Guide To Selling a Business

In general terms, people and companies buy businesses because they believe that the purchase will benefit them in some way. That is, they believe that buying is a more efficient route to a particular business goal than is any other available alternative. For example, company XYZ may have a goal of adding 200 customers within one year. That company may estimate that it would cost $500,000 in advertising and sales expense to add that number of customers. If you own a business that has 200 customers of the type that XYZ wants, and if you are willing to sell your business for under $500,000, buying your business may be a more efficient way for XYZ to reach its goal.

This section outlines some of the more common reasons why people buy businesses.

Low Risk

Most buyers, whether corporations or individuals, are looking to keep their risk as low as possible. Buyers see a startup as inherently more risky than the purchase of a going concern. They also see purchasing a going business as a less risky method of getting new business, entering new markets, or adding production capabilities, than any of the more traditional methods.

In preparing your business for sale, a key task is demonstrating how low the actual risk is to the prospective buyer. This translates to convincing the prospective buyer that the business will continue to perform well after an ownership transition. You need to alleviate buyers' fears about what will happen to the company after the new owner takes over. Some of the fears that buyers have are:

-Seller is Trying To Put One Over On Me-- Prospective buyers approach a prospective target company with skepticism and a certain amount of fear. They are often afraid that the seller is concealing important negative information, misrepresenting some vital facts, or being less than candid. This fear starts at the very beginning of the presentation. One of the first questions that prospective buyers ask is, "Why is the owner selling.?" The buyer is afraid that (no matter what the stated reason) the real reason is that the business is about to go south, and the owner is desperately looking for a way out, a way to make someone else take the loss.

-Many Customers Will Be Lost- Buyers need assurances that the firm's existing customers will remain with the new owner. A sophisticated buyer expects to lose a small percentage of the existing customers in the transition but also expects to retain the majority of the customer base.

In some types of businesses this fear is more justified than in others. A business that has been successful based upon the dynamism of its owner may well lose customers. A seller of commodity goods or services will lose very few customers in a transition of ownership. For example, how much does it matter to you who owns the company that delivers your heating oil? Probably not a whole lot as long as the deliveries are on time and the price is right. That kind of business will retain most of its customers.

-Employees Will Leave- Buyers are concerned that key employees will leave when the new owner takes over. This fear is more acute 1) in businesses that are highly dependent on skilled labor, and 2) when unemployment is low and labor shortages are common.

-Supply Will Be Jeopardized- In businesses that are dependent on inventory, buyers are afraid that the supplier(s) will either go out of business, or will stop selling to the company. This is a particularly serious fear in situations where there are limited sources of supply. An example of a situation where this fear might be a factor would be a company that is importing unusual products from a few sources in countries that are not politically stable. At any time, the supply can end, and the new owner is left holding the bag.

-"I Won't Know How To Handle Certain Situations"- There are aspects of running your business that are almost second nature to you because you have been doing them for so long. However, what is simple to you may be complex and frightening to a new owner. Buyers are afraid that they simply won't know what to do in some situations. You can usually alleviate this fear by agreeing to stay with the new owner for a period of time to help him make the transition. It may also be a good idea to offer to be available to consult and to answer questions for one to two years after the new owner takes over.

These types of objections can be addressed with good process documentation, by grooming a manager or managers to be able to take over, and other steps you'll take while preparing your business for sale which is discussed in Section III

Add to these fears, the buyer's insecurities-- Can I manage the business? Will I be able to pay the bills? What if I fail? What if I lose all my savings?, etc., and you will understand why buyers tend to be very jittery.

You need to soothe the buyer's fears to enhance the possibilities of a sale. It's fair to say that the lower the perceived risk, the higher the value of the business. Most of the other reasons that people have for buying businesses are at least partly based on perceived low risk. If you can successfully lower the perceived risk to the buyer, you will sell your business at a good price.

Turnkey Business

Individual buyers (as opposed to existing companies) are generally looking for a turnkey business, or a business that can be easily taken over and run without a lot of training or a lot of modification on the part of the new owner. A business that a new owner can walk right into and run profitably starting from day one has a higher intrinsic value than one that will take time and effort to get up and running.

If you can modify your business so that it can be more easily taken over and run by a new owner, it will enhance salability. Get the business operations out of the owner's head and into systems and operating procedures. Recently, I was involved in the sale of a business where the owner spent a year modifying the business so that a new owner with minimum initiation could easily manage it. He broke the business down into concise and easily understandable components. He then assigned each of his two employees to a number of components. To test the new structure, he would stay away from the office first for one day then two, then three, and so on. By the time he was ready to sell, he could honestly insure the new owner that the business could practically run itself.

