So, you’re thinking about selling your business.
Your answer will help determine how best to proceed, whether you’ve been in business for decades or just a couple of years.
Why does the question of “why?” even matter? It’s a matter of trust.
Is your motivation for selling unique, or does it fall into any of a number of common categories such as burnout or retirement? Whatever the reason, it’s important that potential buyers believe your cover story, or they’ll immediately become suspicious. And that’s no way to kick off a negotiation.
So, what can you do to ensure the buyer trusts you? First and foremost, be upfront.
Some industries, such as food businesses, experience inherently high turnover rates. Many sellers are actively involved in their business but may be burnt out and looking for a change. Others may simply be seeking other opportunities.
For some sellers, the business may not have proven to be a good fit. Others may be looking to return to a prior job and may have found that business ownership was not for them. Some may be having health problems, family issues, or partner disputes. Some may be seeking retirement.
Owners of small businesses usually sell for different reasons than owners of larger firms. For small businesses, burnout and boredom are more common. For larger businesses, retirement and taking money off the table may be higher priorities.
In any event, the process of preparing your business for sale and selling it should be based on your specific circumstances and reason for selling.
At Morgan & Westfield, we’ve pretty much seen it all when it comes to the buying and selling of businesses. Whatever your motivation, chances are we’ve successfully assisted a seller in a similar circumstance.
This article explores the many reasons business owners ultimately decide to sell, and it offers concrete advice for preparing for the transition based on your specific circumstance. To see where you may fit on the spectrum, keep reading.
Table of Contents
- Differences Between Small and Mid-Sized Businesses
- Why Do Entrepreneurs Sell a Business?
- A Better Opportunity
- Bankruptcy or Financial Pressures
- Boredom or Burnout
- Business Growth
- Close Out of Private Equity Fund
- Death or Disability
- Economic Reasons
- Health Reasons
- Unsolicited Offer
- Other Reasons
- Combinations of Factors
- Tips for Sellers of Businesses
- Plan for the Sale in Advance
- Clarify Your Reason for Selling
- Be Intellectually and Emotionally Prepared
- Remember that Honesty is the Best Policy
- Be Proactive when Deciding to Sell Your Business
- Make an Exit Plan Early
- Tips for Buyers of Businesses
- Determine Why the Owner Wants to Sell
- Find Out the Real Reason the Owner is Selling the Business
- Address the Seller’s Emotions
- Keep the Owner Involved
Differences Between Small and Mid-Sized Businesses
For professionals who regularly buy and sell businesses, the decision to sell a business will be less traumatic than for the owner of a family business. For corporations, the decision to sell a business is as straightforward as deciding what to eat for lunch that day. The decision usually starts with management and then goes to the board for approval. The board then hires an investment banker to handle the sale. The consequences may be different depending on if the board is selling a standalone entity, a division, or a subsidiary.
For a small family-owned business, the decision to sell can be emotional and gut-wrenching. Selling a business may bring about major life changes for the entrepreneur. If you own a small family business, planning for the sale and thoroughly exploring your motivations are key to ensuring a smooth transition.
|Advice for Buyers and Sellers based on Seller’s Reason for Selling|
|Reason||Advice for Buyers||Advice for Sellers|
|Retirement||Offer the seller a continued role in the business, often at below-market rates.||Find a new passion to keep you busy.
Create an exit plan in case your health fails before you can exit.
|Health Problems||Sympathize with the owner. Trust but verify the owner’s claims.||Prepare for the exit as soon as possible to avoid leaving money on the table.|
|Burnout||Ask why the owner is burned out. Restructure the business to avoid the same thing happening to you. Focus on your strengths and delegate everything else.||Be honest with the buyer regarding your burnout.
Attempt to restructure the business to focus on your strengths before you consider selling.
|Boredom||Learn to recognize the signs of boredom vs. a dying business.||Focus on building value before exiting.|
|Partner & Family Disputes||Ensure all partners are in agreement before you invest too much time in the negotiations.||Create a buy-sell agreement that has a mechanism for resolving disputes and offers all partners exit options.|
|Unprofitable||Previous turnaround experience is best. Ask the seller to remain to assist.||Focus on selling the business to someone within the industry.|
|Relocation||Verify the seller’s relocation plans to ensure they aren’t hiding anything.||Plan your exit well in advance so you don’t leave money on the table.|
|Economic||Avoid investing too much time before agreeing on a price. Sellers in this category may be inflexible, so be prepared to walk or give in on key points.||Communicate your earnest desire to sell your business. Avoid coming across as abrasive or only concerned about the economic aspects of the transaction.|
Why Do Entrepreneurs Sell a Business?
