selling a business: what works, what doesn't and how to avoid the common pitfalls

Selling a business What works, what doesn’t and

how to avoid the common pitfalls

http://www.jpabusiness.com.au

jpabusiness.com.au +61 2 6360 0360 2

Table of Contents

Introduction ........................................................................................................... 3

Chapter 1: Three first steps in the business sale ‘journey’ ...................................... 4 Step 1: What is your objective in selling? .................................................................................................. 4 Step 2: What is your business worth? ......................................................................................................... 6 Step 3: What help do you need to sell it? ................................................................................................... 7

Chapter 2: Professional, credible information key to a successful sale ................... 11 Share what you know ..................................................................................................................................... 11 Poor quality IMs a turn-‐off for potential purchasers ....................................................................... 12 How to prepare a professional IM ............................................................................................................. 13 Be prepared – timing is critical .................................................................................................................. 13 Developing a marketing plan ...................................................................................................................... 14

Chapter 3: Interest qualification and negotiations ................................................. 15 Asking the hard questions ............................................................................................................................ 16 The confidentiality agreement ................................................................................................................... 16 Initial due diligence period .......................................................................................................................... 18 Negotiation ......................................................................................................................................................... 19

Chapter 4: Sealing the deal ................................................................................... 22 Data rooms .......................................................................................................................................................... 22 Site visits ............................................................................................................................................................... 23 Holding back sensitive information ......................................................................................................... 24 Using condition precedents to protect information .......................................................................... 24 The negotiating team ..................................................................................................................................... 25 What can go wrong? ....................................................................................................................................... 27

Disclaimer: The information contained in this eBook is general in nature and should not be taken as personal, professional advice. Readers should make their own inquiries and

obtain independent advice before making any decisions or taking any action.

http://jpabusiness.com.au/



Introduction

Comments by James Price JPAbusiness Pty Ltd

Over the past 12 months we’ve published two tools designed to help people embarking on the business sale process:

• the JPAbusiness Selling a Business Checklist, and • our brief eBook titled How NOT To Sell A Business, which featured our

Top 10 Do’s and Don’ts of Business Selling.

As business brokers and advisors working for both potential purchasers and vendors, we see the best and worst of how business owners go about exiting their businesses.

Based on the feedback we received after publishing the above tools, we decided it would be helpful to create an eBook that provided a little more detail on what works, what doesn’t and how to avoid some of the common pitfalls in a business sale process.

With the beginning of the new financial year we figure the time is right to release this eBook, as it’s a time business owners use to both review last year’s performance and make decisions about the year ahead – decisions which often involve succession and exit plans.



http://jpabusiness.com.au/e-book/how-not-to-sell-a-business

http://jpabusiness.com.au/e-book/jpabusiness-selling-a-business-checklist


Chapter 1: Three first steps in the business sale ‘journey’ Comments by James Price JPAbusiness Pty Ltd

Step 1: What is your objective in selling?

If you’re thinking about selling your business you need to be very sure – from the outset – of your objective in selling.

That sounds a little simplistic and you may be tempted to respond: ‘I know my objective, stupid – it’s to sell my business!’

But the question you need to answer is ‘why’ do you want to sell it?

• Do you want to sell because you’ve had the business for five years and the results have been poor?

• Do you want to sell because you’re over-exposed to borrowings, your cash flow is tight and you can’t see a way to get ahead?

• Do you want to sell because it’s time to retire or move on to the next stage of your career?

My point is, be honest with yourself.

Your reasons for selling will help you create a negotiation framework to determine what an acceptable offer might be.

Going headlong into a business sale without having clarified your honest objectives, as well as your shareholder’s, business partner’s and spouse’s clear objectives, is setting yourself up for disappointment.




Have a destination in mind

Once you’ve established your objective, write it down on a piece of paper and/or discuss it explicitly with your business partner, spouse and/or advisor.

That discussion process will allow you to pressure test your objectives.

We have observed numerous examples of business owners who are halfway down the sale process and experiencing huge frustration because suddenly they’re not sure whether the sales process is meeting their objectives or not.

This is usually because they weren’t clear about what their objectives were in the first instance.

Selling a business should not be like exploring an uncharted continent.

When embarking on a business sale you’re not just taking yourself, but you must also bring along your business partners, staff and advisors for the journey.

