You have put in the long hours. You have risked your health, personal wellbeing, your family life and maybe your personal wealth all for the potential of the capital upside of selling your business. You may have sold a business before and be a seasoned entrepreneur and if so, you will know that the sale process is never straightforward.
When you come to sell your business, a purchaser will not see the value the same as you. They will want to know all the risks and they will likely want to use those risks to minimise the price paid. One of the main risks to the business is how it will continue without you. Any purchaser will want the business to remain intact after you go and keep the ability to grow in value, so they make a return on their investment. A purchaser may therefore want to tie you into the business on an earn out arrangement.
What is your exit strategy?
Preparing to sell your business includes an exit strategy. Are you prepared to continue working in the business once you have sold your shares?
Earn out agreements normally appear attractive because of the potential upside of meeting certain targets. Meeting those targets would result in increased consideration in the form of cash or equity. Are the targets realistic for a business under different management? Is the way of measuring performance towards those targets prescribed or open to consideration (manipulation)? A purchaser will only want to pay more if the targets as they see them are met and even then, they may be reluctant if they can’t see a continued brighter future. Earn outs can be very good but are also fraught with risks. As such, the reward needs to be commensurate. Also, there is nothing quite so rewarding as receiving a satisfying payment at the time the sale is agreed.
If you wish to cleanly exit and sell your business, it will need to be equipped with a management team that doesn’t include you. A management team also introduces the potential of a management buyout or a vendor-initiated management buyout (VIMBO), which could be with venture capital funding.
Seasoned entrepreneurs will generally know their exit strategy at the time they are formulating their business idea. It is always useful to know potential exit strategies even if the desired exit is not for a few years.
Should you appoint a broker?
Using a broker can help although you will have to choose the most appropriate broker. You will need to consider what makes a broker appropriate:
- Industry knowledge
- Track record
- Existing interest parties
- Relationships with venture capitalists
- Processes they will adopt
- Guidance and assistance with due diligence
- Business valuation
- Types of deal envisaged
- Broker fees and whether they are performance driven
It is not always the broker who indicates the highest value of your business that has the correct skill set in practice.
What is the value of your business?
The value of a business to the owner may be substantially different to that on the open market. Similarly, the accounting value based on EBITDA may not consider the risks that a purchaser may identify and use to formulate their offer. If you have a plan to sell your business in say five years’ time, it may be worth each year having a review and valuation to conclude what needs to be done to achieve a higher value when you come to sell.
It is essential to manage expectations of value and to know a value you want to achieve for sale. There are several simple things a business can do to improve its value and having an independent valuation a few years in advance of a potential sale allows time to increase the business value.
Can you make the business more appealing?
Who are your potential purchasers and what would they like to acquire? The potential purchasers may have a particular set of values. You may be able to take steps to align the culture of your business with that of potential purchasers. This process may take a few years to implement so analysing your exit strategy early is essential.
The sales process will include significant due diligence over financial performance, security and longevity of income streams, litigation risks and tax risks amongst others. Uncertainty in risk areas will reduce the value of your business and affect its attractiveness to purchasers. Testing your business’ risks will allow you to prepare the business for sale, maintain value and respond quickly through the due diligence process.
Most entrepreneurs dislike lots of paperwork. However, if you are building a business for a significant sale, paperwork is necessary. You should hold regular board minutes and record the board’s decision in a suitably prepared minute. That minute should include copies of contracts considered. Hopefully those contracts have not been sourced from the internet and instead a reputable solicitor involved in their preparation.
Company House filings and accounts should be prepared and filed ahead of time demonstrating good internal process. Also, shareholder registers, stock transfers, share certificates and director’s appointments should all be prepared, filed and maintained correctly. It is also important to ensure employment contracts and other important legal agreements are maintained.
Many internal processes should be documented allowing the business to function with new resources.
Common tax problems
One of the biggest due diligence items will be tax. The following are common tax problems found during the due diligence process:
- Employment Status: companies often seek to engage self employed persons rather employ and this may give rise to tax risks where the employment status is questionable
- Termination Payments: tax free payments given when they are arguably taxable
- Profit Extraction: the shareholders have implemented methods to extract a fund’s tax efficiently, which may constitute tax avoidance
- VAT Compliance: treatment of recovering input tax is incorrect
- Expenses and Benefits: no policies in place and weak procedures to enforce policies
- CT Compliance: allowable deductions against profits have been overstated
- Overclaims: capital allowances or research and development costs are over claim or the basis of the claim is flawed
- Transfer Pricing: no policy in place
- Poor Tax Compliance: returns are filed late and penalties are incurred
- Lifestyle: the company has been run as a lifestyle business meeting personal expenditure of the shareholder/director