Process documentation and formal management systems can also be very useful in ensuring that a new owner will know how to run the business. If your business is not capable of standing on its own, selling it as an add on to an existing business or to a venture capital group (as a start up) are the best strategies.

Smooth Transition

Buyers don't like rough transitions. The more sophisticated buyers will make as few changes as possible for the first few months of ownership and then start gradually modifying the business. If you can demonstrate to a prospective buyer that the transition would be a smooth transition free of unpleasant surprises, your business will be easier to sell. One key, as mentioned above, is to agree to remain with the firm and work for the new owner for an agreed period of time, in order to help make the transition.

Customer Base

Most buyers are looking for an existing base of customers. The most important element of any business is its customers; without them, there is no business. Customers that are locked in are worth more than customers that may leave, or customers that are one time (non-repeat) customers. For example, an insurance agency's customer base would command a premium value. These customers tend to stay for a long time. In fact the customer typically stays with the agency as long as he or she does not take an active step toward ending the relationship-- namely canceling a policy (or not renewing). While this happens, it is the exception.

Contrast that with a company that repairs garage doors. Customers of this kind of company need service once in ten years if that often. When it comes time to fix a broken garage door again, the customer may not even remember whom he called last time, let alone feel any loyalty. This kind of customer base is worth much less. Also, several small customers are worth more than a few large ones. If a few small customers are lost, it won't have a serious effect on the business. However if even one or two large customers leave, the effect will be painfully felt. A firm with only a few customers, all of whom are large, is a tough firm to sell.

Another issue that affects how the buyer will view the risk of customer defections is the cost of switching. For example, a company that provides computer systems that have been customized to run a particular business is unlikely to lose customers quickly. The customer would not only need to buy new software, but would need to customize it, convert data, train its employees on the new software, etc. There is a large risk of failure, delay, and cost over-runs. While the new software is being customized and the data converted the customer may need to pay for maintaining two systems. This makes the cost of switching high enough that large software vendors are seldom displaced.

Synergies With Existing Company

It is not uncommon for one company to buy another with the goal of expanding its sales with no increase or only a small increase in expenses. For example, I recently helped sell a company that recruits pharmacists and finds them temporary employment in pharmacies. Two pharmacists owned the company, and it was not profitable although sales were reasonably brisk.

I approached a company in the temporary employment field, not of pharmacists, but of office and light industrial personnel. Our pitch to the latter firm was that they could profitably take over the pharmacist temporary business despite the fact that it was not making money. They could do so by using their own existing offices, personnel, computers, and even their existing forms to run the pharmacist business. That is, they could take on the accounts without taking on the overhead. The office temporary firm bought the pharmacy company. With the pharmacy company's volume added to the buyer's volume, the buyer had a 27% increase in sales volume overnight. However, the buyer's overhead expense increased only 3.5%. The sellers were able to successfully sell a business that their accountant told them was worthless.

If you can't sell your business as a turnkey business, or if it is not profitable as a stand-alone business, look for synergies or economies of scale. Ask yourself, "What kind of business would find value in my company that might not be obvious to others?" Many businesses that were given up as worthless found buyers through persuading competitors or companies in related industries of synergies and economies of scales that could be achieved in an acquisition.

Production Capabilities/ Competitive Advantages

Sometimes one firm will acquire another to gain access to production capabilities, proprietary or patented processes, favorable locations, or favorable supply contracts. For example, I know of a testing equipment manufacturing company that bought a small software company, primarily to gain access to the seller's proprietary process control software. Had the test equipment firm not been able to buy the software company, it would have had to hire programmers to develop appropriate software at a much higher cost.

In another situation, a successful pizza chain gave me a list of neighborhoods and said they would be interested in purchasing a pizza restaurant in any of the neighborhoods. They were buying desirable locations and in-place equipment. They converted each location to their own name and menu. It was cheaper to do this than to rent a space and buy and install equipment.

Favorable Lease

Occasionally a company will have a long-term lease at below market rates. For example, a retailer may have signed a lease in a less than perfect location. However, the area may have changed for the better due to gentrification, changing traffic patterns, or other evolutionary changes. A retailer in this enviable situation with a 15 year lease at $5.00 per square foot, while the other store in the area are paying $15.00 per square foot, may well have a very saleable asset. The lease could only be transferred to a buyer if there were a lease provision stating that it were transferable, or if the holder of the lease were a corporation, and the business were sold on a stock sale basis (see section XIII).