It’s a massive undertaking and not one to be entered into lightly.

Don’t go exploring on a business sale unless you at least know where you want to end up.

Selling a business – it’s not an exact science

As we always tell our clients, selling a business is not an exact science.

Just like an explorer, a business seller has to accept a degree of risk, but the more targeted and focused you can be, and know what outcome you want, the more you can mitigate the risk of failure or missing the mark.




Step 2: What is your business worth?

Once you’ve determined your objectives in selling you need to pressure test them by getting a proper valuation of what your business is worth.

We talked about this in our Top 10 Do’s and Don’ts of Business Selling, where I shared the example of my first business sale – two retail businesses that had been on the market for eight years because they were grossly overpriced.

Getting a valuation as to the likely fair market value of your business is critical to making decisions against your objectives.

For example, if your objective is to retire and you need a certain amount of money to do that, then sure as eggs you want to know how the market will value your business.

If you don’t get a valuation you could find yourself investing significant time, effort and money in a sale process that doesn’t actually have a chance of meeting your needs.

Lack of valuations continues to baffle

As surprising as it may seem, it’s very common for people to put their business up for sale without first getting a professional valuation.

If you were selling your car, wouldn’t you do some research and at least find out:

• What is this make and model with this number of kilometres selling for today?

• If I get paid in cash versus paid in instalments for my car, is that good or bad?

A business sale is one of the largest transactions a person will be involved with in their lifetime. Why would you trifle with that?




Step 3: What help do you need to sell it?

You know why you’re selling and what you want to achieve from the sale process.

You have a clear idea of the fair market value of your business.

The next step is: how are you going to sell it?

If you decide against self-marketing and, instead, plan to place your business sale in the hands of a professional business broker or advisor, how do you evaluate their abilities?

Choosing a business sale ‘partner’

If you think of a broker as simply someone who takes commission for selling your business, you’re not likely to get value from the relationship.

Working with an advisor or broker is a partnership.

In order to find the right partner I suggest you evaluate more than one advisor or broker to help you sell your business.

Our Top 10 Do’s and Don’ts included three key attributes to look for in a business broker, and these are:

1. Experience 2. Project management skills 3. Communication skills




In order to determine whether your potential broker has these attributes I suggest asking for evidence:

• Ask them for examples of businesses like yours they have sold; • Ask them for the shapes of the deals they’ve done with these

businesses; • Ask them for an indication of the process they intend to implement to

sell your business; • Ask them about the level of communication and reporting – verbal,

written, formal and informal – that will be provided as part of the sale process to keep you abreast of progress; and,

• Ask them for referees you can speak to i.e. business owners they have worked with to sell their businesses.

Databases – size doesn’t matter

Brokers will often talk about their large database of potential clients who might be interested in your business.

Make sure you pressure test the strength of that database.

Whether a broker has 10,000 contacts or 100 contacts on their database is really immaterial.

A broker’s strength is in the quality of the connections and relationships they have within your target market.




So the most important questions to ask your potential broker are: ‘Who do you think we would target in selling my business?’ and ‘What do these people look like?’

Here’s an example:

I own a large business in the construction sector, operating multi-projects on multi-sites. The business has a significant amount of heavy equipment.

I ask my broker:

• Who are you going to target as potential purchasers? • Will you target my employees? • Will you target my competitors who are looking to get onto the

sites and into contracts I have? • Will you target private equity firms looking to merge and acquire

businesses like me to bulk up an offering for a potential IPO?

Asking those questions gives me a sense as to the genuineness of this broker in terms of their understanding of my industry and the relationships they have in my sector.

Of course, direct contacts aren’t the only means of driving interest.

Obviously there is also advertising and marketing and you need to get a full appreciation of the marketing program a broker will offer for marketing your business to the appropriate target markets.

Beware the international database

You’ll often hear brokers saying ‘we have great connections to international buyers from Asia, South Africa’ and so on.

Remember, in selling anything, it’s about making a connection around the needs and wants of both parties, and the features and benefits of a product, in this case a business.

Be careful to evaluate the degree of difficulty around the connections that a broker or advisor might bring to look at your offering.




Be prepared to invest in your business sale

Finally, in terms of selecting someone to partner with you, don’t be afraid to invest some money in the sale of your business.

That old adage – you get what you pay for – holds true when selecting a partner to help with your business sale.

