Options for Selling a Business

Whether you are seeking options for selling your small service business or your mid-market manufacturing firm, read this article to help you

  1. Select a transaction mechanism, 
  2. Understand your deal structure options, 
  3. Consider the different buyer types, and 
  4. Select an advisor.
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Transaction Mechanism Options

A transaction mechanism is how you select a buyer and arrive at an agreement with them. There are two business sale options:

Option 1: Ad Hoc Mechanism

In this mechanism, you (and your advisor) negotiate with prospective buyers when the buyers are ready to do so.  This generally means that if you like what someone offers you move forward with them.  If you are uncertain about whether a particular offer is good enough, then you (and your advisor) ask the offerer to wait until you have received more offers. 

PROS:

  1. Less expense and work is required before receiving offers.
  2. You commit practically nothing to the acquirer until final closing documents are signed, which is relatively late in the process.  This implies that you are free to change your mind.

CONS:

  1. This is a loose process.  Sometimes, that looseness can cause problems because prospective buyers are only willing to wait for a finite amount of time.  If we ask them to wait for too long, we risk losing them.
  2. The best prospective buyer might drive a hard bargain, offering too little.  A less qualified prospective buyer might not drive such a hard bargain.  As a result, you might go forward with the less qualified buyer.  In deals where the buyer’s and seller’s financial outcomes are somewhat tied, it is important that we find the best buyer because everyone wins when that is the case.
  3. There can be many small and large ways that two parties’ offers (letters of intent) differ.  As a result, it can be difficult to compare two parties’ offers on an apples-to-apples basis.
  4. Because this is a less structured process, with less agreed upon upfront, it is more likely that the deal will fall apart after a non-binding offer is accepted.  This can result in lost time and effort.

Option 2: Auction Mechanism

An auction has some similarities with and differences from the auctions that we see in movies.  Relative to the first option, it is a highly structured and coordinated process. Here is a brief introduction to auctions for selling businesses.

PROS:

  1. If you have at least two bidders, then an auction will generate more value for you than an ad hoc mechanism.
  2. The business is more likely to end up under the control of the right person.
  3. The high amount of structure required for an auction forces everyone to produce and act upon a high degree of clarity early in the process.  This reduces the likelihood of the deal falling through late in the process.
  4. The representations you make about the business to all prospective acquirers are more credible because they are backed by a binding contract.

CONS:

  1. You are limited to considering the buyers that are interested at one point in time rather than being able to speak with buyers that are interested over a longer period of time.  Therefore, the potential pool of buyers may be smaller.
  2. There is somewhat more work to do earlier in the process:  (a) Sale-related agreements need to be generated before a buyer is selected, rather than late in the process.  (b) You must decide upfront on precisely how you would value different possible deal structures.
  3. Once you have executed an auction agreement with the prospective acquirers, you cannot back out of it.

Deal Structure Options

Deal structure entails specifying the

  1. “Asset Transfer,” which is whether the buyer will acquire the business entirely at closing or over an agreed-upon period; 
  2. “Payment Structure,” which is how the buyer will pay you; and 
  3. “Protection,” which is how you mitigate risk by specifying resolutions to problems that might occur post-closing.

Here are options and approaches for all three:

Asset Transfer Options

In most cases, the buyer will assume ownership of 100% of your business at the time of closing. However, it is also possible for the buyer to acquire a percentage of your business at closing and then to acquire the remainder of your business’s equity over time.  There are at least two benefits of this second approach: 

  1. Even as  you reduce your involvement in the business, you can continue to own a share of it and earn its profits. 
  2. Your continued ownership of the business conveys to the buyer that you have an incentive to ensure that they transition successfully and that you believe they will be successful.  As a result of this second benefit, selling the business over time is expected to result in a higher purchase price.

When a business is sold over time (in parts), generally the seller maintains control during much of the sale period and maintains a right to unwind the transaction under certain or all circumstances.  These measures enable adequate protection of the seller in a multi-year sale.

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In addition, the transaction can be structured either as

  1. an asset sale (i.e. of all of your business’s tangible and intangible assets) or
  2. an equity sale (i.e. of some or all of your business’s equity).

An asset sale generates tax advantages for the buyer and is therefore generally preferable in cases when the buyer acquires full ownership at closing.  Buyer tax advantages translate to higher purchase prices.