A Better Opportunity
Some owners may be simply seeking more profitable or more attractive opportunities. This is often the case with small business owners who struggle on a daily basis and may have friends who are thriving in another industry. At the same time, some businesses may be a bad fit based on an owner’s skill sets or their passions.
Bankruptcy or Financial Pressures
Few sellers admit to having financial issues because doing so is admitting failure. But financial troubles may not be the root cause — instead, the root cause may have to do with management issues, fierce competition, or the inability to obtain financing. Drug, alcohol, or gambling problems, which may, in turn, cause financial pressures, also could be in play.
Some owners are selling because their business is unprofitable. Despite their efforts, they have not been able to turn the business around. In these cases, the buyer should have industry or turnaround experience, and they may often have an interest in retaining the current owner. These businesses are difficult to sell except to those within that industry, especially if there are little to no assets or proprietary technology.
If you discover that an owner is having financial issues, it makes sense to dig deeper and find out the real reason for the financial problems. When a seller tells a buyer they want to sell to pursue another opportunity, the real reason is often that the seller believes the business has limited opportunity. When analyzing an unprofitable business, it’s important to determine if the root cause can be fixed. Often, the problem can be fixed with a new owner or management. Other times, the problem may stem from competition or another issue in the industry that cannot be easily fixed.
Boredom or Burnout
One of the most prevalent reasons for selling a business is boredom or lack of interest. This is common in small businesses and is not usually a cause for concern for buyers.
Certain industries, such as retail, are more prone to this because they may not present enough challenge to the seller, and the daily grind and monotony may quickly bore a talented entrepreneur. Many entrepreneurs lose interest and are no longer challenged in industries in which they cannot express their creativity.
This may also be common with franchises, in which you must follow a specific formula, as opposed to innovating and creating a business model from scratch. Boredom and burnout are often masked as “other business interests.” Many owners believe they should hide the fact that they are bored or tired. We don’t believe boredom is a game-breaker.
Some owners enjoy building a business but not running it. They enjoy the thrill of the startup phase and are looking for the next exciting idea to chase. This type of business owner often has a drawer full of ideas they wish to start on. This shouldn’t be a warning sign for a buyer because everyone is wired differently. Many successful entrepreneurs thrive at starting businesses but not at running them. While they may find the everyday monotony of running a business tedious and uninspiring, it may be exactly the type of business the buyer is looking for. By selling, this type of owner can use the capital from the sale to jumpstart their next idea. This type of entrepreneur should focus on building substantial value before considering an exit.
“Burnout” is a legitimate reason for selling a business, but many sellers believe they must keep their lack of passion for the business a secret from the buyer. Many entrepreneurs are tired after working 50 to 60 hours per week in their business, with no vacations for decades. They likely have not successfully built processes and a management team that allowed them to escape the business to rejuvenate regularly.
For these businesses, it’s important that the owner elicit help to build infrastructure, allowing them to capitalize on their strengths and delegate everything else. Often, the business can be restructured, and talent can be hired to allow the owner to focus solely on what they enjoy and do best. While the learning curve to building infrastructure is steep, those who successfully do so find the journey is worth the effort.
An owner selling due to an inability to manage growth is less common. Sometimes, a talented sales or marketing-oriented entrepreneur may drive revenue to the point where they have a difficult time internally financing their own growth. This is common in businesses with a long cash-flow cycle in which growth requires an increase in working capital, such as businesses with a long sales cycle and that offer terms.
These owners often must seek outside capital, and debt financing may be hard to obtain. Talented entrepreneurs who can drive sales but cannot fund growth internally or seek outside financing may believe that another industry is going to be a better fit for them.
If competition is acute in your industry, you should go to market as quickly as possible while you still have a valuable business to sell. Sometimes, an owner knows in advance that competition may adversely affect their business, but this problem isn’t always evident when reviewing a business’s financial statements.
Perhaps the owner knows the landlord will not renew the lease at the end of the ten-year term, or perhaps a major customer will soon be going bankrupt. Most savvy buyers will ask the seller of a business to sign a purchase agreement that contains representations and warranties that address these and other unforeseen issues that could arise down the road.
When purchasing a business, it’s critical to assess the business and the character of the seller as well. Performing a credit and background check on the seller would be wise if you question the seller’s true motives.
Close Out of Private Equity Fund
Private equity (PE) funds usually operate funds (i.e., limited partnerships) that have a ten-year life span. Financial buyers are often under pressure to liquidate their investments before the end of the fund by either selling the company in the private market or through an initial public offering (IPO).