Don’t be closed off to considering an upfront investment in professional sale preparation support, documentation and/or marketing, and be sure this will be reflected in the ‘value’ of the service you receive.

From my experience, those business owners who are not prepared to invest in the sale of their business – one of the largest transactions they will ever make – are frugal to the point of foolishness.




Chapter 2: Professional, credible information key to a successful sale Comments by James Price JPAbusiness Pty Ltd

The next step is to develop a professional, credible information memorandum (IM) on your business sale opportunity.

We discussed this topic in both our Selling a Business Checklist and the Top 10 Do’s and Don’ts of Business Selling.

In fact, you could accuse us of going on and on about this topic, but we do so because the importance of getting this right cannot be understated.

Share what you know

As a business owner, you know your business better than anyone else because you’re taking the risk, getting the return, working either in it or on it.

You understand the idiosyncrasies relating to markets, customers, suppliers, cash flow, regulatory environment and so on.

This stage of the sale process involves taking all that knowledge and presenting it to potential purchasers in a credible, professional, robust way – not a glossy, marketing way.

You want to reflect your business in all its glory, while ensuring your information is accurate and not misleading.




Selling your business is about trying to get someone to share the same or better perspective on your business that you have.

Get this information provision right and interested parties can successfully understand and evaluate what you know and value about the business, and then put a fair price on it relative to this type of asset in the marketplace.

Present them with a poor quality IM and it will reflect sourly on your business.

Poor quality IMs a turn-off for potential purchasers

We see a lot of failures in this area because we’re often involved working for a purchaser looking at a number of businesses in a particular industry, such as the wholesale sector.

We see IMs on businesses prepared by owners or their advisors or brokers, and some of them will be just one page long.

Some of them will be several pages, but with incorrect or incomplete information, or out-dated information.

Probably 10 per cent provide a credible basis to assess the risks and opportunities a business may have, i.e. just one in 10 of the IMs we see are solid enough for an interested party to form an initial view as to whether a business meets their objectives.

And what happens to the other 90 per cent?

Whether it’s prepared by the business owner or their broker, a poor IM makes you think:

• the business is being run unprofessionally; and/or • they’re hiding something; and/or • this process is going to be very costly for me as a purchaser

because it will be like pulling teeth to get the right information.

Ultimately, both the potential purchaser and their advisor look at each other and ask: ‘Is it really worth the risk?’




How to prepare a professional IM

When preparing an information memorandum, put yourself in the shoes of a potential purchaser.

What would you want to know before making a decision about such an important purchase?

The following is our list of what to include in an IM:

• Business overview • Financial summary • Explanation of the opportunity • Industry sector dynamics • Point of difference and

competitive advantage • Products and services • Customers and suppliers • Plant and equipment • Business premises • Operating hours • Location • Marketing • People, processes, systems • Asking price and inclusions • Appendices and supporting

information

Be prepared – timing is critical

Be very careful, whether you’re marketing the business yourself or you have a broker, that you don’t tease up interest unless you have your information ready to share.

You know yourself, when you’re looking to buy something, you’re in a period of heightened interest.




It’s like going to a car dealer and saying: ‘I’m interested in that new 4WD you have displayed over there. May I have the specification sheet?’

The salesman says: ‘No, we don't have any specs yet. We can send you a brochure when it comes in.’

Doesn’t this guy understand I have been to three car dealers today, I’m assessing two different models, and I’m ready to do business now?

Don't disappoint me, as a purchaser, by not being able to meet my basic information requests when I make them.

Developing a marketing plan

Once your information memorandum is locked in you can go ahead and put your marketing plan into action.

If you’ve handed over the management of your business sale transaction to a broker or advisor, don’t forget they will need your help with this process.

We’ve said it before: no one knows your business like you do.

Use that knowledge to inform and populate the marketing material your broker will develop for your opportunity.

Work with your broker to answer the following questions:

• Who is your target market? • What is your value proposition and the key selling points that will

appeal to prospective purchasers in this market? • What’s in it for the purchaser?

Summarise your key messages and relevant content for use in advertising. At all times keep in mind: If I was buying this business, what would appeal to me?




Chapter 3: Interest qualification and negotiations Comments by James Price JPAbusiness Pty Ltd

In the past we’ve used the analogy of the funnel, or sifting process, when assessing potential business purchases and conducting purchaser due diligence.

