your EBITDA by $100,000 per year, you will have increased the value of your business by $400,000 ($100,000 x 4.0 multiple = $400,000).

There are only two direct ways to increase EBITDA or SDE:

1. Increase Sales: 
   • The easiest way to increase sales is to increase your prices because 100% of your price increases will fall to the bottom line. For example, if your company currently generates $10 million per year in revenue, and you increase pricing by 5%, then your EBITDA will increase by $500,000 per year ($10 million x 5% = $500,000), less any direct sales costs such as commissions. If your current EBITDA is $2 million, your EBITDA will increase by 25% (to $2.5 million from $2 million). In essence, a 5% rise in prices can increase your EBITDA by 25%. 
   • Other methods for increasing revenue primarily include creating new products or services, or selling more of your existing products and services. But be careful before engaging in risky product development or marketing campaigns if you plan on selling in the next few years. Conservative buyers will generally not allow you to make adjustments for any marketing campaigns or product launches that were unsuccessful when calculating EBITDA. I recommend sticking to low-risk methods of increasing your revenue if you plan on selling in the next three years, such as increasing your budget in predictable marketing campaigns with measurable returns. Avoid high-risk sales or marketing strategies like hiring a new sales manager or launching a new marketing campaign in which you have no experience. These strategies can drain cash flow, which decreases EBITDA and therefore decreases the value of your business.
2. Decrease Expenses: Decreasing your expenses is often easier than increasing revenue. Doing so also has the advantage of having an immediate impact on EBITDA, and is less risky than attempting to increase revenue. The only caveat here is to not reduce expenses that the buyer would view as unfavorable – standard insurance premiums should be maintained, for example, as should normal inventory levels.

Another alternative for increasing the value of your business is to increase its growth rate so that “projected EBITDA/SDE” is used to value your business instead of “current year’s EBITDA/SDE.” The value of your business is normally based on its most recent 12-month EBITDA or SDE (trailing twelve months, or TTM). But, if you have demonstrated strong and consistent growth, you may be able to negotiate a price based on some measure of projected EBITDA or SDE.

Now that we have explained why the range of values can be so wide for businesses, let’s explore the actual mechanics of valuing a business. But before we do, let’s take a deep dive into the two primary measures of cash flow that all valuations are based on for small to mid-sized businesses – earnings before interest, taxes, depreciation, and amortization (known as EBITDA) and seller’s discretionary earnings (known as SDE). All valuations are based on a measure of cash flow, so it’s critical that you understand how EBITDA and SDE are calculated and which measure of cash flow is right for your business. After I explain how EBITDA and SDE are calculated, I will walk you through the primary methods for valuing a business.

EBITDA

EBITDA is the most common measure of earnings for mid-sized companies. EBITDA allows a buyer to quickly compare two companies for valuation purposes. Once you know the EBITDA of a business, you simply apply a multiple to arrive at a value of the business. 

Here is the strict definition of EBITDA:

EBITDA = Earnings (or Net Income) Before Interest (I) + Taxes (T) + Depreciation (D) + Amortization (A)

EBITDA measures the profitability from the core operations of the business before the impact of debt (Interest), taxes and non-cash expenses (Depreciation and Amortization). It eliminates the impact of financing (Interest) and accounting decisions (Depreciation and Amortization), which can vary.

Here is a description of each component of EBITDA:

• Earnings (E): This is the net income of the business after all operating expenses such as insurance, rent, payroll, etc., have been paid.
• Before (B): Referring to “Earnings Before” …
• Interest (I): This includes interest from all debt financing, such as loans provided by banks. Different companies have different capital structures and varying levels of debt, resulting in different interest payments. This results in varying net incomes. EBITDA allows you to easily compare two businesses while ignoring the capital structure of each business, which changes post-acquisition anyway. In other words, EBITDA includes interest payments because interest payments discontinue post-acquisition in most cases, with a few rare exceptions.
• Taxes (T): This includes city, county, state, and federal income taxes. Income taxes vary based on a number of factors and are likely to change post-acquisition. As a result, EBITDA includes taxes in its calculation. Note: Only income taxes are added back; don’t add back sales or excise tax when calculating EBITDA.
• Depreciation (D): Depreciation is a non-cash expense. Methods of depreciation vary by company based on the method of depreciation used. Actual cash flow is based on real capital expenditures, not depreciation; therefore, depreciation is also added back.
• Amortization (A): Amortization is a non-cash expense and is the “depreciation,” also technically called the “write-down,” of intangible assets such as patents or trademarks.

Here is a sample EBITDA calculation:

Net Income (Earnings, or “E”) = $700,000

EBITDA = Net Income (Earnings); plus …

Interest (I): $400,000; plus

Taxes (T): $300,000; plus 

Depreciation (D): $200,000; plus

Amortization (A): $100,000

EBITDA = $1,700,000

Seller’s Discretionary Earnings (SDE)

Seller’s discretionary earnings (SDE) is a measure of the earnings of a business and is the most common measure of cash flow used to value a small business. Once you know the SDE of a business, you apply a multiple to arrive at the value of the business. 

SDE is defined as pre-tax net income, plus …

• Owner’s compensation paid to all owners, less the cost needed to replace a second or third owner
• Interest expense
• Depreciation and amortization
• Discretionary expenses such as auto, cell phone, meals, entertainment, travel, etc.
• Adjustments for extraordinary, non-operating revenue or expenses, and non-recurring expenses or revenue such as from a lawsuit, flood damage, etc.

Here is a sample SDE Calculation:

What’s the difference between EBITDA and SDE?

EBITDA and SDE are two different methods of measuring the profit or cash flow of a business. The main difference is:

• EBITDA is the primary measure of cash flow used to value mid-to-large-sized businesses and does not include the owner’s salary as an adjustment.
• SDE is the primary measure of cash flow used to value small businesses and includes the owner’s salary as an adjustment. 

Why EBITDA and SDE?

There is one primary reason buyers use EBITDA and SDE – to quickly compare two businesses with one another. Keep these points in mind:

• Rules of Thumb: EBITDA and SDE are rules of thumb. They are approximate measures of cash flow available to the buyer. The goal of calculating EBITDA and SDE is to make an apples-to-apples comparison between businesses. EBITDA and SDE facilitates comparisons across companies, whether they are in the same industry or not. 
• Rough Estimate: These are just a rough estimate of the amount of free cash flow available to pay back interest or debt and fund the purchase of new equipment, such as “capital expenditures.” Once EBITDA and SDE are calculated, buyers will dig deeper into a multitude of other factors to calculate other measures of cash flow and the multiple, such as the growth rate of the company, its gross margins, customer concentration, and hundreds of additional financial and non-financial factors. 
• Measure of Earnings: EBITDA and SDE are primarily used at the outset as a measure of earnings. They are useful when a buyer is initially evaluating a company as an acquisition target. Once a buyer digs deeper, they will use other more specific measures of earnings to assess the company and will make adjustments to account for interest payments and capital expenditures. 
• Multiple Uses: EBITDA and SDE are used both in income-based and market-based valuation methods. For example, EBITDA and SDE are used to calculate the value of a business using a multiple in several income-based valuation methods. They are also used to consider comparable transactions and compare multiples among similar businesses that recently sold.

Benefits of EBITDA and SDE

What are the benefits of EBITDA and SDE?

There are advantages and disadvantages to using EBITDA and SDE to value your business. Let’s first explore the benefits:

• Common Use: EBITDA and SDE are the most commonly used measures of earnings by buyers, sellers, investment bankers, M&A advisors, business brokers, and every other party to value small to mid-sized companies.
• Straightforward Calculations: EBITDA and SDE are simple to calculate and less prone to error, thereby facilitating comparisons.
• Eliminate Non-Operating Variables: EBITDA and SDE eliminate variables that may not impact the buyer post-acquisition, such as interest or taxes. They also remove non-cash expenses, such as depreciation and amortization, so buyers can make their own estimates regarding the amount of these expenses. They can then deduct the amount from cash flow based on when the money is actually expended, not when it is deducted for tax purposes.
• Allow Comparison: Because EBITDA and SDE are commonly used and straightforward to calculate, they allow you to easily compare a business’s earnings with other businesses. This comparison also facilitates the use of comparable transactions to value a business.

Downsides of EBITDA and SDE

EBITDA and SDA aren’t infallible. It’s important, therefore, to be aware of their shortcomings as well:

• Rules of Thumb: EBITDA and SDE are simple rules of thumb. Expect buyers to dig deeper into your financials than just calculating EBITDA or SDE. EBITDA and SDE are not magic bullets. Just because your business has a high EBITDA or SDE doesn’t necessarily mean that your business will be an attractive acquisition candidate to a buyer.
• Inaccurate Measure of Actual Cash Flow: EBITDA and SDE are not wholly accurate measures of cash flow for a buyer post-acquisition for the following reasons:
  • Depreciation: Adding back depreciation for companies with significant depreciation and ongoing capital expenditures results in an inflated measure of earnings. EBITDA and SDE are misleading for companies with significant fixed, depreciable assets. 
  • Amortization: The same can be said for amortization, as in the case of companies with significant amortizable intellectual property, such as pharmaceutical companies. However, this is less common.
  • Working Capital: EBITDA and SDE ignore working capital needs by not accounting for working capital injections that might be required by the buyer, especially in the case of high-growth companies.
  • Taxes: EBITDA and SDE also ignore the impact of income taxes. Theoretically, a company in a non-taxable state such as South Dakota may be worth more than a company operating in a state with corporate income taxes. However, this varies based on the tax strategy employed by the company.

Are EBITDA and SDE the same as cash flow? No, they are entirely different concepts. Your cash flow can be determined by your “cash flow statement” or “statement of cash flows.” Many small businesses, unfortunately, don’t prepare a cash flow statement. “Cash flow” as a term is used loosely in the industry and you should always ask for a definition whenever someone uses it. 

A common question when it comes to business valuations is: “Why is there a wide range of values for a business?” And the simple answer is: business valuations are always one person’s opinion. An opinion of value can vary based on who performs the appraisal, what they’re looking for, and the methods they use. That being said, the real answer is much more complicated. There are many reasons a business can have a wide range of values. Here, let’s look at some of the major factors that affect that range. 

Factor 1: Information is Limited

Comparable Transactions are Often Unreliable

There is a limited amount of information available on comparable transactions for the sale of small to mid-sized businesses. Information is readily available on public companies, but there are vast differences between valuing private and public companies. The market for small-to-mid-sized businesses is inefficient and relevant information is scarce, to say the least.

The information available in transaction databases for small and mid-market transactions is often submitted without being verified, and only pieces of the story are provided, such as high-level financial information. Critical transaction information may be missing from the database, such as the terms provided, how EBITDA was calculated, whether the parties are related, whether the seller was distressed and other relevant information. This makes it difficult to adjust transactions to make them truly comparable.

Not only is information limited or biased but it can also be incomplete or inaccurate. Appraisers must rely on information from ownership or management, which can be biased; or on accounting and financial information, which is often incomplete. An appraiser’s opinion of value will continue to evolve as they acquire new information, or as their understanding of existing information changes.

Value Is Only Determined in a Sale

Price does not equal value. Actual value is only determined when a business is sold. Just because “ABC Corporation” was valued at $100 million does not mean it’s worth $100 million until someone actually pays $100 million. Just because your friend’s company was valued at a six multiple does not mean your company is also worth a six multiple because you’re both in the same industry and have similar-sized businesses. Just because your uncle received an offer on his business for $10 million, which works out to 70% of revenue, doesn’t mean your business is worth $14 million just because it generates $20 million in revenue.

An appraisal or the asking price of a similar business is not a comparable transaction. A comparable transaction must come from an actual transaction – not an appraisal, the asking price from a similar business, or other hypothetical non-transactions. 

Price does not equal value. Actual value is only determined when a business is sold. 

Factor 2: Predicting Human Behavior and the Future Is Difficult

Market Variability Is Hard To Predict

The essence of valuation is predicting how other people will behave, such as anticipating the price they will actually pay for a business. Predicting human behavior is perhaps one of the most universally challenging problems on the planet. Even the world’s most respected mutual and hedge fund managers, with billion-dollar budgets and thousands of employees on staff, whose sole objective is to predict the future value of publicly traded companies, can’t consistently beat the markets. 

In 2007, Warren Buffett bet $1 million that the S&P 500 would outperform a collection of hand-picked hedge funds. Buffett wasn’t betting against the “average” hedge fund. Far from it. Buffett allowed the opposing party to hand-select from among the best-managed funds in the world. Protégé Partners took him up on his offer and meticulously selected five hedge funds. What were the results at the end of the decade-long bet? The results were calamitous for the hedge funds. From 2007 to 2017, the S&P 500 gained over 125% while the five hedge funds gained a paltry 36% in comparison. The bet was open to anyone in the industry that wished to participate but only one stepped forward. And despite their ability to actively monitor the funds with the assistance of hundreds of analysts, their performance was crushed by a passive investment in an index fund that required no work and a staff of exactly zero.

What’s the lesson? The market is impossible to predict, even for those with teams of hundreds of people who professionally manage billions of dollars.

Fear and greed drive human behavior and even the world’s best investors can’t accurately predict movements in the markets with any consistency. Even Warren Buffett, considered by many to be the greatest investor of all time, admits he can’t predict the price of a stock in the short term, or even predict how the economy will do in the mid-to-long-term. From the tulip bulb craze in Holland in the 1630s, to the dot-com bubble in 1999, humans’ irrational behavior has proven impossible to accurately forecast. Predicting the behavior of a single individual is difficult enough, let alone predicting the impact of fear, greed, and herd behavior. Changes in the macroeconomic environment can have an enormous impact on the value of a business and such changes have proven impossible to foresee.

Estimating Cash Flow Is a Challenge

The fundamental premise of most methods of valuing a business is placing a value on expected cash flows. After all, a buyer is buying future cash flows, not historical ones.

Most projections prepared by owners of small businesses are based on assumptions that are impossible to substantiate. History is not an accurate representation of what is expected to happen in the near future for any business, especially in a volatile or unpredictable economic environment. Assessing future cash flows for a small business is especially difficult if there is a lack of consistent, historical financial projections that have been met. Assessing future growth rates is inherently difficult for any business, even one with well-documented and predictable growth, let alone a small business with inconsistent financial results.

Not only must future cash flows of a business be predicted, but the potential risk of receiving the cash flow must be assessed as well. Accurately assessing risk is impossible, and the presence of risk must be built into any financial model.

When valuing a business, one must estimate the future cash flows as well as their potential for growth and associated risk. Such an estimate is subjective at best, even if based on strong, historical financial results, and even more so if historical financial information is limited. The degree to which a business’s value is tied to future results, and the great degree of risk associated with estimating future cash flow upon which a business’s value is based, must always be considered when reviewing any business appraisal. 

The fundamental premise of most methods of valuing a business is placing a value on expected cash flows.