The PE firm’s rate of return is calculated using the internal rate of return (IRR), which is based on the length of time the investment was deployed. Extending the investment time period will lower the rate of return. While financial buyers can often extend their investment timeframe, they rarely do so.
While waiting to sell the company may result in a higher valuation, it could also lead to a lower IRR and tarnish their reputation by having to extend the fund’s life. Corporate buyers, on the other hand, are not under the time pressures that a financial buyer may be under.
Death or Disability
Death is a traumatic event for all parties involved. Without proper planning, an untimely death can drastically reduce the value of a business overnight. An exit plan can help prevent the degradation of the value of the business in the event of a death or disability.
Arguments among family members or partners are all too common in small businesses. When these problems are irreconcilable, the owners may decide to sell. This may represent an opportunity for a buyer.
Problems can be friendly disagreements, such as discussions over key strategic decisions, or they may be unfriendly, such as arguments over personality differences. A buy-out agreement can prevent these disputes by creating an agreement in advance on how to handle such issues. It’s critical for any business with partners, including family members and spouses who co-own a business, to create a buy-sell agreement that addresses these disputes and offers everyone a method for selling their interest or purchasing another partner’s interest in the event of a dispute, death, disability or other crisis.
It’s common for partners to disagree on many issues in the business, and if they come to a standstill, they may have no way out other than selling. There may not be enough cash available to buy out other partners, or they may be unable to agree on a price, and there may not be a buy-sell agreement in place to resolve these problems. If buying out a partner is not possible, the company must be put up for sale.
It’s nearly impossible to sell a minority interest in a small business. Often the only way out is to sell the entire business. For small businesses, it’s also difficult, although not impossible, to sell a majority interest in the business if one partner remains.
Some owners who have multiple businesses may claim they want to diversify. For a small investor, they will not achieve diversification by selling one asset to buy another. When presented with this reason for selling, it pays to dig deeper and uncover the owner’s true motivations.
Divorce is a legitimate reason to sell a company. Selling a business while going through a divorce can be a stressful event. The sale will have to be approved by the trustee. In nearly all cases, it is wise to obtain the consent of both spouses, even if one of the spouses is not a shareholder. This is particularly true in community property states.
Some entrepreneurs, primarily serial entrepreneurs, sell solely for economic reasons. They may attempt to sell at an industry’s peak, for example. These owners are experienced and sophisticated and will deal with all parties in a no-nonsense manner. Typically, they will not sell unless they achieve their financial objectives.
Other owners are forced to sell their business due to unexpected health reasons. If the health problems are chronic or acute, the owner should begin preparing for the exit as soon as possible. In the case of acute health problems, it’s likely a significant amount of money will be left on the table.
Many owners claim to be selling due to health reasons because they believe that burnout and boredom are not legitimate reasons to sell. “Health problems” is often the default reason an owner gives if they are not comfortable disclosing the real reason for a sale. While health issues are a common legitimate reason for selling a business, you still should be on the lookout for other problems that may be masquerading as health issues.
Your business should not be so dependent on you that it collapses in your absence. With proper planning and documentation, your business should be able to survive disasters and be able to run without you. Building your business so it can smoothly operate without you not only increases the value of your business but also ensures that things can run smoothly in the event of a personal catastrophe.
Your spouse, a key employee, or a manager may also get sick. With proper documentation of your operations, your business should be able to survive disasters such as the temporary disability of an owner or the loss of a key employee. Dependence on a key employee is risky without having backup plans in place.
Owners who operate a large, successful business may want to take some chips off the table and diversify their net worth. They may be reaching retirement age and may be uncomfortable with such a large portion of their net worth tied to an illiquid asset — their business. Selling a portion of the company creates liquidity for the business owner and allows them to diversify, thereby lowering their risk.
A recapitalization is much different than the sale of an entire company. When structuring a recapitalization, or “recap,” a private equity group purchases a portion of the company and retains the owner as a key manager. The owner retains a portion of ownership in the business. This allows the owner to partially cash out while creating the possibility for a second sale in the future. Private equity groups can bring more than just money to the table — they can bring industry and operational experience. This often results in a substantial increase in the value of the business.
Many owners desire to relocate either due to a spouse accepting a new job offer or for other personal reasons. Many business owners in the North seek a warmer climate in the South. Others may wish to be near their family, such as new grandchildren. Whatever the motivation for the relocation, it may be the reason for the sale.
Relocation is a valid reason for selling a business. However, an intention to relocate is often used by owners to disguise other reasons for selling.