The analogy holds just as true in reverse, when you’re the seller considering the strengths of a potential purchaser.

At the mouth of the funnel we have our objectives, followed by the credible information we have prepared on the business.

The next level involves sharing that information with the market and identifying people who might be interested in your business.

At this point you want the funnel to be getting a little narrower.

It’s important that you value the information you have put together on your business and not just share it with anyone.

Therefore you need to work with a broker or advisor who is sensitive about how they share your information and has a prequalification process in place for dealing with potential purchasers.



http://jpabusiness.com.au/blog/posts/james-price/2014/05/18/due-diligence---uncover-those-skeletons-before-it's-too-late

http://jpabusiness.com.au/blog/posts/james-price/2014/05/18/due-diligence---uncover-those-skeletons-before-it's-too-late


Asking the hard questions

The first step of prequalification is determining: Is this person likely to have a chance of buying the business they’ve enquired about?

When an interested party enquires about a business with us, often the first thing we do is ask them about their intentions, their objectives, their financial capability. As business brokers we do this before we discuss the business they’ve enquired about.

It’s human nature not to like to asking hard questions:

• Why are you interested in my business? • Do you have funds at hand to purchase a business? • If you do, tell me how much and how those funds are available? Are

they liquid? Are they sitting in an asset?

These are all very straight up and down questions and as a broker I have no trouble asking them. But there are countless examples of business owners we have come across who have been frustrated with sale processes, and it often gets back to the fact they felt those questions would embarrass the other party.

I would stress the importance of finding a partner you are confident will ask those sorts of questions on your behalf, upfront.

The confidentiality agreement

Often the next step is to have an interested party sign a confidentiality agreement.

Again, it’s only a document, a signature on a page, but it’s a further step of prequalification that the party is actually seriously interested in looking at the proposition.

You can’t weed out all tyre kickers and neither can your broker or advisor, but there is a standard professional process for sharing information.




I shudder at times when I hear of business owners who have shared detailed financial and business information to a competitor, or a party that has approached them directly to buy their business, without any form of documentation or pre-qualification.

They think: ‘Great, someone is interested in my business. I’ll share some information with them and see how it goes. They might make an offer.’

No matter how desperate you are to sell, if you tease up that relationship without some proper protocols in place, the risk is you will go down a long and sometimes expensive exercise without clarity around whether they’re actually the right person to buy your business.




Initial due diligence period

The next step is what I call the ‘initial due diligence period’ where a good broker will share sufficient information for potential purchasers to make an informed decision about either making a non-binding offer for the business, or the fact they’re not interested in the business.

This information usually involves the information memorandum (IM) and facilitating answers to IM-related questions.

As I often tell clients, it’s better to know if people are interested or not as early as possible. It’s where you get parties in between that wastes time and becomes frustrating.

You need to ensure you’re working with a partner or broker who can ‘wrestle interested parties to the ground’, manage the information flow on your behalf, and continually prequalify and qualify the level of interest, up to the point that it needs to be documented in a non-binding offer, or in fact a withdrawal on the basis that it’s not quite right.




Keep an open mind regarding feedback

If an interested party does withdraw their interest, you need to get feedback from your broker on why they weren’t interested. Did they lose interest because of:

• the price; • the risk around the business owner being heavily involved; • the fact the market is turning sour; • the regulatory environment, or • their own personal circumstances, mostly unrelated to the business?

It’s vital that you, as a business owner, know why those target individuals aren’t wanting to take the bait in terms of progressing the sale. You can then respond by discussing the need for any revisions to your selling strategy in terms of asking price, IM, information provision, terms, and so on.

The answer may be ‘no’, ‘yes’, or ‘wait and see’, but the best policy is to keep an open mind regarding market feedback.

Negotiation

Brokers and advisors in the business sales market will manage initial offers on a business and the negotiations around that differently.

I believe there are three key themes that are important:

1) The non-binding offer

The non-binding offer needs to document a party’s interest by including:

• the price they’re willing to pay; • their understanding of, and requirements for, specific sale terms and

conditions; • their position on whether they have finance available, and • any special requirements they have prior to exchanging a contract

and completing a sale.




We tell our clients that unless a party is prepared to provide that information in a non-binding offer, they’re not qualified enough to deal with.