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Payment Structure Options

There are several ways you can receive payment for your business.  If you are open to a larger number of options for payment, you will grow the pool of prospective buyers and the net present value of your purchase price.  Here are the payment structure options:

  1. Cash paid at closing, which is the main form of payment in many business sales
  2. A fixed amount paid to you over time in fixed quarterly or monthly installments with interest
  3. A fixed amount paid to you over time with interest, where each installment payment depends on the business’s profit distributions (higher distributions means higher installment payments)
  4. A percentage of the future revenue or profit of the business for several years
  5. Equity in your business or in the company acquiring your business

Key points:

  • Most deals involve a combination of multiple of above five options.  You may set a floor or ceiling on the portion of your overall purchase price that you are willing to receive from each of these options.
  • The above payment options are in addition to any consulting or employment payment you receive for working at the business during its transition period.

Protection Options

If selling your business entails sharing sales, profit, or ownership with a buyer post-closing, you need protection.  We recommend the following:

  1. List (with your advisor) the adverse outcomes that can occur.  For each, design a resolution mechanism that protects your assets.
  2. List (with your advisor) the possible disputes that can arise between you and your buyer.  For each, implement a binding procedure for resolving the dispute fairly and at a low cost, ideally without involving courts or lawyers.  We recommend expert determination.

Deep expertise in designing protection mechanisms matters.  (We are exceptional at it.)  Lawyers will draft the legal language that implements protections in a contract, but only a capable advisor can design protection mechanisms.  Proper protection design requires economics and finance expertise in addition to legal expertise.  We possess this rarely held combination of skills.

We have developed a 12-page expert determination agreement by working with several attorneys and business owners.  If incorporated into any contract, this agreement provides a legally binding answer to any objective or subjective question.  It can thereby resolve most predictable disputes.  It resolves disputes at low cost, at relatively fast speed, with minimal vulnerability to the answer being overturned by litigation, and with a high level of fairness and justness.

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Options for Who the Buyer Is

There are four main types of buyers:

Financial buyers are firms, wealthy individuals, or people supported by wealthy individuals who buy businesses.  They either hire people to manage the business or manage it themselves.  Although they do not necessarily benefit from any synergies from acquiring businesses, their deep pockets and access to debt capital enable them to offer attractive prices.

Strategic buyers are firms that are either in your industry or that want an asset that your business has.  That asset could be software or goodwill in a certain market, for example.  Strategic buyers anticipate benefiting from being able to increase revenue or decrease cost because of the synergy between your firm and theirs.  Theoretically, these firms should be able to offer the highest price.  However, sometimes these firms prefer organic growth and internal product development over business acquisitions.  In addition, these firms are often unwilling to take risks that financial buyers are willing to take.

Employees of your own firm can be suitable acquirers.  Employees in sales or operations leadership roles sometimes have the know-how to continue operating the business where they work.  Often, however, they do not have the financial resources to acquire their employer.  In these cases, it is important to engage an experienced advisor to structure a deal that is financially workable to the employee and protects both the owner and employee.  Protecting the seller from the pitfalls that exist when selling to an employee unable to take large financial risks requires specialized skill. Read more here about selling your business to an employee.

Experienced operators can also be suitable acquirers.  These are individuals who have the necessary experience and skill to sustain and grow your business.  They are sometimes able to take more financial risk than your employees but typically can afford less risk than a financial buyer.  In many cases, your business will do best in the hands of this type of buyer.  Structuring a deal with these buyers can be tricky because they cannot afford to bear as much financial risk as a true financial buyer.  Therefore, some creative structuring is necessary.  Here again, protecting the seller from the pitfalls that exist when selling to a party unable to take large financial risks requires specialized skill.

Key points:

  • Thinking about who your buyers might be will help you decide how to present your business and which parts of your business to improve in preparation for a sale.  For example, most buyers fitting the first two types prefer businesses with a management team that will remain in place post closing.
  • You can solicit offers from all four types of buyers.  Although the offers that different buyer types present will vary vastly, a good advisor can enable you to assess offers on an apples-to-apples basis.

Options for Your Advisor

You can proceed with a business broker or an M&A advisor.  Some business brokers approach selling businesses they way real estate brokers approach selling real estate.  That is because some business brokers were real estate brokers before they started brokering businesses.  Some take a relatively passive approach and see their job as mainly referring buyers to sellers and holding both parties’ hands throughout the process.

In deal-making, value is created not only by introducing the right buyers but also in intelligently implementing a sale mechanism and deal structure.  Good deal makers are equally marketers and chess players.

Having been established for 13 years, Next Bridge Advisors has built a network of 28,000 buyers and a unique combination of expertise in the finance, marketing, structuring, and dispute prevention aspects of business sales.  We sell businesses anywhere in the US and internationally.

Email us at sell@nextbridgeadvisors.com or call (646) 755-3926 to learn how to maximize your earnings from selling your business.

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