Retirement is the most common reason business owners sell their businesses. However, for highly driven, type-A personalities, an owner may pull the trigger too early and later regret their decision. It may be difficult for them to let go and stop working. For these entrepreneurs, it’s critical to find a new passion to keep them busy after the sale. A buyer may be able to capitalize on this situation by offering the previous owner a continued role in the business, even at lower-than-market rates. It’s unlikely the owner will initially take the buyer up on this offer. However, it may sound more appealing to the owner after they tire of re-organizing the garage and lounging around the pool, sipping margaritas with little to keep them busy. Without a passion keeping their mind occupied and an inability to relax, these former entrepreneurs will soon be itching for something productive to do.
Other business owners who decide to sell may delay pulling the trigger, and their health may begin to fail before they let go. For these owners, it’s important to create an exit plan before it’s too late and the inevitable happens. The exit plan should include objectives such as building a management team and grooming a successor, but every exit plan is different. The plan should also address what to do in the event of an emergency, such as a sudden health crisis.
If you are thinking about retiring, you should plan well in advance. Only about 30% of businesses transfer to the second generation, and only 15% make it to the third generation. Discuss the potential with your family well in advance of the sale. It’s never too early to find out if they are not interested in taking over.
Most buyers ask the seller to stick around after the sale to ensure a smooth transition. The thinner your management team, the longer the buyer will want you to stay for the transition period. By planning for the sale in advance and building a strong management team, you will reduce the length of time the buyer requests you to hang out after the sale.
The sale of a business triggers capital gains taxes and ordinary income taxes. Favorable changes in tax rates often motivate entrepreneurs to sell.
Unsolicited offers can either come from mass mailings from business brokers or from a legitimately interested competitor. Few businesses with revenues ranging from under $2 million to $5 million per year receive unsolicited offers. By always being prepared, you can effectively negotiate with a buyer who approaches you.
The following reasons are less common, but do occur:
- A family member took over the business and is not doing well, or they may have determined the business is not a good fit for them.
- Some owners consider selling because the business is growing too quickly, and they do not have the skills or experience to handle managing a larger company. Or, they may need capital to further grow the business. These owners may consider a recapitalization.
- A larger organization may divest a subsidiary that is unprofitable or not in line with the company’s long-term vision.
Combinations of Factors
The reasons for a business sale may not be mutually exclusive; instead, many reasons may mutually contribute.
For example, an owner may be experiencing minor health problems and need a back operation that requires a three- to six-month rest period. They may also be burned out and feel they could benefit from a multi-month respite from the business. It may also be nice to finally get rid of that 20% minority partner who does nothing but cause trouble.
Any one of these issues in isolation may not provide enough motivation to the owner to sell. However, all three in combination might prompt a sale.
Tips for Sellers of Businesses
Plan for the Sale in Advance
Your business is likely one of your most valuable assets and an important part of your life. Seventy percent or more of your net worth may be tied to the value of your business.
Unlike selling a house, selling a business is something you will probably do only once in your lifetime. Selling a home is child’s play compared to selling a business, even for sophisticated businesspeople. You only get one chance, so don’t screw it up.
Most business owners are so busy with the day-to-day minutiae of running a business that they neglect to plan in advance for the sale of their company. With so much of their net worth tied to the value of their business, failing to plan can put them at a disadvantage.
Less than 30% of small businesses on the market eventually sell, and less than a fifth of small business owners actively plan their exits. Most of the reasons for failure can be prevented by thoroughly preparing for the sale months or years in advance. It’s critical to be proactive about the sale process. Decide exactly why you want to sell your business and what your objectives are, then rehearse this story with your family and advisors.
Clarify Your Reason for Sale
Lying to a buyer about the reason for selling your business can kill a deal. Buyers are naturally suspicious of your true motives and will question you multiple times to be sure you aren’t running from a problem child. By clarifying your reason for selling, you will:
- Be more prepared
- Be able to negotiate more effectively
- Be able to maintain a cool head
- Be better able to make intelligent decisions during one of the most stressful transactions of your life.
You may be having partner issues, going through a divorce, preparing for retirement without a successor in the family, or experiencing health issues. You may also be successful but suffering from burnout or boredom. Whatever the case, be honest with yourself, your advisors, and the buyer.
Planning the sale of your business begins with discovering your motivations and goals, then crystallizing your reasons for selling. The reasons people sell businesses are varied. Whatever the motivation, it is critical that you are honest with all parties involved.
