Can you sell your business without using a broker? Of course! Is it a good choice? That depends. Let’s explore what’s involved.
There is an art to selling a business but basically you have two choices. The first choice, is the shotgun approach, that is, blast the financial metrics to the world in an anonymous teaser ad, hoping to attract attention with either the numbers or specific narrative, such as, Phenomenal Opportunity, Don’t Wait This Won’t Last. You get the idea. Then have them sign a Non-Disclosure agreement once you are comfortable with their identity and their ability to follow through and execute.
The Right Buyer
The other way is to find the “right” buyers and pitch directly to them. The “right” buyer is one who is willing to pay a premium for your business. The right buyer could be a competitor, a supplier, or someone in a similar industry. There are several advantages to selling to a competitor. First of all, they understand the business and recognize the opportunity. Second, they may be able to absorb your overhead with very little incremental cost, creating instant synergy. Third, as they grow, they become more valuable as typically valuation multiples increase as size increases. However, it takes time to find the “right” buyer. You need to research the market, identify potential buyers, and then find the right individuals to make your pitch. Not an easy task, all while keeping your business running and maintaining confidentiality!
The LOI
Assuming you make it this far, and you have identified a few potential buyers, the next stages can get very interesting. Some buyers feel more comfortable issuing a Letter of Intent or “LOI”. An LOI is a summary of terms the buyer expects to include in the purchase agreement and will normally include; the purchase price, the terms of payment, any contingent consideration such as an earnout, the owner’s role post-acquisition, any conditions that need to be satisfied prior to a closing such as financing and due diligence. And don’t forget exclusivity, which is a big one. Exclusivity will vary but most arrangements requires the seller to put all other buyers on hold, and only negotiate with this buyer until the expiration of the exclusivity period. I urge caution before blindly agreeing to the exclusivity clause. First, you need to be satisfied that the buyer will be able to obtain financing and that they have the qualifications to operate the business. No lender in their right mind will lend to a buyer who has no prior experience operating a business similar to your business. Second, buyers may ask for 60-90 days for an exclusivity period which in theory, allows them to perform their due diligence and which, hopefully, will result in a purchase agreement. Every business is different so you need to ask yourself if the time period they ask for is reasonable to perform the due diligence. For most businesses, 60 days is plenty but larger deals typically require a bit longer. Don’t feel shy about limiting the exclusivity period to a shorter time span and my advice is to avoid any extensions unless you have a lot of confidence in the buyer. Here’s more discussion on what to expect in an LOI. How to Use a Letter of Intent (LOI) to Make a Deal (investopedia.com)
Due Diligence
So, after the LOI is executed, the deal will normally immediately goes into the due diligence phase. Pay attention here, you Must be prepared for buyer Due Diligence! Experienced buyers approach due diligence methodically. They give you a list of documents they want to see and review, a long list. For example;
- Tax returns for five years
- Historical financial statements
- Bank statements for the last three-four years
- List of employees, their compensation, and licensing, if any
- Copies of all leases
- Copies of all notes payable
- Copies of employee W-2’s and 1099’s for the last three years
- List of all employee benefits provided
- List of all insurance policies
- List of software used in the business
- Aging of accounts receivable if included in the sale of assets
- List of inventory and related cost
- List of suppliers and vendors
Every deal will be different and every buyer will conduct due diligence to satisfy their own perspective of risk. The above list is just an example, the point being, you should anticipate what the buyer will want to look at to satisfy that what you represented is valid and complete.
Now let’s assume the due diligence period has ended prior to the end of the exclusivity period and the buyer arranges to have a meeting with you to go over the results of due diligence. In that meeting, the buyer tells you that you have a few customers who are continually late on paying their balance, a piece of machinery is likely nearing its useful life and will need to be replaced within six months, and your bookkeeper is paid below market rates. Based on those factors, the buyer informs you that they will proceed with the sale, but the price must be reduced by 10%! This is not uncommon. Many buyers will use due diligence as an exercise to compile data that they will present to the seller in order to get a reduction in price. What do you do? If you are representing yourself, without a broker, you will likely blow up the deal in anger and frustration, and you will have wasted a lot of time for nothing. A broker handles the situation differently. A good broker listens, explores the claims, and may either agree or disagree with the buyer’s claims. A good broker is prepared to listen to the buyer’s posturing and accepts it for what it is. If the claims are valid, a good broker will counter on other terms of the deal such as seller financing, earnout terms, or the purchase price allocation (discussed later). A good broker does not blow up the deal. For the owner-seller, it’s very difficult to ignore your emotional involvement when negotiating directly with the buyer. You are much better off to leave that to a professional.
Negotiating Terms
Let’s get to the final phase, closing the deal. By now, 60-90 days has elapsed between identifying potential buyers and going through due diligence, so that the buyer finally produces a purchase agreement. I always recommend the seller obtain legal counsel to review the purchase agreement, but be careful, not all attorneys are interested in seeing the deal close. Attorneys have egos too. A good broker will work with the seller and attorney to help bridge any differences between what the buyer’s attorney proposes and what the seller’s attorney recommends. Usually these aren’t deal-breakers but they could be. The purchase agreement usually requires many, many exhibits that are required to be produced, such as a list of assets sold, a list of customer balances, details of all inventory parts, etc. Of special interest is the allocation of purchase price which must be agreed to by buyer and seller. When you sell your business assets, you and the buyer must agree to the value allocated to the different classes of assets and file the statement with the final tax return for the seller and the initial tax return for the buyer. Of special interest to the seller are items that are treated as ordinary income, such as a non-compete agreement and inventory, as well as any potential depreciation capture on fixed assets. Always, always, always consult your tax advisor before agreeing to the purchase price allocation. In fact, as soon as you arrive at the purchase price you should already be determining how to allocate the purchase price between the assets included in the sale. Usually I leave this as one of the last items to negotiate between buyer and seller. The seller and buyer may or may not be on opposite sides of allocating the consideration to any specific asset, but when you are the seller, you will want to allocate as much as possible to the assets that generate capital gains to you, not ordinary income. The allocation for inventory is where a lot sellers get caught. For years they have been under-reporting inventory to reduce their taxable profits, but in the year they sell, the buyer want to report the full value to generate the highest deduction on their initial tax return and the seller may have to report a large, ordinary item of income on the final tax return.
Closing
The last step is the closing, when everything get wrapped up in a bow, signatures are obtained on remaining documents and contingencies are finalized. Your attorney may handle the closing on your behalf of you may use an escrow agent. Don’t forget to bring the champagne! Your tax advisor has calculated the tax on the gain so sock away that amount and enjoy the rest! What do you think? Can you sell your business without using a broker? If so, congratulations! If not, let me know how I can help.