Trade Name Or Trade Mark

A trusted product or company name can be a valuable and saleable asset. For example, if a company wanted to go into the business of marketing breakfast cereals, the name Rice Krispies, Captain Crunch, or Frosted Flakes would certainly help sales. This would be true even if the exact same cereal were offered under a different brand name. That is because the consumer faced with a choice of buying a name brand cereal and an unheard of cereal is far more likely to choose the brand name, all else being equal. The same is true of a retail store. A store with a known name will in all likelihood sell more than a similar store without a recognized and established name.

Buyers will pay for the rights to a name that they believe will enhance marketability. However, would-be sellers are often disappointed at the buyer's valuation of the trade name. Sellers tend to have an inflated concept of the worth of the name of their businesses. Nevertheless, an established, recognized, and trusted name may be a saleable asset in and of itself or as part of a business sale package.

Proprietary Technology and Patents

If you have proprietary technology, patents, or even pending patents they may make your business attractive to a buyer. The buyer will, however, evaluate how easy it is to work around the patent or to develop an alternate technology. Remember that most patents lead a sleepy life, never challenged and never enforced, since the cost of enforcing a patent can exceed the amount recovered in court if there is a small violation.

If you are developing new products or services, consider patenting them if they are non-obvious and a patent would seriously impede your competitors. Business methods can also be patented now.

Elimination of Competitors

Last year, the owners of a typing service in a prime area (near the campus of two large colleges) approached me to sell their business. I didn't have to look far. It's only nearby competitor, literally across the street, bought the business almost immediately. The new owner closed the door on the firm it had just bought and put up a sign referring customers across the street. Within three months the buyer raised its prices by 25%. The price increase stuck because customers could no longer play the two competitors against each other. While this example is a bit extreme, it is not uncommon for a buyer to buy a competitor merely to create a less competitive marketplace.

Leapfrogging Startup

Some buyers are looking to buy an established business to save the time, energy, and the inherent risk of a startup. If I wanted to own a video production service, I could buy the equipment, rent a space and modify it to my needs, print stationery, order a phone line, and gradually gain customers. Another option would be to find a company already set up, and purchase that company. Of course, if that company were profitable, it would command a significant premium for goodwill. But even if it were not profitable, buying it would save me the time and energy of setting up from scratch.

This kind of buyer is generally looking for a company that is relatively new (a bit beyond startup but not yet mature), or a company that is in trouble but can be turned around. If it is the latter situation, most buyers will expect a bargain price.

A warning here is that sellers use this logic to establish value more readily than do buyers. I often hear from sellers, "To start a company like this would cost double what I'm asking; I know because I did it." If that company is not making money, a buyer would often argue, "The seller made a bad investment but that doesn't mean that I have to do the same." Successfully consummating a sale based merely on the buyer's skipping the startup phase is a bit rare but not unheard of.

A Bargain

Finally there is no lack of buyers searching for a bargain. There are buyers who believe that they can pick up a business for far less than it is worth if they play their cards right. Unless your goal is to sell very quickly, I would advise screening out the bargain hunters right away. They tend to ask you for all sorts of information, without regard for the expense to you or the value of your time in getting the information together. After all your work they will make a very low offer so fraught with contingencies that it is a nearly worthless offer. The challenge is screening out the bargain hunters without screening out serious prospects. Try to get an offer with a (refundable) cash binder before you do too much work.

Inside Information

As a final note, beware of spies disguised as prospective buyers. While this problem is not nearly as widespread as some sellers believe, there are people posing as buyers who merely want to spy on the competition. Remember, however, that most business owners are busy enough running their own business that they have more profitable uses for their time than trying to get inside information on competitors by posing as buyers if they are not interested in consummating a transaction. There are also people considering starting a business who figure out that they can garner a lot of information about that line of business by posing as a buyer.

There is no surefire way to protect yourself against spying short of not putting your company on the market. However, you can use discretion in making sensitive information available. Don't offer any information that has no immediate bearing on the possible sale. Don't under any circumstances share customer or employee names (except for a handful of sample names). You can provide information to the prospective buyer where pseudonyms are used (For Example Customer X or Salesperson 1)

Insist that each and every prospective buyer sign a confidentiality agreement. A business broker will have a form. If you are selling on your own, talk to your lawyer about drafting an agreement or you can easily purchase legal forms on the Internet.

The same advice offered earlier holds here too. Get an offer with a cash binder as soon as possible. Even if such an offer has contingencies for full refund, non-serious buyers will seldom go so far as to make an offer secured by cash.

To sell your business you will have to make a lot of financial (and other) information available to prospects. Even with the best screening procedures, you run the risk of sharing information with non-serious prospects and even people with ulterior motives. This may not be the most pleasant situation to be in, but it is unavoidable.

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