Impact of Future Factors Is Unpredictable

Future value is dependent on factors beyond our immediate control and the impact of these factors can’t be predicted.

Price depends on demand, which itself is dependent on a wide variety of factors, from interest rates to the availability of financing to unemployment rates in the case of individual buyers. There are also manifold other macroeconomic, demographic, industry, competitive, political factors, and social factors such as seen in consumer products.

The economy impacts some types of industries to a great degree, especially those selling a discretionary product or service, or consumer product companies, or companies that operate in a cyclical market. The impact of a protracted recession can be disastrous for cyclical businesses. Other industries, such as finance or healthcare, are susceptible to the impact of external factors, such as governmental regulations, and one can only conjecture at their likelihood and potential impact. Our lawmakers wield power to determine the fate of many industries, some with motives that are questionable, which introduces an additional layer of guesswork for any business operating in such an industry.

Even the world’s most widely esteemed economists can’t predict the future trajectory of the broad economy, let alone the outlook for specific industries or businesses within those industries. Such a requirement introduces a level of uncertainty, so the best one can do is to make an educated guess based on a limited amount of information. These limitations on the ability to predict such uncertainties must be considered when weighing the merits of any business valuation.

Factor 3: Wide Universe of Buyers With Diverse Criteria

Perceptions of Risk Are Subjective

The group of potential buyers for a business is diverse, thereby greatly expanding the potential for a wide range of opinions. For example, a lower mid-market business may have the following potential buyers: wealthy individuals with varied ethnicities or business backgrounds, direct competitors, indirect competitors, financial buyers, and possibly publicly traded companies. 

Any valuation should first explore the potential universe of buyers, and then calculate a range of potential values those buyers may pay.

The views, perspectives, expectations, and tolerance for risk among a diverse group of buyers can vary greatly, resulting in a wide range of potential values. The tolerance for risk also varies widely from buyer to buyer. Their opinion of value varies significantly as the price a buyer can afford to pay is a direct function of their assessment of the risk of the potential investment. A buyer’s assessment of risk may also be limited by their ability to acquire accurate information on the business and industry. The value of a business is ultimately determined by a buyer’s perception of risk, which can’t be accurately predicted or measured. Any valuation should first explore the potential universe of buyers, and then calculate a range of potential values those buyers may pay.

Lost Opportunity Cost to the Buyer Varies

The value of a small business is highly dependent on the lost opportunity cost to the buyer. Someone with an earning potential of $300,000 per year wouldn’t invest in a small business that requires their full-time involvement and only earns $200,000 per year, even if it were given to them for free. This is because it would cost them $100,000 per year in lost opportunities ($300,000 – $200,000 = $100,000). On the other hand, some buyers might see tremendous opportunity in a business that has the potential to earn them six-figures. 

Lost opportunity costs also vary for corporations. The lost opportunity cost of an acquisition for any corporate buyer is the cost of not completing another transaction, or any other form of corporate development. Some examples include launching a new product, forming a joint venture, or expanding distribution channels. Because the lost opportunity cost varies from buyer to buyer, the value of a small business will also vary from buyer to buyer, and such a variation adds another layer of complexity to any business appraisal.

Synergies Are Impossible To Calculate

The financial benefit of potential synergies is also impossible to anticipate. When selling a small to mid-sized business, the potential universe of buyers normally includes direct or indirect competitors. Often, competitors bring synergies to the table in the form of potential increased revenue or decreased expenses. To properly value a business sold to a synergistic buyer, one must calculate the amount of the synergies so they can be analyzed and valued. 

As an example, if a company with an EBITDA of $2 million per year is purchased by a competitor that brings an additional $1 million in increased EBITDA in the form of synergies to the table, the valuation could look like this:

Before Synergies: $2 million EBITDA x 4.0 multiple = $8 million value

After Synergies: $3 million EBITDA x 4.0 multiple = $12 million value

Implicit in this valuation is that we know the amount of the potential synergies and, therefore, the post-sale EBITDA, which forms the basis of the valuation. In most cases, this information can’t be obtained. Buyers rarely provide the target access to their financial models, let alone their reasons for the acquisition. As a result, a target may not understand the buyer’s true motives for a transaction. They will rarely be privy to a buyer’s financial models, projections, or other analyses, which can be used to calculate the amount of the synergies. The best they can do is to reverse-engineer the buyer’s potential synergies, estimate their value, and then negotiate the highest purchase price possible, ideally with multiple buyers, in the form of a private auction. 

A valuation based on synergies is, at best, an educated guess and normally only serves as a baseline upon which the company may be valued. Any excess of the baseline value can only be achieved, and therefore determined, in the actual marketplace through a competitive marketing process.

Factor 4: Biases and Conflicts of Interest Cloud Judgment

Appraisers Lack Real-World Experience

Most business appraisers lack an important requirement – experience. Most of them have never sold a company in the real world, yet the appraiser’s job is to make an educated guess as to what a buyer will pay for a business. While the majority of appraisals are commissioned for tax or legal purposes, those prepared for selling a business should be put together by a professional with real-world experience in the marketplace, such as an investment banker or M&A advisor.

Brokers’ Compensation Can Impact Objectivity

Business brokers’ and M&A advisors’ form of compensation may also affect their opinion. If their estimate is too low or too high, a potential client may go elsewhere. As a result, an advisor may pad their opinion so as to not lose a client, and then later backtrack on the valuation in an attempt to bring the owner back into the “real world.” Interests should be aligned, if possible, and the true beneficiary of any valuation should always be questioned. 

Most business appraisers lack an important requirement – experience.

Cognitive Biases Cloud Rational Judgment 

Humans are biased, and analysts are no different. Not only must an appraiser deal with an enormous amount of uncertainty, they must also cope with their own biases, which are often subconscious and therefore undetectable.

Here is a list of cognitive biases and potential examples that may come up when valuing a business:

• Confirmation Bias: The appraiser seeks information to confirm their bias. For example, they may have a long-term belief that the range for multiples for radio stations is 8 to 10 times EBITDA, and they may ignore information that doesn’t support this bias. They may also form an initial opinion regarding the value of a business and then fiddle with the valuation to ensure it aligns with their initial expectations.
• Recency Bias: The analyst may assign more weight to companies they have appraised or sold recently and forget about data or transactions that aren’t recent.
• Anchoring Bias: The appraiser first learns through another appraiser, who is widely considered a leader in the field, that multiples in the aerospace industry are in the range of 6 to 7 times EBITDA. This becomes the “anchor” and the advisor then seeks information to confirm this anchor, ignoring factors that conflict.
• Availability Bias: The appraiser may place too much emphasis on data that is readily available and not perform an exhaustive search for information that is less available.
• Conservatism Bias: The appraiser may cling to their long-held belief that multiples never exceed 6 if EBITDA is below $5 million, and then consciously ignore information that doesn’t support this personal belief.
• Contrast Effect: The investment banker may hear of a transaction with a 20 multiple in an industry in which they are valuing a business, so they push up their estimate to a 6.0 multiple from 5.0. After all, an increase in the multiple by a factor of one “isn’t a big deal” if a larger company in a related industry sold at a much higher multiple.

In preparing any valuation, an advisor should attempt to be aware of their biases and take efforts to mitigate the impact of their biases on their opinion. Readers of appraisals should also be aware of the potential for biases to be built into any valuation and be cognizant of the impact such biases can have on the appraisal.

Factor 5: Significant Time and Effort Required

Software Is Not Designed for M&A Valuations

Most software to appraise businesses is designed for legal or tax purposes. The methods used in the courtroom are entirely different from those used by buyers in the real world. Most software is inadequate to address a variety of situations and must be designed to handle the highest level of complexity the appraiser might encounter. An appraiser can be faced with having to arbitrarily input information into a program simply because it’s required by the software, despite it being irrelevant to the business’s stage of growth or its industry. 

For example, many appraisal software programs analyze key financial ratios, such as debt to equity. These ratios may be irrelevant for a small tech company in which the transaction is structured as an asset sale.

For owners considering a sale, an M&A advisor’s oral opinion can sometimes be more valuable than a written appraisal. 

At Morgan & Westfield, for example, we combine a financial assessment of the business with an exit strategy and an in-depth consultation with the owner to develop a full understanding of the business. We then explain our opinion of value in detail during a phone call with the owner. We can best assess and communicate our opinion of value if we aren’t encumbered by the built-in limitations of external software. 

If you’re considering paying for a written appraisal, ask for a sample report. Be sure you can understand it and that the information is relevant for your business and industry before you pay for a valuation.

Significant Time and Effort Is Required

Properly valuing a business takes a significant amount of time, especially when it comes to understanding and predicting future cash flows. The more sweat equity that’s invested in preparing the appraisal and predicting cash flows, the more accurate those predictions are likely to be. But most small business owners understandably don’t want to pay tens of thousands of dollars for an advisor to spend hundreds of hours developing an understanding of their business. As a result, many valuations, particularly oral valuations, are predicated on input from the owner or management team, whose views are biased.

Second, even if sufficient time is spent understanding the business and the industry, how accurately can future cash flow be predicted for a small business? The best one can do is to make an educated guess. A small business is highly dependent on the aptitude and drive of the entrepreneur, and predicting the long-term drive of one individual is difficult, to say the least. Larger businesses are less dependent on one individual, making them less vulnerable to the concentration of skills and effort that may be present in smaller businesses. 

The value of any appraisal is in direct relation to the skill and experience of the appraiser, and the amount of time spent understanding your business and industry. As a business owner, you should be aware of such limitations and accept that you’re paying for a professional’s opinion, and the accuracy of such an opinion is related to the amount of time and effort spent by the appraiser.

You have taken all the necessary steps to prepare your business for sale but you would like reassurance that your business will, in fact, sell. Why don’t some businesses sell? And what can you do about it?

Let us count the ways …

Based on my 20-plus years of experience at Morgan & Westfield, when deals die it usually occurs during one of the following four stages:

• Marketing: Sometimes deals never get off the ground because we can’t get the traction necessary to generate meaningful discussions with buyers.
• Offer: We have sparked interest but once potential buyers look at the business they lose their appetite.
• Due Diligence: The buyer makes an offer but for a variety of reasons the deal dies during due diligence.
• Closing: The buyer successfully concludes due diligence but the deal dies before the closing.

There are numerous reasons a deal may never make it to closing. In the section that follows, I examine and analyze more than 25 real-world case studies from past clients whose businesses did not sell. Reviewing these examples will give you insight into the salability of your own business, along with steps you can take to help ensure your company does sell when you decide to put it on the market. 

These are some of the specific reasons businesses have not sold that we have encountered over the years at Morgan & Westfield:

• Rural Location: The business was located in a small, rural market in Indiana and there was not a large enough buyer base in the town to generate sufficient activity. The area was also not attractive enough to entice outsiders to relocate there. This business could not be relocated to another locale and no companies would consider acquiring it due to the difficulty of hiring a talented manager in the area to run the business after the acquisition.
• Niche Business with Limited Buyer Pool: This business was in a niche segment in the construction industry and required a specialty contractor’s license that few individuals possess. Most individuals holding the license already owned a business, and we could not generate any buyers that had the license and were open to the idea of buying a business.
• Business Easy to Replicate: A service business was considered easy to replicate by most buyers, so none felt an investment in the company was justified due to the ostensibly low cost of replicating the business. Moreover, the business depended on a strong sales team, there were no processes or elements of the business that were considered proprietary, and there was little documentation in the business.
• Risky: This business was considered too risky due to the recent entry of venture-backed competitors into the industry. As a result, no buyer was willing to make an offer.
• High Growth: One business was growing at a rate of 30% per year. Buyers were only willing to buy the business based on the historical earnings, but the owner wanted to be paid based on the next 12 months’ projected earnings and was not willing to consider an earnout.
• Unattractive Industry: An industry was considered unattractive by many buyers due to the emergency nature of the industry. Our marketing activities for this business generated few results, despite multiple iterations of our marketing campaigns.
• Low Revenue: In this instance, our marketing activities generated few results because the business generated little revenue and cash flow. While the business was attractive and the products were proprietary and patented, no buyer was willing to take a look. Their thought process likely was: “Why does the business generate so little revenue if the products are so great?” The truth was that the owner unsuccessfully tried to raise venture capital and had no capital to invest in marketing. However, buyers never had a chance to hear this part of the story because they immediately dismissed the business due to the lack of revenue. 
• Low Profitability: This business was break-even. Our online marketing efforts yielded poor results because buyers immediately dismissed the business due to its lack of profitability, and the company could not feasibly be sold to a competitor.
• High Customer Concentration: One customer generated over 80% of the revenue for this business. Despite the fact that the customer was bound by a long-term agreement, no buyer was willing to take the risk inherent in such a high level of customer concentration.
• Landlord Raised Rent: One retail business was highly successful so an opportunistic property manager, who represented an aggressive foreign landlord, attempted to raise the rent by 30% for the new buyer. The buyer balked and walked away.
• Franchisor Changed Terms: We received an offer on a franchised business and the owner accepted. The franchisor informed the buyer that they were increasing the minimum revenue threshold for each territory, which effectively served to decrease the territory size. The buyer thought that eight territories were included in the sale, but after the change, the buyer would only receive two territories. The buyer walked – and we don’t blame them. Now, this is a common issue. Many franchisors grant territory sizes that are too large when they initially start franchising. They claw back some of these territories several decades later when the franchise becomes successful and they begin running out of territories.
• Inaccurate Financials: A buyer made an offer on this business. Then, the buyer discovered multiple inaccuracies in the financial statements during due diligence. The buyer attempted to clarify the inaccuracies with the seller’s accountant but the accountant was unable to sufficiently assuage the buyer’s fears. The buyer walked.
• Personality Conflicts: An offer was made and accepted. Due diligence began smoothly. However, personality conflicts between the buyer and the seller developed and gradually grew out of control. The parties became deadlocked on several issues and both refused to budge. The issues mounted to the point where the deal finally died.
• Revenue Declined: For one business, the revenue declined by 10% between the time the business was put on the market and the time due diligence was complete, but the owner was unwilling to lower the price. The revenue decline implanted fear in the buyer, however, the seller was unwilling to attempt to pacify the buyer and offer a price reduction, which we consider fair in the event of a revenue decline. As a result, the buyer walked.
• Unattractive Franchise: Our marketing efforts for this business yielded several interested buyers, however, as each buyer dug into the details of the franchise, they walked. Several of these interested buyers told us that turnover in the franchise was excessive. (Turnover must be disclosed in “Item 20” of the Franchisor Disclosure Document.) They talked to several franchisees in the system and new ownership at the franchisor was considered unfavorable, so the deals died.
• Minority Partners: We put a business on the market, successfully generated several buyers, accepted an offer, and began the due diligence process. The owner then contacted us and told us that their minority partner was demanding a 200% premium for their minority share of the business. The owner refused to give in to the demands of the minority partner and the buyer subsequently walked.
• Economy: During the 2007 to 2009 recession, we had dozens of deals die, either during the marketing stages, before, or after an offer was made. Some businesses were severely impacted by the state of the economy and other deals died due to the uncertainty the economy created in the eyes of the buyer.
• Industry: We had a business for sale in the consumer goods industry. Recent changes in the industry related to consumer preferences were expected to have a negative impact. A buyer made an offer on the business and the seller accepted. However, as the buyer performed their due diligence, it became evident that the impact of changes in the industry was uncertain and difficult to predict. As a result, the buyer retracted their offer.
• Competition: We had a technology business for sale that generated significant buyer interest, as is usually the case for tech companies. During the process, it was reported that one of their major competitors had received a large capital injection from a venture capital group. The buyers became apprehensive and downgraded their valuation of the business, which the seller was unwilling to accept.
• Lack of Preparation: We had a construction-related business for sale that seemed like a promising investment for a buyer in the industry. We successfully marketed the business and subsequently accepted an offer from a competitor. During due diligence, the buyer uncovered numerous defects in the business that could have been prevented with proper preparation. Some of these defects included inaccurate financials, a lack of proper insurance, no tax planning, lack of approval from a minority partner, and no agreements or retention plan with key employees. The transaction ultimately fell through due to a lack of time invested in preparing the business for sale. 
• Third-Party Delays: We received an offer for a service-based firm in the Midwest. The seller accepted the offer and the buyer began due diligence. During due diligence, the buyer noticed several inconsistencies in the financial statements. The seller forwarded the questions to their CPA, but two months later the questions remained unanswered and the CPA was generally unresponsive. As a result of the delays, the buyer walked.
• Lack of Bank Financing: We received an offer on a specialty manufacturing business. Due diligence was successful. However, the buyer was unable to obtain financing and did not have an adequate down payment for the seller to consider financing the sale.
• Owner Unwilling to Finance: A buyer made an offer on a large business in the healthcare industry. The offer included a 50% cash down payment but the seller was unwilling to finance more than 20% of the purchase price. You guessed it: the offer was not accepted.
• Asking Price Too High: We performed a valuation on a technology company and valued the company at approximately $1.5 million. The owner believed his company was worth $2.0 million to $2.5 million. We attempted to market the business at $2.5 million, but generated little response. Revenue then declined, which reversed a positive trend in the business, and the owner dropped his price to $2.0 million. We downgraded our valuation to $1.3 million due to the recent decline in revenue, but the owner chose not to drop the price. As a result, we received negligible buyer interest.
• Dependent on Owner: We represented a professional services firm and received significant buyer interest in a short period of time. However, as most of the buyers dug deeper, they discovered that the owner was inextricably tied to the business and determined that a transition would be too difficult, costly, and risky. Most of the clients were close friends with the owner and the name of the firm was tied to the owner’s name. However, the owner wouldn’t allow a buyer to use the company name moving forward. Therefore no buyer was willing to make an offer despite the high cash flow and an attractive price.
• Family Involved in Business: Multiple family members were involved in a business we represented in the service sector. Our marketing efforts generated several interested buyers. However, every buyer that dug deeper into the mechanics of the business discovered there were several family members involved in the business who were instrumental to operations. The family members’ compensation was not at the market rate and no family members were willing to stay past the initial transition period. As a result, buyers considered it too risky to replace the owner and the spouse, as well as two additional family members involved in the business.
• Key Employee Dependency: In another transaction, a valuation was performed on a business in the online education space. An offer was received and the buyer began performing due diligence. During due diligence, the buyer discovered that two employees were instrumental to the operations of the business. Against our advice, the seller allowed the buyer to talk to the employees to ensure they would be retained. However, the employees demanded an increase in salary that was far beyond what the buyer considered reasonable. The buyer walked.
• Employees Fail to Cooperate: An offer was received on a commercial landscaping business. Once the employees received news of the offer through indirect sources, they felt slighted and were determined to derail the deal. Despite the seller’s attempts to pacify the employees, their resentment could not be contained. Once the buyer received news of the lack of cooperation from the management team, they rescinded their offer.
• Tax Returns Unreconciled With Financials: An offer was accepted on a roofing company and due diligence uncovered disparities that could not be reconciled between the financial statements and federal income tax returns. The differences could not be explained, so the buyer downgraded their offer, which the seller was unwilling to accept. Upon the advice of their CPA, the buyer walked.