A verbal offer is not enough. Unless you can get an offer in writing, notwithstanding the fact that initially it will be a non-binding offer subject to a number of factors, the party is really not that interested.

Insisting on a non-binding offer sorts the ‘wheat from the chaff’ and is the first part of the negotiation process.

2) Assessing the offer

Once you have non-binding offers, it’s a matter of sitting down with your advisor and broker and referencing those offers back to your original objectives and business valuation.

Consider where they match up and where there are gaps.

It’s very important at this stage to have quite a comprehensive discussion about the shape of the offer and, if necessary, whether it can be moulded to meet your objectives.

3) The heads of agreement

A good broker will then facilitate a negotiation which will culminate in a heads of agreement, or a term sheet, which is a commercial document that principally gets everyone on the same page.

In simplified terms it will say:

Party A has agreed to pay Vendor B X dollars for this business.

Party A and Vendor B have agreed on the following terms of sale.

This potential transaction is subject to a period of detailed due diligence by Party A.

To facilitate this, Vendor B agrees to a period of X number of days of exclusivity for Party A to conduct their due diligence.




In this context, ‘exclusivity’ means that as a vendor I will not solicit or deal with any other parties for the stated period of time because I know you, as Party A, have put forward an offer and terms that, in principal, I am happy with. I know you intend to invest money and time to conduct financial, commercial and legal due diligence, and you have genuine intent to purchase my business, subject to this due diligence.




Chapter 4: Sealing the deal Comments by James Price JPAbusiness Pty Ltd

Sealing the deal is about managing the information flows through the detailed due diligence process. A good advisor or broker will successfully manage that interface for you.

Data rooms

Today’s electronic environment allows you to efficiently share information in a way that also protects its sensitivity.

At JPAbusiness we use data rooms to give restricted access to people involved in the transaction.

A data room allows sensitive information to be corralled in a secure spot.

It’s an efficient way of managing that final information exchange during a detailed due diligence process – without an avalanche of paper!




We give restricted access to the data rooms to people involved in the transaction and they can log questions and answer queries as required.

This can assist the purchaser by giving access to their advisors who may, for instance, be conducting legal due diligence, and can also assist the vendor, whose solicitors may be drafting the legal contract of sale.

A good broker will manage the question-and-answer process, seek answers from the relevant parties and ensure a flow of credible information.

Site visits

Your broker can also coordinate and manage site visits that may be a part of the final stages of sealing the deal, including meetings with key staff that the purchaser may require.

Often a purchaser will be very keen to tramp out on site at any hour, meet customers and key staff, and have a look around the premises when it suits them.

And, just as often, we see business owners allowing that to happen.

I don’t like standing in the way of information flow because, ultimately, a purchaser getting to know a vendor and their business is what this process is all about, but this is not the way to go about it.

Best practice involves allowing your broker to facilitate those meetings, site visits and information exchanges so they are structured and present the business in its optimum position to the purchaser. It’s also important to protect confidentiality.




The broker also manages any sensitive issues and avoids the downsides of direct contact with customers and staff potentially causing uncertainty in the event a sale doesn’t proceed.

Holding back sensitive information

There is some information that, during a due diligence process, a broker will advise you to hold back until such time as you have a binding contract, or an exchanged contract, where the purchaser has paid a deposit.

Usually that information is commercially sensitive and relates to pricing, customers, terms of existing contracts and so on.

It is important that it is eventually shared with the purchaser, but it is also important that it is not shared until there is a binding situation.

In the interests of transparency, we would let the purchaser know early on that some information would be held back and as part of the data room there would be ‘black box information’.

Using condition precedents to protect information

Often, as the business sale agreement is drafted in parallel to the due diligence process, it will provide for certain conditions – what’s called ‘condition precedents’ – which occur post-exchange.

Exchange of contract is where a legal contract – a business sale agreement – is exchanged between the parties and a deposit is paid on the sale price.

That deposit is held, but the sale doesn’t complete, until various condition precedents occur.

One of those condition precedents may be related to the sharing of black box information between exchange and completion.

The condition precedent may say: ‘This information has to be shared prior to completion and the purchaser reserves the right to confirm their position based on reviewing the final black box information.’




The negotiating team

There are three key people we would advise a business owner, in selling their business, to work closely with during the sealing the deal process.

