Over the course of decades of providing professional services to thousands of business owners, we have fielded hundreds of questions from middle-market business owners about selling their businesses. The below is a list of some of the most frequently asked questions, along with insights that will provide business owners the information they need to know.
Do I Need a Business Valuation?
I’ve had a lot of business owners ask me if they should get a formal business valuation. My normal answer is a resounding, “No!”. Ultimately, a business is only worth what a buyer is willing to pay… regardless of what a seller thinks (or hopes) the business is worth, or what some business appraiser comes up with.
Keep in mind that one of the overarching principles of business valuation theory is that fair market value is based on a hypothetical transaction between market participants, where neither is under compulsion to act, and both have reasonable knowledge of relevant facts. I’m not sure about you, but I’ve never dealt with a hypothetical buyer or seller, and I’ve not yet met a potential buyer who truly has (or is able to obtain) all of the relevant facts. And often, one or more parties to a transaction is, in fact, under compulsion to act.
I’ve seen business valuations that were orders-of-magnitude different (both higher and lower) than the actual price received on the open market. In my experience, valuation reports often set unrealistic expectations about what a business is truly worth, and may even dissuade a business owner from going to market.
The best advice I can give a middle-market business wondering about the value of his or her business is to talk to someone that actively helps parties buy and sell middle-market businesses. They are typically a wealth of good information.
When is the Right Time to Sell?
We generally tell business owners that the right time to sell for the maximum price is, “when three stars align.” First, the business owner truly needs to be ready to sell. Second, the business needs to be doing well (ideally doing very well and growing). Finally, the economy needs to be doing well, and ideally, interest rates are low. Unfortunately, to maximize the price, you need all three. Two out of three just isn’t going to cut it.
Are There Options Other Than Selling the Business to a Third Party?
Absolutely. There are countless other ways for business owners to transition out of their business. Management buy-outs, family succession, ESOPs, and simply liquidating the business are just a few ways that I’ve helped clients transition out of their businesses. But if the three stars align (as described in my answer to question #2), my experience has shown time and again that an outright sale to a third party is the best way to maximize price.
Who are the Potential (Third Party) Buyers for my Business?
Again, I could write a whole book on this topic, but it usually boils down to two or three choices—an entrepreneurial individual, a private equity firm, or a strategic buyer (normally a competitor or supplier). While it always depends on the specific characteristics of the business in question, I’ve found that the prices offered for businesses are lowest from individual buyers and highest from strategic buyers, which conceptually makes sense. An individual buyer usually has less capital at his fingertips. Private equity firms, which typically have deeper pockets, often have a hard time competing with strategic buyers, because the strategic buyer is most often in the best position to maximize their return (by consolidating administrative functions, selling new products to existing customers, taking a competitor out of the market, etc.). In other words, they can typically generate the highest returns from the business and are therefore generally willing to pay the highest price.
What is an Investment Banker?
When it comes to selling your business, the best thing you can do is hire an expert to help you with the process. You typically have two choices—either hire a business broker or an investment banker. When it comes to the sale of a middle-market business, those two terms are often (incorrectly) used interchangeably. I oversee an investment banking practice, and it bothers me when people refer to me as a broker, because (as I’ll illustrate), they are actually very different.
A business broker typically sells a mom-and-pop business, and they do it by trying to reach as many potential buyers as they can, typically by sending emails and posting information about the business to various websites. It’s usually a fairly passive process that relies on potential buyers coming to them. And brokers are normally marketing to entrepreneurial (individual) buyers. It’s basically the same process as selling your house: you set a price, broadcast information to the market, and wait for offers to roll in.
An investment banker, on the other hand, specializes in selling larger businesses. It’s a much more active process than that used by business brokers. An investment banker will create a list of specific potential buyers (often after countless hours of research), create an offering memorandum summarizing (a lot) of information about the business, and then actively contact potential buyers to create a market for the business. They are normally marketing to corporate and private equity buyers. They facilitate the entire process, from contacting potential buyers to providing information, to receiving non-binding term sheets, then they negotiate for the best deal. And they don’t set a price—they let the market decide by creating a private auction for the business. There is no better way to get the best price (and best terms) for your business than having multiple qualified buyers competing for it!
Based on the above description, you might wonder why anyone would choose a business broker. The type and size of the business typically dictate the answer. The investment banking process is much more time consuming, and therefore much more expensive, and some businesses are just too small to justify the cost of an investment banker.
How Much Does an Investment Banker Cost?
A good investment banker is worth his or her weight in gold. They typically charge an upfront retainer, plus a success fee on the back-end. While the upfront fee may not be insignificant, it usually only helps to defray the upfront costs associated with preparing a business to go to market. I’ve personally spent hundreds of hours of preparation time in getting a single business ready to go to market, and I can assure you that I’m not earning a living off of the upfront retainers. Other than the retainer, we typically only get paid if the business sells. And the higher the price, the higher the fee. But that’s actually good for both the seller and the investment banker. After all, wouldn’t you be willing to pay a higher fee if you got a higher price?
In my experience, success fees typically range from maybe 1 percent (on the very low side) to maybe 10 percent (on the very high side). Again, the investment banker employs a disciplined process, and the level of effort is typically similar regardless of the size of the business. So, if the business is worth $5 million, they may charge 10 percent. Conversely, if the business is worth $100 million, they may only charge 1 percent.
Although not specifically asked by the question, I’d like to point out that a good transaction attorney is equally valuable. Your college roommate, who is now a real estate attorney, is probably not a good choice.
When Should I Start Planning?
Another good question. Business owners typically start way too late. In an ideal world, a business owner should start the process about two to three years before they want to sell. That will allow them to work with the investment banker (or consultant) to analyze the business and determine changes that should be implemented prior to going to market. A business is ultimately worth some multiple of how much cash flow it can generate in the hands of a buyer. You wouldn’t put your house on the market before cleaning it up and making some necessary improvements, so why wouldn’t you do the same with your business?
What Steps are Involved?
We typically think of the process as having six distinct phases: Assessment, Preparation, Marketing, Deal Making, Due Diligence, and Transaction Documents/Closing. I won’t go into the details of each here, but suffice to say, it’s a very formal process. If your goal is to maximize the price for your business, you can’t cut corners. After all, you get what you pay for.
How Long Will the Process Take?
I saved the easiest two questions for last. A formal investment-banking process will typically take six to nine months from the point you decide it’s time to go to market. Yes, I’ve had them go more quickly. Yes, I’ve had them take longer. But I normally tell business owners to expect six to nine months … and to prepare themselves for a wild ride!
What Should I Expect Post-Transaction?
Although there is no one-size-fits-all answer here, most transition plans that I see typically involve the seller’s involvement for six to 12 months after closing. The seller is typically paid a market-based wage in exchange for his or her services. I recently closed a transaction where the buyer, a large public company, wanted absolutely NO transition plan; the seller was free to (and expected to) leave at 5:00 p.m. on the day of closing, and never look back. I thought I’d seen it all in this line of work, but that was a first for me!
If you’re considering a sale of your business and would like to discuss your specific situation, please contact our experts today.
This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute an accountant-client relationship.