As you can see from the examples, there are a wide variety of factors that can cause a business to not sell. While some of the factors are unpreventable, many of them can be prevented through proper preparation. 

Keep in mind the factors I have mentioned can also occur simultaneously. For example:

• The business can be located in a rural area.
• The business can be in a niche field with a limited buyer pool.
• The business may not be pre-approved for bank financing.
• The seller may not be willing to finance a portion of the sale price.

While some factors can be overcome, buyers often consider the totality of the circumstances. The more risk for the buyer, the more likely they are to walk away from a deal. The more risk factors that are present, the more nervous the buyer will become and the less appetite they may have for risk.

Conclusion

If you are serious about selling your business and would like to maximize its value, you should prepare for the sale as early as possible.

Hire a third-party expert to perform an assessment of your business to help you identify and mitigate any risk factors well before you put your business on the market. At Morgan & Westfield, for example, our assessment of a business includes the following:

• Evaluation of the salability
• Identification of risk factors
• Determination of potential deal killers
• Creation of a comprehensive plan to help maximize the value of the business
• Exploration of multiple exit options for a business owner
• Review of the business’s financial statements 
• Establishment of a value range for the business from low to high

Many problems can be prevented if you give yourself ample time to prepare your business for sale. Even if a problem can’t be completely eliminated, it may still be possible to mitigate the effects of the problem so that you can provide reassurance to a buyer. 

The list of potential problems may seem overwhelming. However, an experienced expert in the business marketplace will have developed the ability to quickly identify patterns and can help you identify and mitigate any potential deal killers in your business. This can ultimately help ensure a successful sale and dramatically improve the value of your business. 

Once you’ve prepared your business for sale, it’s time to have it valued. That’s the subject of the next chapter.

If you’re like most business owners, you’ve operated your company in a way designed to minimize taxes. You may have given yourself and your family members as many perks and benefits as possible, kept offspring on the payroll, and written off other expenses through your business – all of which contribute to decreased earnings, and, therefore, a lower value for your business. These and certain other common practices are designed to keep your profits and your taxes low, perhaps artificially so.

All well and good. But when the time comes to properly value your business, financial statements, which form the basis of all business valuations, must be “normalized” or “adjusted.” 

The normalization process involves making numerous adjustments to your financial statements so that the true earning capacity of your business can be identified.

Common adjustments include the following:

• Your salary and perks
• Family members’ salaries and perks
• Expenses or income that would not be expected to recur or continue after the sale
• Personal expenses, such as personal auto, insurance, cell phone, child care, medical, and travel expenses
• Depreciation
• Amortization
• Investment or other non-operating expenses or income
• Interest payments on any business loans
• Other one-time or non-recurring expenses
• Non-operating revenue

Removing owner-specific perks, benefits, and expenses is necessary to show potential buyers your business’s actual available cash flow.

Adjusting the financials allows you to compare your business with other businesses using seller’s discretionary earnings (SDE) or earnings before interest, tax, depreciation, and amortization (EBITDA).

• SDE: This is the most common metric used by buyers, business brokers, and many other professionals for valuing companies with annual revenue of less than $5 million.
• EBITDA: The most common metric used for valuing businesses with more than $5 million in annual revenue is EBITDA.

Adjusting your financial statements is one of the most important steps in preparing your business for sale.

Buyers compare potential acquisitions using SDE or EBITDA. By comparing the SDE or EBITDA of one company with another, buyers can easily understand a business’s value based on the business’s actual profit rather than its taxable income. This helps facilitate a more accurate comparison between companies.

Roll up your sleeves and get ready to dig in …

Definitions of Adjustments 

Here are descriptions of the different types of adjustments that can be made. 

• Discretionary Expenses: These are expenses paid for by the business that are a personal benefit to the owner. To qualify, the expense must personally benefit the owner, not the business or its employees. These expenses must be paid for by the business and be documented as an expense on the P&L statements. 
• Extraordinary Expenses: These refer to expenses the business paid for that are exceptional, unlikely to recur, and are documented as extraordinary. Examples include expenses associated with natural disasters, relocation of the business, or a lawsuit. Examples that don’t qualify include a marketing campaign that failed or headhunter fees to replace a manager who resigned.
• Non-Operating Revenue and Expenses: These are extraordinary expenses or revenue unrelated to the business operations, such as interest earned on investments, revenue from the sale of equipment that is no longer used in the business, or insurance settlements. Non-operating revenue should also be removed.
• Non-Recurring Revenue and Expenses: These are expenses that are unusual or one-time in nature and not expected to recur, such as a large legal bill, moving expenses, or a cleanup bill from a natural disaster. Examples of non-recurring revenue include revenue from the sale of a large asset or an insurance settlement.

If you are aggressive or inaccurate with one adjustment, most buyers will question the credibility of everything you say from that point on.

Sample Adjustments

Following are adjustments that generally are allowable and can be adjusted:

• Accounting: Any accounting fees that you have incurred that are unrelated to the business or which are for other businesses or personal matters.
• Amortization: All amortization.
• Barter Fees: Any barter-related fees and income. 
• Child Care: Payments for child care that do not relate to the business.
• Continuing Education: Any continuing education expenses that are not related to business operations.
• Cost of Goods: Expenses for anything purchased for personal use and which were not used for the business.
• Depreciation: All depreciation.
• Entertainment: All personal entertainment and related expenses.
• Insurance: Any insurance expenses related to personal needs, such as health insurance, auto insurance, dental insurance, and life insurance.
• Interest: All interest expenses, unless necessary in your industry, such as floor financing for auto dealerships.
• Legal: Any personal legal fees.
• Meals: Any personal meal expenses.
• Medical: Any personal medical expenses.
• Memberships: Any fees for personal memberships that do not relate to the business.
• One-Time Expenses: Any investments in new equipment, one-time start-up expenses, build-outs, major repairs, or one-time legal fees, for example.
• Owner’s Salary: Your W-2 or 1099 income, including your payroll taxes and any payroll taxes that have been paid by your company – but not your draws or distributions. Only salary in the form of W-2 or 1099 income can be added back. Note: this is added back when calculating SDE, but normalized to market rates when calculating EBITDA.
• Payroll (Other): Any payroll taxes for your salary and for the salaries of non-working family members.
• Personal Vehicle Use: Any automotive expenses, payments, fuel, insurance, and repairs for non-business purposes.
• Rent: If you own the property, adjustments should be made to normalize the rent to market rates.
• Repairs: Any repairs for your personal home or other personal property.
• Salary: Salaries paid to non-working family members. 
• Supplies: Personal supplies, groceries, etc.
• Taxes: Personal and corporate income taxes.
• Telephone: Personal cell phone-related expenses.
• Travel: All expenses related to personal or nonessential travel.

Adjustments that are generally not allowed or can’t be adjusted include:

• Rent: If you own the property, the rent amount should be based on the cost to rent the property, not the cost of ownership.
• Unpaid Family Members: Salaries for working family members should be adjusted based on the cost in the market. Salaries for non-working family members should be added back.
• Employees: Salaries for underpaid employees, such as family members working in the business, should be adjusted to market value.

Here is a list of adjustments that might be adjustable:

• Bad Debt: This is any bad debt that is considered excessive, based on your prior years. We can often normalize this, but you should not remove it completely. If you had bad debt in the past in your business, you are likely to have it again. This should be normalized based on your prior years by deducting an even amount each year or by spreading a large bad debt expense over several years.
• Charitable Contributions: Owners often make charitable contributions with the expectation of getting business in return. For example, an owner of a restaurant might sponsor a local sports team. Doing so generates publicity and exposure for the business; however, directly measuring the results is impossible. You can adjust any personal contributions made that are not related to the business or in which the business did not receive any exposure, such as a private donation to your church.
• Continuing Education: Some educational expenses are considered discretionary and should not be removed just because they were optional. These expenses should be removed only if they were personal in nature and were unrelated to the business.
• Dues and Subscriptions: Any personal fees, such as country club dues, that have no expectation of benefitting the business.
• Retirement: Your 401(k) and IRA contributions for yourself and any family members only. Do not remove any fees related to maintaining retirement plans that benefit your employees.
• Travel: These are any expenses related to personal or nonessential travel. Any nonessential or excessive business travel should be identified. However, some travel is necessary for business.

The following expenses should not be removed and can’t be adjusted. You can identify these as expenses that can be reduced or limited, but these expenses should not be adjusted:

• Advertising: Owners often attempt to remove fees related to advertising because they feel the advertising campaign did not bring in any business and was considered a wasted expense. However, developing successful advertising campaigns always involves risk. This is a business cost and can’t be removed just because the campaign was unsuccessful. A new owner must continue to advertise and market the business, and many campaigns are unsuccessful.
• Cash Income: Unreported cash income should be verified through other means. 
• Entertainment and Meals: Dining with clients is a critical way of building relationships. These expenses should not be removed just because they were optional.
• Membership: Membership fees in country clubs and other clubs that are optional should be identified.
• Rent: The rent should not be adjusted if you are paying what is considered an over-the-market rate for your lease, unless the lease could be renegotiated.
• Salary: Overpaid employees’ salaries should not be removed. This can, however, be identified as an expense that could be trimmed.

Tips for Making Adjustments

Be Thorough

It is important to remember that all adjustments should be concise and verifiable. The more thorough and accurate your documentation regarding your business expenses, the better. 

If you are aggressive or inaccurate with one adjustment, most buyers will question the credibility of everything you say from that point on. This is why I recommend you hire an objective third party to make these adjustments and calculate your SDE or EBITDA. 

The more detail you provide, and the more documentation to back up your reasoning for claiming your expenses, the more likely your business will sell quickly and for the best price possible.

Be Conservative

When selling a business, always be conservative when making adjustments to your financials. There are several reasons why this is important.

If you are conservative, the buyer will assume you have been conservative regarding other issues as well and the buyer may verify fewer of your representations during due diligence. On the other hand, if your adjustments are aggressive, the buyer may feel the need to perform more thorough and exacting due diligence.

Value is a function of risk. The lower the risk, the higher the value. 

A buyer who is dealing with a conservative seller will view the transaction as less risky and may be willing to pay a slightly higher multiple than if the buyer were dealing with an aggressive seller. 

Keep in mind that when I say “aggressive” in the context of selling a business, I am referring to the representations that are being made. 

An example of an aggressive representation is, “We can definitely grow revenue by 20% per year for the next five years.” 

An example of a conservative representation would be, “We have grown revenue by 18% to 22% during the previous three consecutive years, and we hope this trend will continue. However, we are always aware that the economic and competitive landscape can change at a moment’s notice, and our estimates are just that – estimates.”

If your behavior is excessively liberal, the buyer may include “representations and warranties” in the purchase agreement to protect themselves after the closing.