Be Intellectually and Emotionally Prepared
Accept that you are emotionally attached to the business. You will need to be both intellectually and emotionally prepared to manage the sale effectively. Taking an active role in the sale of your business and maintaining a cool head will help ensure the process goes as smoothly as possible.
Buyers frequently offend sellers with their questions, such as, “If your business is so great, why are you selling it?” By being ready for these sorts of questions, you will be able to stay calm and collected during these stressful times.
Sometimes buyers make remarks designed to get you to snap as part of their negotiating strategy. By being prepared for this eventuality, buyers will see you as a savvy businessperson, and they will be more likely to respect you throughout the negotiation process. The moment you lose your cool, buyers will lose trust and will be suspicious of everything you say or do.
Remember that Honesty is the Best Policy
Be honest with yourself and your advisors about the real reason you are considering selling your business. Buyers probe for facts throughout the sale process. Being upfront will simplify the procedure and increase the chances of a successful sale. If your reason for selling does not fit your facts, expect buyers to probe deeper.
Rehearse your story with your family members or advisors. If a buyer has made an offer on a business before and the seller was dishonest, expect them to be suspicious of everything you say. Be prepared for buyers to be cautious — have your documents in order and be ready to back up your reason for selling with facts and paperwork.
Be Proactive when Deciding to Sell Your Business
Planning to sell is all about building a business people want to buy. By planning well in advance and then proactively managing the sale process, you can ensure you will sell your business for the highest price possible. Crystallize your reasons and motivations. Do you want to get out altogether, or do you want to stay involved part-time in the business? What do you want to do after you sell? If you are unprepared with your responses, most buyers will develop their own ideas about why you are selling. Don’t skip the planning step. Your business is one of your most valuable assets. By starting early on, you will enhance your odds of liquidating your business smoothly and at a favorable price when the time comes to sell.
Make an Exit Plan Early
Regardless of an entrepreneur’s situation, they should begin planning their exit as soon as possible before being put in the position of becoming a seller before they’re ready. The exit plan should contain a succession plan for ensuring continuity in the event of an acute issue, such as a health problem. The plan can also ensure owners have options for exiting the business in the event of retirement, burnout, boredom, or if the owner wishes to relocate. Any exit plan should address building a management team for high-growth businesses or a means of generating funds to finance growth. And, we always recommend that a separate buy-sell agreement should be in place if there is more than one owner, even if the owners are family members.
There are many reasons an owner might be ready to sell their business, and these reasons can have a significant impact on how the sale proceeds. Understanding the true reason behind the sale can help owners and buyers navigate the sales process more easily and successfully.
Tips for Buyers of Businesses
Determine Why the Owner Wants to Sell
When buying a business, one of the most important things you can determine is the owner’s reason for selling. You should find out as early as possible why the owner wants out. Sophisticated buyers will dig deep and ask this question many times. Knowing why the owner is selling will often give you, as the buyer, leverage in negotiations.
Find Out the Real Reason the Owner is Selling the Business
Simply ask the owner why they are selling. If you have doubts or suspicions, keep asking. Don’t be afraid to be blunt if you spot inconsistencies in their story. It’s better to risk offending the seller than to be duped into a poor investment. Consider including the seller’s reason for the sale in the purchase agreement, which can take the form of a representation or warranty.
Address the Seller’s Emotions
Most of the reasons people sell their businesses are emotional. Because of this, it’s important that a buyer addresses the owner’s emotions throughout the transaction. The longer the owner has owned the business, the stronger their emotional ties will be, and the more these should be addressed. If the owner started the business from scratch, emotional ties could be even stronger.
Keep the Owner Involved
In many cases, except for serial entrepreneurs or owners wishing to start another business, the buyer may be able to retain the owner in some fashion after the sale. This can work to the buyer’s advantage, as many sellers are willing to stay involved in a limited role to keep themselves busy. The buyer can often create a win-win relationship, where the seller continues performing the roles they love that also benefit the business, such as recruiting, sales, or marketing.
Even if the seller is relocating, the seller may be able to stay involved remotely, by phone and email. For partner disputes, one partner may be willing to remain, either as a part-owner or as a salaried employee. If the business is unprofitable, the owner may remain as a manager or salesperson. And retirement? What better way to ease into retirement than maintaining a part-time role in the business? Health problems? The owner may be able to work part-time in the business, especially if offered flexible hours.
Burnout? The entrepreneur may be burned out because they are spending the majority of their time on tasks they dislike doing, whereas they may be intrigued if offered the chance to continue in a role where they do what they enjoy.
The possibility of the owner staying involved in the business after a sale is worth considering as it can offer significant advantages for both the owner and the buyer.