They are:

1. The broker 2. The solicitor 3. The accountant

1) The broker

To use an American football analogy, think of the broker as the quarterback to the business sale. The broker’s role is to manage all the expertise and information flows around achieving the business owner’s objectives.

Smart business owners use their broker or advisor as the glue that holds all the parties together.




The ‘quarterback’ manages the sale process with the business owner, the purchaser, the business owner’s solicitor and accountant.

The quarterback/broker will also have a strong relationship and positive interaction with the purchaser’s solicitor because, remember, a contract has two sides.

The broker also needs to manage the process like a project – very closely and very deliberately – because these transactions don’t just happen. They happen because the broker is in there keeping everything moving, getting the questions answered, resolving sticky issues and tackling the final pieces of negotiation that appear as a result of the final due diligence.

2) The solicitor for the vendor

A good broker will provide the solicitor with a detailed list of key commercial terms that have been worked through and the heads of agreement, so the solicitor can draft the business sale agreement.

We’ve said it before: this is not a job for a lawyer who simply knows about property conveyancing. Having a lawyer with experience in business sales is critical.

3) The accountant

The business owner’s accountant is an important team member in sealing the deal, but they’re actually very important throughout other parts of the sale process.

We covered this topic in our Top 10 Do’s and Don’ts of Business Selling. Often there are specific tax considerations around apportionment of assets, such as the value on plant and equipment, versus the value on stock, versus the value on goodwill, and the need to handle more complex financial and tax-related due diligence questions.

Don’t wait until you’re getting offers on your business to understand the potential tax benefits and tax minimisation opportunities that may be available in the course of selling your business.



http://jpabusiness.com.au/e-book/capital-gains-tax---issues-to-consider-when-selling-a-small-to-mid-sized-business


What can go wrong?

We’ve all heard stories of business sales almost making it to the point of deposit and exchange of contract, then unravelling. Why does this happen?

Sometimes it unravels for very plausible reasons. For example, the purchaser, despite their genuine interest, finds something about the business during their due diligence that causes them to reconsider.

Or the purchaser, despite what they’ve told the vendor and their broker upfront about their finance capability, in the final analysis is unable to get finance.

A good broker will do their best to identify these issues early and flush them out.

As an advisor to business, whether it’s on the broking side or the advisory side, I always work on the basis of transparency.

If the parties are transparent with each other in terms of their intentions, right from the start, there is a much better chance of either a ‘happy marriage’, or a mutual understanding that it is not going to work out.

Don't surprise the buyer

The detailed due diligence process is akin to the Australian stock exchange – it’s not a good place to surprise people.

For example, if listed companies don’t surprise the market their share price tends to perform in a consistent way, regardless. But if a company comes out and says ‘last quarter we said there would be a $2.5 million profit and this quarter we’re actually saying there will be a $0.5 million loss’, the market gets jittery.




It’s the same story here. If you’ve done your preparation upfront, you’re on top of your information about how the business is performing and you have a good broker who can position that positively and keep an active information flow with the interested party or parties, then there are no surprises, or very few.

The same piece of information delivered openly at the start can be much less detrimental than if it turns up to ‘surprise’ a purchaser later in the same process.

When parties change their tune

Sometimes sealing the deal goes wrong when either the purchaser or, in fact, the vendor, changes their tune.

I’ve seen really frustrating circumstances where the business owner is about to sign and exchange a contract, and suddenly thinks: ‘I’m not sure I really want to sell this business. I don’t think I’m ready. I don’t think I’m getting enough for it. I could probably continue in this business and make XYZ more dollars. On reflection, all these terms are onerous – I don't think I want to go down this track.’

Luckily, this doesn’t happen all that often, but it does happen.

The antidote for seller’s remorse, however, is to take a tablet upfront.

In other words, don’t head into a business sale process unless you have reflected on Chapter 1, step one of this eBook: What is your objective in selling?

With that box ticked you’ll at least be setting out on your business sale journey on the right foot.

If you would like to learn more about the business broking and advisory services offered by JPAbusiness, you can contact the team by visiting www.jpabusiness.com.au/contact-jpabusiness.



http://jpabusiness.com.au/contact-jpabusiness

selling a business: what works, what doesn't and how to avoid the common pitfalls

Business

common pitfalls

tableofcontents introduction