This could include language in which you warrant that any claims you made were true to the best of your knowledge. If your representations later prove to be untrue, your representations will come back to bite you, even after the closing. The buyer can sue you, or even offset losses from your representations against future payments via a setoff.

Let’s be clear on what representations and warranties are and why they are important. Also known as “reps and warranties,” these are statements of facts you make in the purchase agreement regarding your company’s business, assets, liabilities, and operations. Many sellers think they can run off into the sunset after closing, free of all future obligations related to the sale of their business once the check clears. Not true. The reps and warranties you sign in your purchase agreement survive the closing when you sell your business. 

In the purchase agreement, you indemnify the buyer, and a breach of a representation will be subject to indemnification. In other words, if a statement you make later proves to be untrue, the buyer may offset a portion of the purchase price, withhold funds from escrow, or sue you to make themselves whole again. For example, if you make erroneous adjustments to your financial statements and these adjustments later prove to be untrue or inaccurate, the buyer can seek damages from you, even after the closing. 

The bottom line is that you’ll remain liable for a significant period of time after the closing if any of your representations later prove to be untrue. I cover reps and warranties in greater detail in the chapter on Closing.

The fewer the adjustments when selling your business, the cleaner your financials will look. Step back and look at your P&L. How many total adjustments do you have? Don’t look at the total in dollars, for example, $436,950 in adjustments, but rather look at the total volume, as in, 14 adjustments in the most recent year – the fewer the adjustments, the better. 

When a buyer first looks at your P&L, the total number of adjustments is one of many factors they will take into consideration when evaluating your business as a potential acquisition. If your P&L is clean, with minimal adjustments, a buyer may assume that due diligence will be faster and less expensive. 

I recommend not including any adjustments less than $500. Your goal is to reduce the total number of individual adjustments, not the total amount of adjustments. Adjustments less than $500 do not impact cash flow enough to have a substantial impact on the valuation. A P&L statement with fewer adjustments looks “cleaner” to a buyer and may justify a higher valuation because the buyer may perceive that fewer adjustments must be verified during the due diligence period.

If you minimize adjustments, they will assume you will be easier to deal with than other business owners and are therefore running your business in an upright, above-board fashion. Collectively, these strategies build trust with the buyer, thereby reducing risk and thus maximizing value for you during your business sale. It may even lessen the burden of due diligence.

Value is a function of risk. The lower the risk, the higher the value.

The ideal scenario is to eliminate adjustments altogether at least two to three years prior to a sale. This will increase the value of your business and improve the buyer’s odds of obtaining financing for your business. Doing so may enable you to cash out at closing instead of taking back a portion of the proceeds in the form of a three-to seven-year promissory note. 

If you want to maximize the purchase price, there is one trick you can employ. Be conservative regarding your adjustments but be aggressive regarding the multiple you choose when valuing your business. When doing so, you must develop a strong position to justify a higher multiple. 

Here is an example:

You can often justify this higher multiple, as in Business B, if you can demonstrate to the buyer that your business is lower risk. Not only must your business be low-risk, but your disposition in all interactions must also be conservative and modest. But don’t overdo this. Demonstrate conservative optimism. Humility can backfire if it’s overdone.

The strategies above don’t prevent you from keeping “potential adjustments” in your back pocket to whip out as needed when selling your business. For example, if you pay $5,000 per year in country club dues but you occasionally network with a business friend at the country club, then you could consider keeping this adjustment in your back pocket. You can mention these adjustments later. Just don’t put them in writing and only mention them if necessary. 

If the buyer is performing due diligence and they uncover a few problem areas or attempt to renegotiate the purchase price, sit down, and have a talk. Walk the buyer through the expenses you decided not to adjust. Tell the buyer you wanted to be as conservative as possible and point out each expense that you believe should be adjusted but which you chose not to.

Yes, being conservative and humble pays sometimes.

How to Easily Produce a Detailed List of Adjustments

The best way to prepare a list of your adjustments is to export a detailed P&L, or “General Ledger,” from your accounting software to Microsoft Excel or another similar program. This is called a “P&L Detail” in QuickBooks. The detailed P&L lists every transaction for each account on your P&L statement.

Once you have exported this to Excel, simply mark each adjustment with an “X” or highlight the entire row. The advantage of doing this is that you will have a highly organized, detailed report available for buyers when they perform due diligence. 

Simply show the buyers this report and the buyer will be able to tie the adjustments to the specific entries in your accounting software. However, the buyer may request the source documents, such as receipts for the transactions, so be prepared to produce detailed invoices or receipts if the buyer requests them.

Many sellers think they can run off into the sunset after closing, free of all future obligations related to the sale of their business once the check clears. Not true.

Below is a list of documents you should organize before putting your business on the market. While the majority of these documents will not be requested until due diligence, begin preparing these the moment you decide to sell. Having an organized physical or electronic file of all these documents will put you at a significant advantage and speed up the sale process. It will also reduce the perceived risk to the buyer since buyers always view purchasing an organized business as less risky than purchasing a disorganized business.

• Operations
  • Marketing: Marketing material and/or collateral.
• Third-Party Contracts
  • Premises Lease: Print and have on file the details of the lease for your premises.
  • Supplier and Vendor Contracts: Print all major supplier and/or vendor agreements.
  • Advertising Contracts: Print all key advertising agreements.
  • Insurance Policies: Print all key insurance policies, such as liability, auto, etc.
• Assets
  • Asset List: Compile a complete list of all tangible assets included in the sale.
  • Equipment Leases: Print a copy of all major equipment leases.
  • Inventory List: Print a detailed schedule of all inventory included in the sale. 
• Financial Statements
  • Profit and Loss Statements: Have on hand a copy of the last three years’ P&L statements. This should include a breakdown of revenue by product or service and customer type, and a breakdown of sales by month for the previous three to five years.
  • Adjustments: Provide documentation for all adjustments or add-backs to your financial statements. (This is discussed in more detail in the next section.)
  • Full Accounting: Prepare a general ledger or detailed list of all transactions and expenses or a full accounting file, such as QuickBooks, Z Reports, etc.
  • Financial Budgets and Projections: Keep these updated if they are available.
• Financial/Other
  • Bank Statements: Compile a copy of bank statements for the previous three years. The bank statements should match the profit and loss statements and your federal income tax returns.
  • Merchant Statements: Compile a copy of merchant account statements for your credit card processor for the previous two to three years.
  • Accounts Receivable and Payable Schedule: Print a current AR and AP schedule and make sure it is up to date.
• Tax
  • Tax Returns: Have on hand a copy of federal income tax returns for the previous three years. Ensure they match your P&L statements, or ask your accountant to prepare a reconciliation to ensure any differences can be explained.
  • Sales Tax: Compile sales tax reports for the previous three years.
  • Annual Personal Property Tax Certificate: Create a copy of your annual personal property tax certificate, which will be prorated at closing.
• Staff
  • Staff Schedule: Compile a schedule of owners, officers, employees (with names redacted), independent and/or outside contractors, consultants and their titles, compensation, job descriptions, benefits, length of service, turnover, and compensation benefits.
  • Agreements: Compile all employment, agency, and independent contractor agreements, and other employment-related agreements.
• Legal
  • Entity: Compile any documents dealing with the formation of your entity, such as Articles of Organization, Operating Agreements, LLC Minutes, and a Certificate of Good Status from the Secretary of State.
  • Licenses and Permits: Copies of licenses, permits, certificates, and registrations from all governmental authorities. These may include Resale Permit, Business License, etc.
  • Fictitious Business Name Statement (FBNS): FBNS or Doing Business As (DBA) certificate.
• Technology
  • Website: Ensure your business website is up-to-date and accurate.
  • Web Hosting: Print and have on file a list of all web hosting agreements and documentation.
• Tech and Online Businesses
  • Code Audit: It is likely a buyer will retain a third-party expert to perform a software code audit.
  • Key Metrics: Compile information regarding customer acquisition and retention.

There are no hard-and-fast rules regarding when you should tell your employees about your plans to sell your business. They will obviously find out about the sale eventually, but when they find out, and how, can play a part in how smoothly the transaction goes.

Deciding if You Should Tell Your Employees

• Positive Culture: If your company’s culture is positive, and you have trust with your employees, you may consider telling a select group of them about the sale in advance. 
• Company Size: If you have a larger business, you will benefit from informing your controller or CFO because they will play a pivotal role in the sale process. It would be almost impossible to keep the sale a secret from your in-house controller or CFO during your preparations and due diligence. The process of selling your business will involve numerous financial requests, and your controller would quickly become suspicious as a result. You may want to talk to them directly and disclose the sale only to them. If so, we recommend asking them to sign a non-disclosure agreement (NDA) to ensure they keep your plans confidential.
• Large Staff: If your staff is large, I recommend disclosing the sale on closing day. It’s nearly impossible for a large group of people to keep mum. While your staff may feel betrayed, you can simply explain to them that it would have been impossible for everyone to keep the sale a secret, so you had no choice but to keep it under wraps until the sale became official. And while you’re at it, this would be an excellent time to announce a bonus for all employees, if you choose to do so.

Tell your employees as early as possible or as late as possible.

The Advantage of Telling Your Employees

If you decide to tell your employees before the sale, you can use this to your advantage. You can mention to buyers that you have told your employees, and selectively let buyers meet with some of your top people. This helps the buyer feel more comfortable and lowers the perception of risk for the buyer. Because there is a relationship between risk and return – the lower the risk, the higher the return – or purchase price – that can be justified. Telling your employees in advance also helps them feel more comfortable since they have the opportunity to meet with prospective buyers before one is selected.

This section walks you through the process of deciding when to tell your employees – specifically how you should tell them, tips for retaining your employees, and who else you should consider telling in advance of the sale. 

Deciding When To Tell Your Employees

Tell your employees as early as possible or as late as possible. Why? 

• Early: If you tell your employees early, you have plenty of opportunities to repair any damage that occurs as a result of your conversation with them. Some employees may jump ship. If this happens, you will have time to replace them. 
• Late: By telling them as late as possible, the amount of damage that can occur between your conversation and the closing is minimal. In most cases, telling your employees as late as possible involves telling them the day of closing.

Deciding when to tell your employees also depends on the circumstances and the culture of your company. If you have 10 to 50 employees and your culture is trusting, you may consider telling them in advance. The longer the employees know, the more opportunity you will have to build trust and prepare them for the process. You should stress that you will only sell to a buyer who will retain them. Frankly, this shouldn’t be a problem since nearly every buyer will want to retain your current staff, unless they plan on relocating the business. Buyers are just as nervous about losing employees as employees are about losing their jobs.

Deciding How To Tell Your Employees

Use a Tiered Approach

If you decide to tell your employees, we recommend informing your top people initially, either individually or as a group. Once they are on board, you can meet as a team, and the other employees will look to see how the top people react. If your top people react favorably, the rest of the team will likely follow suit.

Ask Employees To Sign a Confidentiality Agreement

Consider asking your employees to sign a confidentiality agreement. This agreement can be paired with a retention bonus agreement and a non-solicitation agreement. The non-solicitation agreement prevents your employees from actively recruiting other employees or customers in the event they choose to start a competing company or work for a competitor. Ensure this agreement is assignable to the buyer.

Plan the Employee Meeting

Most employees will be terrified of losing their jobs or experiencing major changes in the business. It may be helpful to have the new owner at the meeting to reinforce that they would like to retain everyone and not make any major changes to the business. An intelligent buyer will not rock the boat until they have established a strong relationship with your team. Once this relationship has been established, they will also help ensure buy-in to any changes.

Keep Things Positive

Position your plans as a positive move for your employees. For example, a new buyer may invest heavily in the company, increase salaries, and make other improvements to the business. If you position the transition correctly, employees will view this as an opportunity rather than a threat.

Your employees’ primary fears are the loss of their jobs or major changes to their roles. If you can assure them that neither will happen and that they may benefit from the transition, your employees will be comforted and can assist more readily with the transition. Informing your employees also makes buyers feel enormously comfortable with your business.

Retain Your Employees With a Retention Bonus

Retention Bonuses for Key Staff

If you decide to tell your employees, I suggest offering your key staffers a bonus for staying through the transition. The bonus should be substantial enough to motivate them to stay for a significant period of time following the transition, especially if you are financing a portion of the sale.

Amount and Timing

You can also consider releasing the bonus in stages for 6 to 12 months following the closing. A typical bonus is 5% to 10% of their annual salary. You shouldn’t give the employees so much money that they can band together and start a competing business, but it should be enough to motivate them to stick around after the closing. Releasing this bonus in stages helps solve this problem.

Explaining the Purpose of the Bonus

I recommend positioning the bonus as being your way of sharing your business’s success with your people. If you position it as a “retention bonus,” your employees may realize the leverage they have over you and may use that leverage to their advantage. Instead, you want to let your employees know you will share a piece of the pie with them because the company wouldn’t be in a position to sell without their loyalty and hard work.

Be Prepared for the Unexpected

You must be prepared in case one of your employees approaches you off-guard and asks, “I heard you are selling the business. Is that true?” If this happens, you have two options:

1. Play it Off: “Yes, haha, of course. My kids are for sale, too. Everything is for sale for the right price. Did you bring your checkbook?” In other words, you need a pre-planned story. If you choose this route, I recommend asking your spouse, a friend, or family member to catch you off-guard and ask you several times randomly during the day as to whether your business is for sale. This way, you can practice and hone your response before it’s show time.
2. Confess: Your second option is to spill the beans. Again, there are no hard and fast rules. If you’re unsure, use the first option and play it off – you can always come back and confess later on.

Have a Backup Plan in Case Things Go Wrong

I have had transactions that hit hurdles when an employee left in the middle of due diligence because they found out about the sale and felt betrayed by the seller. This is uncommon, but you should be prepared in case this does happen. Have a contingency plan in place to mitigate possible damage and keep the deal on course. Telling employees as early as possible gives you time to repair any damage before a deal is underway. Alternatively, telling employees as late as possible minimizes the amount of time in which damage can occur.

Key Points

• One of the most delicate decisions during a business sale is the timing of when to tell your employees. You need to determine the best way to approach this for your situation before you begin the process of selling your business. 
• Obviously, word will leak eventually, but if you maintain control of the timing and the process, you can use this critical stage to your advantage. 
• Be prepared for the unexpected, consult with your advisors, and make plans to help the sale become a smooth and successful transition for everyone involved. 

You have produced a list of action steps you can take to prepare your business for sale and maximize its value. How can you determine the first steps you should take?

Start by preparing a list of implementable strategic actions.

The Return on Value Driver’s Model (RVD Model) is a tool I developed that helps identify which aspects of your business to improve that will have the biggest impact on its value. The goal of the proprietary RVD Model is to help you increase the value of your business with the least amount of effort.

When preparing your business for sale, don’t take a haphazard approach. Rather, start by preparing a list of implementable strategic actions and then take those actions based on which drivers will have the biggest impact on the value of your business.

The RVD Model helps prioritize which value drivers to focus on first based on the following criteria:

• Return: What is the potential impact, or return, on the value of the business with implementing the value driver?
• Risk: What is the risk associated with implementing the potential value driver?
• Time: How much time will the value driver take to implement?
• Investment: What financial investment is required to implement the value driver?

The RVD Model helps you determine those action steps that will have the greatest impact on the value of your business in the shortest period of time and which also pose the lowest risks to implement. 

Steps to Completing the RVD Model 

1. Rate Based on Criteria: Return, Risk, Time, Investment. The ratings should not be considered definitive; their purpose is to allow you to loosely prioritize the potential actions you can take to improve your business. This can help you focus first on the highest impact actions that are also the lowest in risk and that require the least investment in terms of time and energy. 
2. Prioritize Based on Rating: Improving the value of your business should not be done in a haphazard fashion. Rather, you should prioritize the potential actions you can take and then execute them in a systematic fashion. Most business owners take a hodge-podge approach to value maximization as opposed to a strategic, intelligent, and rigorous approach. The objective of the RVD Model is to provide you with a strategic, structured approach to increasing the value of your business. It helps you prioritize the actions you can take based on potential returns, the risk involved in achieving those returns, and the associated cost in terms of time and money. 

Sample RVD Model

Below is a sample chart of potential value drivers for a mid-sized technology company, Acme Software. The chart includes the criteria of Return, Risk, Time, and Investment as well as a discussion of how each value driver was rated. Criteria are rated from 1 to 10. A higher rating is better – a 10 rating for risk means the action is lower risk and a 2.0 rating for risk means the action is higher risk. A 9.0 rating for investment indicates that a low investment is required, and a 2.0 rating indicates a high investment is required.

Commentary on the Sample Model

Here are my comments on Acme Software’s RVD Model. Factors are ordered by priority based on their ratings of each value driver.

• Increase Pricing (Rating 9.25): The potential returns from increasing pricing are extremely high for Acme. If Acme raised its prices, 100% of the price increase would fall to the bottom line, less any sales commissions – if Acme increased prices by 20%, EBITDA could potentially double. Revenue was $10 million, and a 20% price increase would increase EBITDA to $4 million from $2 million. Such an action was considered low risk by Acme, required little time and money to implement, and was reversible. As a result, Acme focused first on this value driver due to its potential for high returns and the low amount of time and investment required to implement it.
• Document Comparable Transactions (Rating 9.25): Acme was aware of several transactions that occurred within their industry that had higher multiples, but they had no documentation to back up the multiples their competitors received. Acme believed they could obtain more information regarding the transactions through several well-connected individuals in their industry, as well as through their investment bankers and professional advisors. While the potential return from this value driver was less than that of increasing pricing, little in the way of time and money was required to obtain this information. As a result, they began executing this value driver immediately after they increased pricing.
• Reduce Staff-Related Risk (Rating 7.75): Acme had several key employees who lacked employment, confidentiality, and non-solicitation agreements. The company understood this represented a significant risk to a potential acquirer and realized this could be cleared up with minimal cost in a matter of several weeks. Acme asked their attorney to prepare employment agreements for key staff that included non-solicitation agreements with a retention bonus to ensure the employees would be retained in the event of a sale. The retention bonus served as a form of consideration that improved the enforceability of the non-solicitation agreement.
• Reduce Concentrations of Risk (Rating 6.75): Acme also had key employee, customer concentration, and product concentration risks. While these risks could not be immediately mitigated, plans could be put in place to allay these risks over time. Key employee concentration was mitigated by more evenly spreading duties across the management team. Customer concentration risk was mitigated by asking key customers to sign long-term contracts. Finally, product concentration risk was mitigated by developing strategies to invest more in marketing their entire product line, as opposed to just a few products.
• Increase Revenue and EBITDA (Rating 6.25): While the potential impact of increasing revenue and EBITDA was significant, doing so involved a considerable amount of time and investment. In addition to increasing pricing, Acme realized that another method for increasing revenue, and therefore EBITDA, was to hire a more experienced sales manager and invest in building the sales infrastructure so the sales team could scale up their impact on the business. This required a significant investment in time and money, as well as a reasonable level of risk. However, the risk was mitigated by hiring a third-party expert to help interview and screen potential sales managers.
• Code Audit (Rating 6.25): Acme’s owners had some background in development, but they were not entirely sure the software code was clean and well documented. They realized a buyer might retain a third party to conduct a code audit during due diligence and they reasoned that it would be a wise investment to hire an independent firm to conduct a code audit before they began the sale process. The audit cost approximately $15,000, but they felt the investment was justified given the potential impact on improving the certainty of closing once a buyer was located.
• Strengthen Intellectual Property (Rating 6.25): Acme’s name was well respected and known in the industry, and they felt they could obtain a trademark. They also lacked invention assignment agreements for their developers. They hired an intellectual property (IP) attorney at a cost of $25,000 to perform a trademark search, file for a trademark, and prepare invention assignment agreements for key staff. The process was expected to take approximately 4 to 6 months. While doing this wasn’t expected to significantly impact their valuation, it did mitigate risk for the buyer and, therefore, could reduce the due diligence risk for Acme and improve the certainty of closing.
• Sales and Marketing (Rating 6.00): Acme lacked sales and marketing documentation and infrastructure, and they realized this might take a significant amount of time and money to build. Since the potential impact was not as substantial as value drivers higher on the list – such as increasing pricing and reducing staff-related risk – they gave this value driver lower priority given the amount of time and money required to execute it. Acme assembled a team to document the sales and marketing processes, expecting this process to take approximately three months.
• Increase Cost to Replicate (Rating 5.75): Acme felt that a few competitors could easily replicate the functionality of their software, but they felt they could implement several defensive strategic actions that could make any replication more difficult. Acme implemented these strategies over a period of three months.
• Increase Recurring Revenue (Rating 5.75): Acme’s enterprise customers’ agreements were renewable annually and many customers stalled during the renewal process. Acme felt they could create an incentive to motivate customers to sign an automatically renewable contract. Still, this transition process would take at least one year as they thought it would be best for customers to sign the new contract upon the expiration of each annual contract. Acme began implementing this process simultaneously while documenting their sales and marketing processes since they realized that transitioning to automatically renewable contracts would take time.
• Strengthen Customer Base (Rating 5.25): Acme lacked agreements with the majority of their customers and realized this represented a significant risk to a potential buyer. Acme created several pricing models with various contract terms and tested those models over a period of ten weeks using a combination of minimum viable products (MVPs), sprints, and A/B testing. Acme’s goal was to create a pricing model that incentivized customers to sign long-term agreements.
• Improve Infrastructure (Rating 5.50): Acme lacked documentation and infrastructure that could help it quickly scale, but they realized that improving the documentation and infrastructure would require an enormous investment of time and money – perhaps up to nine or more months. They also realized that this work would distract their employees from other projects. As a result, they decided this was their lowest-priority value driver and planned on executing it as their last priority.

Tips for Completing the RVD Model 

• Prioritize the Value Drivers: Priorities will vary significantly from company to company. For example, in a company with underperforming metrics, the potential return on improving metrics may be high (e.g., 9 or 10), but in a company that already has favorable metrics, there may be a much lower potential return (e.g., 2 or 3). Note that for Acme, while there is considerable subjectivity regarding the individual criteria – return, risk, time, and investment – and the overall rating for each value driver, there is a clear distinction between the highest priority value drivers and the lowest priority value drivers based on the overall ratings. Priorities are not absolute but should be considered relative to one another. The individual ratings aren’t important – what is important is the overall ranking or priority of the value drivers relative to one another. For example, it’s clear from reviewing Acme’s RVD Model that increasing pricing should be prioritized over improving documentation. Because completing the RVD Model is simple and requires little time, Acme could perform this analysis in a few hours with the assistance of an M&A advisor, and could begin executing the top value driver within days. There is no need for extensive planning and procrastination – the RVD Model encourages lean planning and action, and emphasizes results.
• Combine Objective and Subjective Data: Don’t restrict yourself to a linear, black-and-white approach. The purpose of the RVD Model is to offer you a high-level perspective of your available options and the associated criteria in deciding your course of action. Once you perform your rational analysis, let your subconscious take over to see if more strategic options evolve. Review your potential value drivers several times and re-rate them from scratch several times to uncover inconsistencies or areas where you may need more information.
• Obtain Multiple Opinions: For a more democratic approach, consider giving a copy of a blank RVD Model to your C-level executives and M&A advisor to complete independently. By asking them to complete it independently, you will counteract the bandwagon effect. Or consider showing your value drivers model to your professional advisors, such as your accountant and attorney, for their input. Don’t show a copy of your completed model to those who are completing it for the first time. Asking others to complete the model blind (without seeing your completed model first), will unveil important assumptions your advisors may have regarding some of the value drivers. For example, the CEO may have a different perspective than the CFO, CMO, or CTO. 
• Reconcile Different Opinions: Once you have obtained multiple opinions, combine the results into one spreadsheet and discuss the reasons for any differences with your team and advisors. By carefully weighing everyone’s opinion, the model flushes out differing opinions and helps prioritize those actions that everyone believes could have the greatest impact and which could be executed for the least cost, time, and risk. In other words, openly debating the model will result in a course of action based on input from your team.
• Ask for Feedback From Your Team: It’s helpful to assemble a deal team to initially discuss the value drivers and formulate and execute the strategy. Once your deal team is established, develop a daily cadence, and use principles from Scrum and Agile (lean) development to improve your speed and iteration time. The more help you have executing the value drivers, the more progress you will make. This may also be a wise time to consider implementing a retention bonus plan for your key executives. A retention bonus will help to align incentives and motivate your key staff to improve the value drivers, especially if the amount of their retention bonus is tied to the purchase price.
• Break Your Value Drivers Into Action Items: Consider breaking the value drivers down by specific actions, such as creating a retention bonus for key employees, as opposed to themes or categories, such as staff. Ratings, and therefore priorities, may be significantly different for specific actions as opposed to categories of actions, and it may therefore make sense to rank the model by specific actions as opposed to categories.
• Know Why a Company May Acquire You: In addition to ranking the value drivers, it’s helpful to know why a company may want to acquire you. Knowing the reasons a company may buy you will also help you fine-tune the ranking of your value drivers.

Identifying your value drivers is an important element in increasing the value of your business and preparing it for sale. Systematically improving your value drivers will push you into the upper limits of valuation for your company. Once you have identified your value drivers, it’s important to prioritize your value drivers and execute them based on their potential impact (return) and the risk, time, and investment required in achieving them. 

Not only can improving your value drivers increase the value of your business, it can also dramatically improve the certainty of the close. While working to maximize your value drivers is not an

If you have the time, you should focus on building a salable business to maximize its value. In order to do that, it’s critical to know what buyers of businesses want – and then give that to them. Most buyers desire a company with infrastructure and a management team as opposed to a one-person show. 

Starting a business requires a different set of skills than growing a business. And different sets of skills are required at different stages of growth. 

The skills required to grow your business from zero to $1 million in revenue are not the same skills needed to grow your business to $10 million or $100 million in revenue. Institutionalizing your company is key not only to growing your business but also to improving its value.

You can accomplish several objectives when you institutionalize your company through installing systems and building a management team. 

• It prepares your company for the next stage of growth. 
• It increases the value of your company.
• It increases the salability of your company.

If you want to sell your business for the most money possible, you should institutionalize your business to maximize its value.

Institutionalizing Your Business

Institutionalizing your business is accomplished through two primary tools – building systems and building a management team. 

Building Systems

Developing systems involves streamlining, automating, and documenting your processes. By documenting your key processes, you increase the chances of selling your business and increase its value. 

Some benefits of building systems include: 

• Easily attracting valuable employees with clear job descriptions.
• Managing your business more efficiently using well-documented processes.
• Increasing the value of your company.
• Maximizing the opportunities to sell your business.

Building a Management Team

Most businesses under $10 million in revenue lack a formal management team. Businesses that lack a professional management team would likely die without the owner’s presence. How long can your business survive without you? A year? A month? A week? 

Building a professional management team requires a new set of skills for most entrepreneurs. When you first started your business, you likely performed most of the key tasks yourself. Once you reach a certain point in your business, however, you must build a team. 

Building a team requires both recruiting and management skills. You have to learn how to find and hire good people, and then how to get results from those employees. 

What position or positions would add the most value to your company? What does your company need most? A CFO, COO, VP of Marketing, VP of Sales, VP of Human Resources? Should you bring in an external president? Take the time to develop a formal management team. Not only will your business be easier to sell, but it will also sell faster, and your revenues and profits will likely increase.

Building the Right Business for Your Buyer Type

There are three broad types of buyers. Each has a different set of preferences regarding the type of infrastructure and systems they desire in a business. When preparing to sell your business, it’s important to understand the different buyer types, their criteria, and how you can best position your business to be as attractive as possible to these different types of buyers.

Understand the different types of buyers and the degree to which they require systems and a management team before you invest in building systems and a management team.

Buyer Type 1: Individual Buyers

If your company is valued at less than $2 million, chances are high it will be sold to an individual buyer. 

Infrastructure isn’t as important to individual buyers because most individual buyers will be involved in the day-to-day operations of the business. If your business is small enough to appeal to an individual, it may not be necessary to invest a significant amount of money in building infrastructure before selling your business. But don’t think you’re off the hook – your business must still have enough infrastructure to ensure a smooth transition, but these types of buyers may require less infrastructure than corporate or financial buyers.

These buyers are highly numbers-driven. You should prioritize profitability over building infrastructure until your profitability exceeds $1 million to $2 million per year. If your business is valued at less than $5 million, it’s usually more beneficial to invest in sales and marketing to increase the revenue or profitability of your business than to invest in building infrastructure. To be sure, adding infrastructure helps, but most individual buyers prefer a more profitable business than one with more infrastructure.

Buyer Type 2: Corporate Buyers

The degree to which corporate buyers require infrastructure in your business depends on if they will be integrating your business with theirs or if they will run your business as a stand-alone entity after the closing.

• Integrated: Corporate buyers who will be integrating your company with theirs require less infrastructure than if it will run as a stand-alone business after the closing. In these cases, the buyer already has existing infrastructure and usually doesn’t require much – if any – more.
• Stand-alone: Corporate buyers who will keep your business as a stand-alone entity will require significant infrastructure. They may not be interested in acquiring your business unless your company has adequate infrastructure in place and it can continue to operate on a stand-alone basis without you. In some cases, this type of buyer has a manager at their corporate office who will be promoted to run your company as president. Still, your business should have a management team and systems in place to ensure that operations continue to run smoothly during the transition process.

Buyer Type 3: Financial Buyers

Financial buyers primarily consist of private equity groups. Private equity is a relatively new asset class, and this group’s criteria are not as homogenous as those of corporate buyers. Some private equity groups specialize in lower middle-market businesses, which tend to have less infrastructure. Others seek stand-alone entities where the owner and management team stay on for several years and where there is already significant infrastructure in place. 

Most private equity firms require significant infrastructure, though the need for infrastructure will vary depending on the buyer. If you plan on selling to a private equity firm or other financial buyer, you should plan on building a significant amount of infrastructure in your business.

Financial buyers expect to double or triple their investment in five to ten years before selling the business again to another buyer. This is often possible only with systems and infrastructure in place, and installing these systems and infrastructure costs time, money, and risks for the financial buyer. If your business lacks these systems, the buyer must make a large investment to build them. A multiple of two to three times the amount of this infrastructure investment is usually deducted from the purchase price the financial buyers are willing to pay. 

Most private equity firms require that the management team and owner remain to run the business after the closing, in addition to requiring significant infrastructure. Partners in private equity firms focus their time on purchasing companies and don’t become actively involved in the management of their investments. So, either existing management must remain to operate the business, or the private equity firm must hire a management team to run the business after the closing. The only exception to this rule is when the private equity firm owns a portfolio company that competes directly with yours, and they plan to integrate your business with that company. 

Three Additional Factors That Buyers Consider

What follows are three additional factors that buyers will look for when considering your company as an acquisition candidate. These factors must sometimes be prioritized before building systems and a management team. An understanding of these critical factors is also important when deciding which systems to implement before you put your business on the market.

Factor 1: Profitability

The most important factor buyers look for is profitability. Few buyers will be interested in your company if it isn’t taking in more money than it’s shelling out. If your business isn’t producing a profit, don’t waste your time or money building systems. Invest in sales and marketing activities instead. Only when your business is profitable should you invest in building infrastructure. 

Many buyers will consider a profitable business that lacks infrastructure. But few buyers will consider an unprofitable business that has significant infrastructure in place. Always prioritize profitability over infrastructure until your profitability reaches $1 million to $2 million per year.

The most important factor buyers look for is profitability.

Factor 2: Scalability

Sophisticated buyers look for a business that is scalable, or that has the potential to quickly grow. Financial and corporate buyers love a scalable business in which the owner hasn’t tapped its full potential. This usually involves an owner who is burned out or one who has not built effective sales and marketing systems – but the business has operational systems in place that allows it to quickly scale once sales and marketing are ramped up. If you want to sell your business for the maximum amount possible, focus on building a business that is scalable from day one.

Factor 3: Competitive Edge

Corporate and financial buyers are usually in the market for a business with a competitive advantage that is sustainable and not easily replicated, while individual buyers regularly purchase lifestyle businesses with little or no competitive edge. 

An unsophisticated buyer may purchase your company if you don’t have a competitive edge, but many sophisticated buyers will not. Superior customer service is not a competitive advantage. Personal relationships are not a competitive advantage. Proprietary technology can constitute a competitive advantage, as can economies of scale and brand image recognition, to name a few.

If your business has low barriers to entry and is a “me too” product or service, then the lack of a competitive advantage may turn many buyers off if they feel they can easily replicate your business. A competitive advantage should be summarized in an objective statement and should be difficult for competitors to copy. 

Your business must have a competitive differentiation that a buyer can’t easily reproduce. Otherwise, it will be difficult to sell your business to anyone other than an unsophisticated buyer. Remember, almost every company over $5 million in selling price is purchased by a sophisticated buyer, so any business valued at more than $5 million should have some form of competitive advantage, or the price will be discounted.

Key Points

• For most small businesses, developing a management team is the critical factor in building a salable business. For other businesses, building systems may create more value. There is no cookie-cutter formula. 
• Your business is one of your most valuable assets. Consider how you will sell your company from day one. Focus on building a profitable, scalable business with a competitive advantage that can’t be easily replicated. 
• Concentrate on hiring the right people and building the right systems. By doing so, you will not only increase the value of your company, but you will likely end up making more money and increasing the quality of your life in the process.

The Centers for Disease Control and Prevention (CDC) posted a blog entitled “Preparedness 101: Zombie Apocalypse.” Really. Try searching up the article.

The author took note of the rise of zombies in pop culture at the time, which he said “… has led many people to wonder ‘How do I prepare for a zombie apocalypse?’”

It turns out that getting ready for an invasion of flesh-eaters is not unlike preparing for a hurricane. Putting together an emergency kit of food, water, and other supplies will get you through the first few days of either occurrence, according to the CDC. Which, of course, was the tongue-in-cheek point of the CDC brief in the first place.

When it comes to selling your business, you won’t need to set aside a gallon of water per person per day or stock up on flashlight batteries. But you really should prepare. And that’s what we tell you how to do in this chapter. Pay attention – your financial survival may depend on it.

Preparation vs. Execution

Which is more important – preparation or execution? 

As with most skilled endeavors, preparation makes execution look effortless. Considering that the sale of your company may be the largest sale you ever make in business, it’s foolish to neglect preparation and potentially leave hundreds of thousands or millions of dollars on the table. Unfortunately, few business owners thoroughly plan their exits by giving this major life decision the thought and attention it deserves. 

Why? 

The lion’s share of entrepreneurs have a strong bias toward action. Once they decide on a course of action, they prefer to dive right in and figure things out later. But you must realize that a lack of preparation will extend the time frame of the sale, reduce the selling price of your business and the cash you put in your pocket, and lower the chances of a successful sale. 

No two exits are alike. Each exit should be planned. There is no templated process you can follow to prepare your business for sale. Rather, the preparation stage involves reviewing a number of steps, prioritizing those steps, and then taking action on those steps.

Preparation makes execution look effortless.

In this chapter, I will offer general strategies to prepare your business for sale. 

When I am approached by a potential client, we prepare an assessment, which includes a customized exit plan or strategy for that business owner. But in the absence of a custom plan, you can follow the general guidelines outlined here.

If you are willing to take the time to prepare your business for sale, be sure the firm you hire can assist you before you begin the sales process. This exercise is formally known as “exit planning.” Many business brokers, M&A advisors, and investment banking firms are heavily biased toward action and prefer to put a company on the market and sell it as quickly as possible. They may not be as concerned with maximizing the sale price and doing the hard work necessary to ensure a successful exit. Be sure whoever you hire is willing to help you in the preparation stage.

If you aren’t intending to spend time preparing your business for sale, then be honest with your professional advisors. I, for one, am accustomed to selling businesses in urgent circumstances or when the situation isn’t ideal. I appreciate any business owner who is upfront with me regarding how much time they can invest in getting their company ready to be put on the market. 

When talking with your advisor, it’s important to be honest regarding your expectations, the condition of your business, and your level of preparation. Your advisors will eventually learn the truth in any event, so it’s best to level with them from the start to maintain a relationship based on trust throughout the process. 

You have gone through the rigorous process of deciding to sell your business, and you have decided that now is the time. You may wonder, how long will it take? 

For all transactions since 2000, the average time on the market is 200 days or about 7.3 months. But the average time to sell a business has increased over the years, from six months in the early 2000s to ten months in recent years. Selling a business has become more difficult and takes longer than it did ten years ago. 

Why? 

I attribute this to four reasons:

1. Internet: The internet has provided buyers of all goods and services with more options, and they have become more educated and selective as a result. When I started in the business in 2000, we used newspapers to sell businesses. These days, I don’t know anyone in the industry that advertises a business for sale in a newspaper. In the old days, businesses were easier to sell and often sold more quickly, likely due to a lack of qualified alternatives and businesses for sale. In the new age, the internet has opened up a range of alternatives for buyers and they have become much more selective. The time frame to sell a business has increased as a result.
2. Information: The internet has also provided a wealth of information on buying or selling a business. Today’s buyer is more educated, able to consider more options, and more selective in which business they decide to purchase.
3. More Businesses for Sale: In recent years, the number of businesses for sale has steadily increased and access to these businesses has gotten easier because of the internet. This has resulted in a larger number of choices for buyers, which has exerted downward pressure on the price of businesses and lengthened the time frame.
4. More Options: Today’s would-be entrepreneurs have more options available to them than in years past. Job mobility has allowed many to work remotely or freelance and, as a result, many potential buyers have instead opted to take a job “for free” rather than buying a business. This has significantly impacted any business that produces a profit of less than $100,000 to $200,000 per year and these businesses are much more difficult to sell than in past years. Businesses producing more than $200,000 per year have not been as impacted by this trend.

But don’t be discouraged. While selling a business now takes longer than it did two decades ago, it’s still possible to get your business sold in a reasonable period of time and for maximum value. How? This book explains.

Sources of Data and Their Accuracy

How accurate are statistics on the time frame?

The business of selling businesses is highly inefficient, especially for those selling smaller businesses. Almost no surveys are validated, and most producers of surveys lure participants in with free results if they complete a survey. This type of incentive can result in inaccurate data. 

For instance, at my firm, Morgan & Westfield, when confidentially marketing a business for sale, we use several web portals where we need to provide transactional data. Our dealmakers operate separately from our back-end administrative team, meaning that, when required to enter data into a web portal, the team may not have complete information available, but they still enter what they can. As a result, we already know that the results of these surveys contain transaction data known to be inaccurate. Many other firms are simply too busy to bother inputting data into databases. 

Nonetheless, two useful sources of statistics are available:

1. BIZCOMPS: This is a database of transactions for businesses sold in the United States, including the length of time the business was on the market. BIZCOMPS contains over 13,000 transactions dating back to 1996. Most of the transactions in BIZCOMPS are smaller businesses priced at less than $1 million. Additionally, almost all of the transactions were completed with the assistance of professional advisors, primarily business brokers.
2. Business Brokerage Press: This is an organization that produces an annual survey of its members. The members primarily consist of full-time business brokers. Out of a few thousand members, a large majority complete the survey on an annual basis. Non-members are also permitted to participate in the survey. The survey is mainly aimed at business brokers and M&A advisors in the Main Street and lower middle-market who sell businesses priced up to $10 million. The survey consists of several dozen questions, of which one is, “How many months is the average period between beginning the process and the closing?” Recent results from surveys have ranged from six to 11 months, with the time period slowly increasing over the years. This data seems to coincide with the information from BIZCOMPS. 

Note: Another useful transactional database that contains more middle-market transactions, the IBA Market Database, includes over 37,000 transactions. But the database doesn’t provide details on how long a business takes to sell. Unfortunately, there are not many useful sources of information regarding the time it takes to sell a business.

While the data can be useful, it’s far from perfect. The data should be used as a rough guide only and supplemented with a dose of common sense and professional advice.

Variables 

There are six variables that affect how long it takes to sell a business:

1. Selling price
2. Region
3. Financing and down payment
4. Industry
5. Attractiveness
6. Marketing strategy

Let’s take a closer look at each one of these variables.

Variable 1: Selling Price

Based on our analysis of BIZCOMPS, the time to sell a business varies from 8.1 months for businesses sold from $500,000 to $1 million, to ten months for businesses sold from $5 million to $10 million.

Larger businesses take longer to sell. Based on our experience at Morgan & Westfield, smaller businesses have, indeed, sold more quickly in the past, but that trend is reversing. Our experience is that businesses become much easier to sell once EBITDA (earnings before interest, taxes, depreciation, and amortization) exceeds $500,000 per year. The more profitable a business is, the more desirable it is and the more quickly it will sell. Larger businesses are easier to sell due to higher demand from professional buyers. Almost all larger businesses are purchased by financial or corporate buyers as an alternative to organic growth, and the demand for quality businesses in the lower middle-market is always high. 

In addition, the more reasonable the initial asking price, the faster the business should sell. Businesses valued in excess of $5 million to $10 million often go to market without an asking price.

Variable 2: Region

Businesses for sale in desirable, high-population growth areas tend to sell faster. For instance, it is easier to sell a business in Orange County, California, (211 days) than it is to sell a business in Iowa (252 days), but this depends on who the ultimate buyer of your business may be. Individuals are more selective about where a business is located than are corporate buyers. 

Many individuals looking to buy a business will consider relocating. In fact, a substantial portion of businesses that change hands in the Southwest and Southeast are sold to individuals moving to the area. If your business is located in a highly desirable region, the fact that people are willing to relocate opens up the number of potential buyers, which effectively speeds up the selling process. Having more potential buyers means that the business will be easier to sell and will often sell faster.

Variable 3: Financing and Down Payment

The more financing the seller offers, the faster the business should sell. But, again, this depends on who the ultimate buyer of your business may be. Wealthy individuals generally put less down than private equity investors and other corporate buyers. If you sell to an individual, expect to finance a significant portion of the purchase price if the buyer can’t obtain third-party financing, such as an SBA loan.

Offering reasonable seller financing terms should result in a quicker sale unless a buyer can obtain an SBA loan or unless they are a corporate or financial entity.

Variable 4: Industry 

A correlation exists between the industry type and the number of days a business is on the market. Manufacturing and technology businesses tend to attract more buyers and therefore sell faster than many retail and service-based businesses. 

If your business is in an attractive industry such as technology or manufacturing, it likely will sell sooner than if it is in a low-growth or unattractive industry.

Variable 5: Attractiveness

To make your business more attractive and help it sell faster, apply the following attributes:

• Increasing financial trends, such as increased revenues or margins
• Low capital expenditures, inventory, or working capital requirements
• Desirable industry
• Strong industry growth and/or stability and/or low-risk
• Scalable business
• Business is difficult to replicate
• High barriers to entry
• Weak competition 
• Strong competitive differentiation 
• Strong brand awareness
• Strong history
• Strong customer loyalty or repeat business
• Minimal customer concentration
• Strong customer contracts
• Recurring revenue
• Strong management team
• Strong infrastructure
• Documented intellectual property
• Favorable lease terms
• Desirable location
• Ability to relocate the business
• Minimal owner dependency
• Minimal dependency on key employees
• Long employee tenure
• Bank financing available to purchase your business
• Limited industry regulations and licensing requirements (this can be a positive barrier to entry if the buyer already possesses these requirements)

Variable 6: Your Marketing Strategy

Aggressively marketing your business for sale through the appropriate channels should help you sell your business faster. Find the best business broker or M&A advisor possible and give them everything they need to help you.

Timeline for Selling a Business

The following is a brief description of the steps involved in selling a business and the time frames involved for each step.

• Preparing the Business for Sale (1 to 2 months): Preparing your business for sale includes normalizing your financial statements, valuing your business, and creating an offering memorandum, teaser profile, and other key documents. Preparation is typically a controlled and predictable step and usually takes one to two months. Often, the biggest bottleneck at this stage is receiving updated financials. 
• Marketing the Business and Accepting an Offer or LOI (1 to 12+ months): This step involves confidentially marketing your business for sale and meeting with buyers. How long this period will take is often unknown, and requires little active effort from you other than meeting with prospective buyers and negotiating the offer or LOI. It can take 1 to 12 months to locate a buyer, and generally one month to negotiate an offer once you identify the buyer. This time period is often frustrating for a seller because you may feel as if nothing is happening. But it’s important to keep your focus on the business and maintain consistent revenues or growth while it’s being marketed for sale.
• Due Diligence and Closing (4 to 6+ weeks): Conducting due diligence usually takes four to six weeks, although it can sometimes take eight or more weeks depending on who the buyer is and how organized you are as the seller. Due diligence can be delayed for many reasons, such as delays with obtaining bank financing or as the result of inaccurate financial information. Negotiating and closing the transaction usually takes from one to two months once due diligence has been completed. In some cases, it can take several months to close the transaction due to third-party delays from attorneys, accountants, franchisors, banks, or license-transfer approvals. These guidelines are rough estimates only, and you should be fully prepared for the transaction to take significantly longer.

Other Factors To Consider

There are a couple of additional factors you should consider when planning how long it will take to sell your business.

Brokers’ Contracts: Why do brokers often require a 12-month exclusive contract? Because the contract length often coincides with the average length of time it takes to sell a business. Half a century ago, listing contracts were 30 to 60 days in length, and businesses were often sold within that period. The time it takes to sell a business has increased steadily over the last 50 years, along with the exclusivity period that most brokers require. 

Value of the Business vs. Time to Sell: Most of the factors that increase the value of a business will also have an impact on the amount of time it takes to sell the business. If you want to increase the value of your business or speed up the time frame, the steps you must take are often the same.

Key Points

When planning to sell a business, you should attempt to maintain a balanced viewpoint. Remember that an average is just an average. The actual time period can vary from one day to more than three years. 

Selling a business is a stressful, emotional event, and it involves anticipating other peoples’ actions, which are beyond your control. As a result, the data is varied and estimating the time is difficult. 

How can you prepare your business for sale and speed up the process? I’m glad you asked. That’s the subject of the next chapter.

Learn More

To view complete statistics on the time to sell a business, you can find my article How Long Does It Take To Sell A Business at the Morgan & Westfield website at morganandwestfield.com/knowledge.

“Questions confine answers. When there are no longer questions, answers are no longer bound by them.”

– Lao Tzu, Chinese Philosopher

If you’ve already decided to sell your business, you can skip this chapter. If you’re still on the fence, read on.

The decision to sell your company is challenging. You’ve invested years or decades painstakingly building your business, and you’ve made countless sacrifices along the way. It’s an emotional decision that should not be taken lightly. 

And when considering such an important decision, there are four important factors to take into account:

1. Your goals, including personal, financial, and business 
2. Internal factors, such as emotions 
3. External factors, including timing and competition 
4. Your business’s value and exit options 

You can’t decide whether to sell your business by going through a simple checklist. Instead, the determination should be made deliberately, taking all factors into consideration and balancing emotion and intuition with facts and logic. 

While this framework is useful, the four factors mentioned aren’t all-encompassing. Rather, these considerations are meant to be jumping-off points to further explore when contemplating the sale of your business. Every entrepreneur’s situation is different, and many will need to consider additional factors not addressed here. Regardless, start by considering these four factors and see where your journey takes you.

1: Your Goals

“You are that which you are seeking.”

– Saint Francis of Assisi, Italian Friar

Start the process by clarifying your goals – understanding what you want is the first step towards getting it. Only once you understand your long-term goals, therefore, can you examine how selling your business will move you closer to them. 

Many factors must be considered when deciding to sell your business, and considering all of the elements at once can be overwhelming. Starting with your goals simplifies the decision-making process. The risk in selling your business before examining your goals, is making a decision that doesn’t align with them. As a result, you may find yourself backing out of the sale or later living with regret.

Would selling your business help achieve your long-term goals?

To gain a better focus on your goals, ask yourself these questions:

• What are my long-term goals? 
• Would selling my business help me achieve my long-term goals? 
• What am I trying to accomplish? 
• How does the sale of my business help me achieve my goals?

Align your long-term objectives with the sale of your company. If your business is preventing you from achieving your goals, you should sell it. If selling your business is critical to achieving your goals, spend additional time planning your exit to ensure the sale helps accomplish these goals.

Is your goal to sell your company to become financially independent? If so, get your business valued and develop a plan for increasing that value. Then track your results to ensure you meet your objectives. Prepare a personal financial and tax plan to make certain your exit will meet your financial goals. 

Is your goal to sell your business so you can start another business or switch industries? If so, consider your lost opportunity cost and the cost of remaining in the business. 

What are you losing now by not pursuing your next business or opportunity in another industry, or a different goal or dream? Ideas are infinite, but time is finite. You have a limited number of ideas you can pursue in your lifetime.

Again, the decision to sell your business should always begin with a thorough and careful review of your long-term goals. If your goals are unclear, then the decision to sell your business will be based on a rocky foundation. It will be harder for you to commit to the sale without a definite goal, and this uncertainty will minimize the overall value you extract from the transaction.

Do you need to sell your business to achieve your financial goals?

If you must sell your business to achieve your financial goals, consult with a financial planner to ensure you can meet your financial objectives upon a sale and meet with a CPA to consider the tax implications of the sale.

For most owners, the sale of their business achieves a personal long-term objective. They depend on the sale to help them accomplish their financial goals. But it’s important to separate your financial goals from your non-financial goals to establish a clear outline of what you want. 

It’s not always necessary to start your planning process with numbers – after all, money is always a means to an end and not an end to itself. Remember as business author David Baughier once said, “Once you have enough money, it’s not about the money.” Instead, ask yourself what stands behind the numbers. First, clarify your long-term goals, and then assign numbers to the goal, if possible. 

Ask yourself these key questions to clarify your financial and non-financial goals:

• What are my financial goals? 
• How do these fit into my long-term plans? 
• What is more important – my financial goals or other goals I may have set? 
• What am I going to do with the money? 
• Is my goal to take money off the table and diversify my risk? 

What other goals can you achieve if you sell your business?

“The price of anything is the amount of life you exchange for it.”

– Henry David Thoreau, American Author and Philosopher

When making the decision to sell your business, consider the lost opportunity cost. Pursuing opportunities is a mutually exclusive decision if you believe in focus. Chasing after more than one objective at a time dilutes your focus and lowers your chance of overall success. There is a significant lost opportunity cost to holding onto a business where you have lost your passion, especially if its value erodes. What other opportunities are you passionate about that you could be pursuing?

If remaining in your business is costing you $500,000 per year due to the value you place on lost opportunities, holding onto your business for an additional three years will cost you $1,500,000. If your company is worth $5 million, it may make more sense to sell your business now for $4 million and experience a $1 million short-term loss rather than lose $500,000 per year in lost opportunities.

While the decision to sell your business can’t always be reduced to numbers, it can be helpful to look at a sale from multiple angles, including both quantitative and qualitative perspectives.

In addition to lost opportunity costs, you need to consider the current state of your industry. Not all industries are created equal and careful consideration must be given as to when to jump from one ship to another. 

Many entrepreneurs make the mistake of thinking that the grass is always greener on the other side and that other industries offer more potential than the one they are currently in. If you believe your industry is in decline, consider consulting with other entrepreneurs who have experience in multiple industries, or ask the opinion of a professional who deals in multiple industries. An M&A advisor, for example, likely has experience in various industries and may have perspectives that you lack.

If your other goals are primarily non-financial in nature, your decision can be especially difficult, and you must carefully weigh your options. 

What is owning your business precluding you from doing? What is that experience worth to you? 

Only you can decide. Life is short, but you should take your time when making this important decision.

2: Internal Factors

“Everything considered, work is less boring than amusing oneself.”

– Charles Baudelaire, French Poet

Here are more questions you should consider:

• Am I happy? Am I really happy? 
• Is my business making me unhappy? 
• Would selling my business make me happier? 

Entrepreneurship is a struggle. No entrepreneur is happy 100% of the time. Look at yourself and your business objectively and determine if a change might make you happier. At the same time, though, beware of trading one set of problems for another. 

Would selling your business make you happier?

If you are facing challenges in your company, ask yourself if the root of the problem is a lack of management skills or if the obstacles are caused by external factors beyond your control, such as increased competition in your industry. If your issues are the result of a lack of management skills, trading one business for another is not guaranteed to solve your problems. 

On the other hand, some industries are not known for creating happy entrepreneurs. These include businesses that may have less-than-ideal customers, such as liquor stores, payday loan shops, and collection agencies. Stressors can also include long hours in restaurants, home health care, and retail, demanding clients in professional services, or low margins in personal services. If the general environment of your industry is an unhappy one and you value your well-being, consider making a change.

Would you keep your business if it made you happier? Would you keep your business if you could revamp your schedule and spend 80% of your time on high-value activities you enjoy and less time on minor details?

If so, then restructure your business to focus on what you love to do and take advantage of your strengths. If you have lost passion for your industry and have a strong gut feeling you need to make a change, it’s time to develop a definite plan to exit your business.

Would selling your business cure your burnout or boredom?

Look in the mirror and ask yourself these questions:

• Am I burned out? 
• Have I taken a vacation recently? 
• What other options have I considered or attempted to cure my burnout?

Burnout is normal in all endeavors, and all entrepreneurs should make time for regular relaxation to de-stress. Professional athletes periodize their training. CEOs take regular time off to recharge. You should do the same to both prevent and treat burnout.

Fatigue is normal if you aren’t taking time off. Just because you are burned out doesn’t necessarily mean you should sell your business. First, determine the cause of your burnout and evaluate if selling your business will be a cure or if other measures are more appropriate for rekindling your passion.

If your burnout is due to problems with your employees, then it’s time to either upgrade your management skills or upgrade your team itself. Trading your business for one in another industry will not help if people-management issues are at the root of your burnout.

If you haven’t taken a vacation in a long time, other methods are available for relieving burnout. Ideas could include stress-management techniques or restructuring your business to minimize activities you aren’t good at or that cause you stress. First, set out to relieve your burnout. If you find you still lack passion for your industry, are bored, and in need of a change, and if you’ve attempted to address your burnout and boredom one too many times without effect, then perhaps it’s time for a change.

How will you spend your time after you sell your business?

The question to ask yourself is not, “What will I do with my money when I sell my business?” The real question is, “What will I do with my time when I sell my business?”

The matter of what to do with the rest of your life is a difficult topic for entrepreneurs to face. Most business owners are so busy that they don’t have time to confront the deeper issues. They are so occupied playing whack-a-mole in their business that they don’t have the energy to face life’s existential questions. 

After selling your business, it might be the first time in decades you’ve had the freedom to decide how you spend your time. Will you fritter away your days buying toys, or do you plan to pursue something more meaningful? How you spend your time should be based on your values. Your values are the foundation on which you make decisions. Having a clear and documented set of values makes the process of deciding how to allocate your time easier. 

After all, as author Michael LeBoeuf once said, “Waste your money and you’re only out of money, but waste your time and you’ve lost part of your life.”

Selling your business will leave you with time. If you don’t have another passion, you will be left with a void, lacking your business to fill that empty time. If this void isn’t filled, your being may lack meaning. Sitting around the pool sipping margaritas on a giant, inflatable pink flamingo can become unfulfilling, especially for driven entrepreneurs. Of course, some may never tire of this. Examine your own values and goals so that you don’t build yourself a void after a successful sale. Don’t avoid the real question by drowning yourself in material pleasures.

Are you committed to the process of selling your business?

Are you truly committed to the process of selling your business, or have you made this decision on a whim?

Move forward with your plans only if you are fully committed. But be aware that doubts will remain no matter how committed you are. Be deliberate in making your decision, so you can deal with doubts as they arise. Talk with trusted friends who have successfully sold their businesses. Journal. Read. Explore your decision from all angles. 

Remember that, as management consultant Peter Druker once said, “Unless commitment is made, there are only promises and hopes but no plans.” 

Selling a business is a process, not an event. The process of preparing a business for sale and successfully exiting takes several years for many entrepreneurs. Shortcutting the procedure can leave money on the table and turn into a big waste of time if you begin the sale only to change your mind later. Only you can answer if you thoughtfully and purposefully made this decision or if an impulse is driving you. If you are still on the fence, take more time to explore the decision fully before making a final determination.

3: External Factors

“We’ve done better by avoiding dragons than by slaying them.”

– Warren Buffett, American Investor

Once you have considered your internal factors, it is time to take a broader look at the external factors that will affect your decision. Industry conditions and competition will play a large part in how smooth, and ultimately successful, the sale process is for you.

Is the timing right to sell your business?

Timing the sale of a business is difficult, but it can be done. The ideal time to sell is when your business and industry are about to peak. Consult with veterans in your industry to obtain their opinion regarding the current market cycle. Consider both industry cycles and macroeconomic cycles. But remember that, as with most important decisions, the timing will never be perfect. 

Align the timing of your goals with the timing of the sale of your business, industry trends, and market activity, if possible. Otherwise, avoid selling in a severe economic or industry downturn. Your revenue should be stable and preferably growing by the rate of inflation or more when you put your business on the market. If it’s not, have an expert analyze your business to determine if it makes sense to stabilize your company’s revenue before putting it up for sale. 

How should competition in your industry affect your decision?

You can bet that the “Oracle of Omaha,” Warren Buffett, has asked himself these questions more than once regarding specific investments:

• Is the competition becoming stronger in my industry? 
• Are new venture-backed entrants threatening my market share? 
• Do I have enough capital to fight a competitive industry war? 
• Are indirect competitors threatening to permanently change the structure of my industry (e.g., Uber vs. the taxi industry, Airbnb vs. the hotel industry, online news vs. traditional news)? 

If competition is increasing and becoming more fierce by the day, but you lack the passion and capital to compete, exit as quickly as possible if you can. The value of your business will decline proportionally to a decline in your revenue and cash flow. Face the inevitable conclusion and sell while you have something to sell. Unfortunately, I see too many entrepreneurs hang on for too long, only to have nothing valuable left to sell. 

Don’t make this common mistake. 

4: Value and Options

“Don’t be afraid to give up the good to go for the great.”

– John D. Rockefeller, American Business Magnate

Knowing what questions to ask yourself is half the battle, like these:

• Have I had my business appraised recently? 
• Am I aware of current multiples in my industry? 
• Have multiples remained steady within my industry, or have there been significant variations over time? 
• Do I know what changes I need to make to unleash the value of my business? 
• Do I know what my business would be worth if I made these changes?

Consider these questions, and many more, as you begin to explore your exit options.

What is your business worth? 

Your business is likely one of your most valuable assets and may comprise the majority of your net worth. Intelligent financial planning is difficult without having an accurate idea of the value of your most valuable asset – your business. 

It makes sense to pay a professional to value your business and have an idea of the steps you can take to increase its value. It’s best if you and your business are prepared at all times for the unexpected buyer, and that you regularly take steps to increase the value. The buyers most likely to pay the highest price are those who approach you directly, unsolicited. So be ready for them.

Consider diversifying your risk if your net worth is highly concentrated in your business. There are many options for diversifying your risks, such as a recapitalization or an outright sale. An appraisal of your business is the most prudent place to start and can help you make this decision.

Knowing what your business is worth also enables you to determine a bottom-line price if a competitor approaches you. Without such planning, you may be caught off guard and end up selling your business for far less than what it’s worth.

What are some exit options?

Ask yourself these questions that go to the heart of the choices you will face:

• What are my options for exiting my business? 
• Should I consider selling or gifting my business to family members? 
• Is my management team, or someone on the inside, a potential fit? 
• Is a sale to a competitor most practical? 
• Is a private equity group likely to buy my business?

Most entrepreneurs lack the experience to determine exit options most suitable for their business and industry – options that will unlock the most value. That’s why you should consider having a third party perform an unbiased assessment of your business.

This assessment should lay out your exit options and steps to prepare your business for sale. The risks and opportunities vary depending on who you sell your business to. Different steps will need to be taken depending on whether you plan to sell your business to an insider, a competitor, or a financial buyer. You should carefully consider these issues before deciding which exit option to pursue.

There are also creative alternatives to a conventional sale. Again, before proceeding, establish your goals. With clearly defined goals, a professional can easily and efficiently lay out the most practical exit options for your business based on your goals, along with tips for reducing the risk associated with each option. In the words of Warren Buffett, the Oracle of Omaha: “Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.” 

Is the value of your business increasing or decreasing?

Sell while you are able to extract any remaining value. If the value of your business is decreasing and you lack the drive to turn it around, you should consider the lost opportunity cost of holding onto your business. If revenue continues to decline, so will the value of your business. Selling a business with consistently declining revenue is difficult, but it can be done. Selling a business with stable or increasing revenue is far easier.

Take an honest look and ask if you can turn your business around. If you are burned out and competition is increasing, it’s time to get out. If the decrease in the value of your business is due to a one-time event or an internal factor and you have time to cure the problem, then do so.

Is your business ready to be sold?

These are not always easy questions to answer, which is all the more reason to ask yourself:

• How salable is my business right now? 
• Are there deal-killers present in my business that need to be fixed? If so, how long will it take to fix them? 
• Is it worth the time and energy to attempt to straighten out these issues, or is it best to sell my business in its current state? 
• What is my personal ROI if I fix these issues before selling my business? 
• What is my lost opportunity cost in attempting to cure these potential deal-killers? 
• Could my time be better used elsewhere?

Ideally, you should invest several years preparing your business for sale to maximize its value. The more salable your business, the more your business will be worth. There are two ways to improve salability: eliminate deal-killers and optimize your business’s value drivers. 

Start by fixing any deal-killers. These could include inaccurate financial statements or undocumented intellectual property. Once these issues are addressed, calculate the ROI on the remaining potential changes and start with the highest ROI tweaks – see my “Return on Value Drivers (RVD) Model” in Chapter One to help you decide which value drivers to focus on first.

Not every business owner has the time and energy to fully prepare their business for sale. In these cases, changes can continue to be made while the business is on the market. If your business is not fully prepared, you may still be able to sell it but expect to receive less than full value.

Key Points 

“See things in the present, even if they are in the future.”

– Larry Ellison, American Inventor

Choosing whether to sell your business will be one of the most important decisions of your life. Use the framework outlined here for making this determination: 

• Goals: Start by considering your objectives and lost opportunity costs. This is the foundation of your decision. 
• Internal Factors: Address the emotional or internal factors of a sale – namely, those relating to happiness. This step takes time to do correctly, so don’t rush it.
• External Factors: Once you have thoroughly explored your emotional objectives, consider the external factors, such as the timing of selling your business and the state of your industry. 
• Value and Options: Finally, you can commit to the process after considering your goals and both the internal and external factors. Only then should you explore the additional facts related to the decision – such as timing, value, exit options, and salability.

By following this framework, you can make sound decisions on your company’s future with the assurance that you have taken the most important factors into consideration.

Learn More

The idea of being happy in business is one which doesn’t get talked about much, but I had an entire conversation about exactly this topic in my M&A Talk podcast episode titled Happiness: How it Relates to M&A and Entrepreneurs with Marco Robert. You can join us for this unusual conversation by going to the Resources section of our website at morganandwestfield.com.

The Audience for this Book

I wrote this book not only for sellers, but for anyone involved in the M&A process, such as buyers, attorneys, accountants, and business appraisers. For the sake of clarity, I address sellers directly throughout the book, but I wrote this book with all of you in mind. 

A Note on Asking Price

Mid-sized businesses, or those generating more than $2 million to $3 million per year in EBITDA, generally go to market without an asking price. But, to help readability, throughout this book I refer to asking prices without mentioning each time that businesses in the middle market almost always go to market without an asking price. When I mention the asking price in the context of a mid-sized business, you can consider this synonymous with the value of the business. 

A Note on Exceptions

I’ve based the advice and guidelines in this book on what you can expect to encounter 95% of the time or at the middle of the bell curve. When selling or valuing your business, you shouldn’t count on exceptions – you should target the middle of the bell curve and base your strategy on what works the majority of the time. Doing so will increase your odds of success and significantly lower your risk of not meeting your expectations. Encountering an exception that works to your advantage is always a nice bonus, but you shouldn’t count on it, or you will likely be disappointed. 

There are exceptions to every rule. For example, a company earning $18 billion a year is unlikely to acquire a company that generates only $3 million per year. But I’ve interviewed the head of M&A for an $18 billion company on my podcast, M&A Talk, who did just that. You can listen to the episode titled The Acquisition Process with Brian McCabe at morganandwestfield.com/resources.

Most seller notes are for three to seven years, but I concluded a transaction in which the seller note was one year and another transaction in which the note was 10 years. There are always exceptions to every rule, but to make this book readable and keep my advice sensible, I have avoided listing every imaginable exception throughout these pages. 

Instead, the goal of this book is meant to illustrate 95% of the bell curve you’re most likely to encounter. The M&A world is highly idiosyncratic, so there are deviations from every rule in the industry. I have noted when an exception is more likely to occur or when an exception can have disastrous consequences. Otherwise, the aim of this book is what you can expect to happen in the overwhelming majority of the situations you’ll encounter when selling and valuing your company.

When selling your business, you shouldn’t count on exceptions – you should target the middle of the bell curve and base your strategy on what works the majority of the time. 

A Note on Size

I refer to small and mid-sized businesses throughout this book. I also refer to the Main Street and the middle markets. What’s the difference?

There are no clear-cut protocols, but I will offer a few simple guidelines. 

Perhaps the simplest guideline relates to what type of buyer is most likely to purchase your business. If the probability of selling your company to an individual is high, you should consider it a small business. However, if the odds are higher for selling your company to a corporate buyer, such as a competitor or private equity group, regard it as a mid-sized or middle-market business.

How do you know who is most likely to buy your business? There are two general benchmarks:

1. Industry: So-called Main Street businesses that are generally not scalable and are likely to remain small are most apt to be sold to individuals. They include small retailers, small service-based businesses, and other companies in industries primarily dominated by small businesses and mom-and-pop shops.
2. Size: The larger your business’s revenue and profitability, the more likely you’ll be able to sell it to a corporate buyer. Generally, once your profitability exceeds $1 million per year, your business begins to appeal to more corporate than individual buyers.

Hence the reason for this book.

Let’s get started.

More Resources on Selling a Business

The Art of the Exit will help you navigate the complex process of selling your business. If you’d like to learn more about buying, selling, valuing a business, or dozens of other topics related to mergers and acquisitions, please visit the Resources section of the Morgan & Westfield website at morganandwestfield.com. Here’s what’s included:

• Ask the Expert: Links to common M&A questions and answers. Ask any question related to buying, selling, or valuing a business. Receive expert advice from industry professionals with real-world experience.
• Downloads: Links to forms and other useful resources for selling your business.
• Books: A complete list of my books on selling, valuing, or buying a business, and all other topics related to M&A.
• Glossary: A glossary of terms used throughout this book. Don’t be confused or intimidated by any terms or abbreviations in the M&A world. You’ll find answers here.
• M&A Encyclopedia: The most exhaustive encyclopedia in the industry with over 800 pages of insight on every step of the process of selling, buying, or valuing a business.
• M&A Talk: The #1 podcast on mergers and acquisitions, produced by Morgan & Westfield and hosted by Jacob Orosz. At M&A Talk, we bring you exclusive interviews with a wide variety of experts in mergers and acquisitions, private equity, investment banking, business valuations, law, finance, and all topics related to M&A, buying, selling, and valuing businesses. 
• M&A University: Complete courses related to buying, selling, or valuing a business. Courses are led by industry experts with decades of industry experience and are designed to give you in-depth knowledge regarding every aspect of the process of preparing your business for sale, valuing it, and closing the deal.

The Art and Science of Selling a Business – A Course by M&A University

Have you ever wished you could get into the head of the party on the other side of the negotiating table? Here’s your chance. Join us in this nine-hour audio course as we take a deep dive into the sales process to discuss the perspective of both the buyer and the seller with Jim Evanger, a serial entrepreneur and operating partner for several middle-market private equity firms. Jim has founded, started, operated, and sold multiple middle-market businesses and assisted in acquiring dozens of companies as both a corporate buyer and private equity partner, giving him deep experience on both sides of the table. 

The Art & Science of Selling a Business contains priceless advice for entrepreneurs of middle-market businesses with revenues up to $100 million. This course wasn’t built on theory – it is grounded in practical advice that’s been field-tested in the real world. Listen as Jim shares the lessons he’s learned on both sides of the table from over 20 years of experience as both a seller and an acquirer. He’s already made the mistakes, so you don’t have to. You’ll learn how to avoid the most expensive errors business owners commonly make that can harm the value of your business or even derail your sales process entirely.

Additional Books

• A Beginner’s Guide to Business Valuation – Lessons Learned from 20 Years in the Trenches: This book walks you step-by-step through valuing a business with $1 million to $50 million in revenue. You’ll learn the fundamental factors that determine the value of any small to mid-sized business and simple methods for maximizing value when it comes time to sell. This practical guide is based on what I’ve gleaned from 20 years in the trenches selling businesses. It’s written for the layman, specifically meant to address the real-world methods buyers use to value businesses. 
• The Exit Strategy Handbook – A Complete Guide to Preparing Your Business for Sale: This comprehensive handbook demystifies the process of preparing your business for sale and helps you unlock real value in your business to dramatically increase your odds of success once you finally decide to go to market. Selling a home is child’s play compared to selling a business. You only get one chance – and The Exit Strategy Handbook shows you how. Planning to sell is all about building a business buyers want to buy. By preparing well in advance, you’ll ensure you’ll receive the highest price possible. The Exit Strategy Handbook arms you with simple steps you can take to dramatically improve your company’s value and marketability.
• Closing the Deal – The Definitive Guide to Negotiating the Sale of Your Company: This book teaches you the art and science of negotiating the sale of your business. You’ll learn the fundamentals of every step of the process, from the letter of intent to the closing. This essential field manual offers you an effective blueprint to maximize your negotiating leverage and foolproof strategies to optimize your deal structure and after-tax proceeds. Closing the Deal is for owners of businesses valued from $1 million to $50 million and contains proven tactics for avoiding the most common pitfalls in negotiating the sale of your company.
• Acquired – The Art of Selling a Business with $10 Million to $100 Million in Revenue: For a business to sell for what it’s really worth – or even more – you need to properly prepare. But too many entrepreneurs put off planning the sale of their business until the last moment. Acquired will help you prepare your middle-market business for sale and walk you through the sales process, dodging the pitfalls along the way. With a significant amount of your wealth tied up in your business, planning your exit is one of the most critical initiatives you’ll undertake. Don’t go it alone. 

Other Resources

• If you’re interested in selling your company, please visit morganandwestfield.com to schedule a free consultation.
• If you’d like the author of this book, Jacob Orosz, to perform an independent assessment of your business before you begin the sales process, please visit morganandwestfield.com/sellers.

Here are the acronyms you will encounter as you read this book:

• AMA: American Bar Association
• APA: Asset purchase agreement
• CA: Confidentiality agreement
• CDC: Centers for Disease Control and Prevention
• CIM: Confidential information memorandum
• COGS: Cost of goods sold
• CPA: Certified public accountant
• DBA: Doing business as
• DCF: Discounted cash flow
• DCR: Debt coverage ratio
• EBITDA: Earnings before interest, taxes, depreciation, and amortization
• ERISA: Employee Retirement Income Security Act
• ESOP: Employee stock ownership plan
• FBNS: Fictitious business name statement
• FMV: Fair market value
• FOMO: Fear of missing out
• GAAP: Generally accepted accounting principles
• GP: General program
• IP: Intellectual property
• IRR: Internal rate of return
• LLC: Limited liability company
• LOI: Letter of intent
• M&A: Mergers and acquisitions
• MAC: Material adverse change
• MVP: Minimum viable products
• NDA: Non-disclosure agreement
• P&L: Profit and loss statement
• PE: Private equity
• PEG: Private equity group
• PLP: Preferred lending program
• R&D: Research and development
• R&W: Representations and warranties
• RVD: Return on value drivers
• SBA: Small Business Administration
• SDE: Seller’s discretionary earnings
• SPA: Stock purchase agreement
• TTM: Trailing twelve months
• UCC: Uniform Commercial Code
• YTD: Year-to-date

For full definitions, check out the Glossary in the Resources section.

The purpose of this book is to educate entrepreneurs on the entire process of planning their exits and selling their business. This book is a team effort, and without the significant contributions from several amazing people, this book would never have come into existence.

I dedicate this book to the entrepreneurs who demonstrate the imagination, focused preparation, hard work, and courage necessary to create and grow the businesses that drive our economic engine. You are a precious resource that should be recognized and rewarded.

I am grateful to all of the people who generously gave their time and provided me with information for this book, including small- and medium-sized business owners, lawyers, accountants, investment bankers, partners at private equity groups, industry analysts, and others with specific knowledge of the issues I address.

I am also thankful for the many guests I have had the pleasure of interviewing on my M&A Talk podcast. Your insights have proven invaluable in rounding out my knowledge of this complex topic. M&A is a complex multidisciplinary topic. No one expert can do it all. Hearing a diversity of viewpoints from a variety of experts has increased my appreciation for the complexity and subtle nuances of this field.

I am particularly grateful for the help of our team of four editors, Pamela Eastland, Bob Bogda, Graham P. Johnson, and Barbara Wright, who have patiently stood by my side throughout the entire process and who have taken what was initially a mess of ideas and turned it into a cohesive story. Thank you for your attention to detail, persistence, and ability to tie up loose ends to make this a finished product.

A special thank you for the help of my father, Emery Orosz, who has carefully reviewed this book. On a side note, thank you for providing me with the discipline I needed as a child and the patience to allow me to mature and blossom into a successful professional. I love you and could never thank you enough for standing by me every step of the way.

Jacob Orosz

President of Morgan & Westfield
morganandwestfield.com
Host of M&A Talk – The #1 Podcast on Mergers & Acquisitions

Author of – The Art of the Exit, A Beginner’s Guide to Business Valuation, The Exit Strategy Handbook, Closing the Deal, Acquired