What to Expect When Selling Your Business

First off, selling your business will always – ALWAYS – take longer than you think it will or should.  We have never seen a business sale, whether it’s five figures or seven figures, close in less than 45 days.  Even 45 days is pretty ambitious. Think about it – you have a buyer, a seller, the buyer’s attorney, your attorney, two CPAs, maybe a banker, a broker, and a partridge in a pear tree.  Each of those people has his or her own schedule, other clients, and time constraints. Though it’s probably the biggest thing in your world, it’s rarely, if ever, the only thing any one of them is working on.

Second, you’re going to have to grow some thick skin because someone on the buyer’s side will call your baby ugly.  Your business is never as attractive or valuable, even to someone interested in buying it, than it is to you.  You’re the one who birthed it, reared it, nurtured it, and raised it into the attractive acquisition target it is.  Yet, your buyer will find all the flaws and all the blemishes you’ve come to love, tolerate, or ignore over the years.

There are several formal stages of a deal and lots that happens in between.  In most deals, the flow goes like this – Letter of Intent, Due Diligence, Purchase and Sale Agreement, and Closing.

Let’s already back up a step.  If you’ve listed your business for sale with a broker, you’ll first sign a listing agreement.  If you’ve ever sold a home, the agreements are similar – you can’t simultaneously list it with someone else, and the broker will take a sizable portion (usually 10%) of your sale proceeds as their fee.  Brokers will usually only accept a listing if they can represent both the buyer and the seller, which means they can’t (or shouldn’t) advocate for one side over the other.  That’s why it’s so important to use your own advisors to watch out for your interests.

Whether you’ve listed your business with a broker or are approached out of the blue, the first step is usually taken by the buyer – the Letter of Intent (LOI).  The LOI is a short document, usually about two pages, wherein the buyer says “hey, I’m interested in buying your business but need to know more.  So, if you accept these terms, for the next __# of days, you need to let me behind the curtain and share information you’d otherwise consider confidential and not sell to anyone else. Here are some general terms of the PSA we’ll eventually sign, but we won’t finalize them until after we uncover all the skeletons in your closet.”  LOIs are typically nonbinding except for obligations of the prospective buyer to keep the information you share confidential, the length of time for due diligence, and a requirement that you take the business off the market while the buyer decides whether to proceed.  The fact that the LOI is nonbinding is notable insofar as the purchase price, if one is even stated in the LOI, is NOT a final offer.  In fact, once the LOI is signed, the prospective buyer’s goal is to put downward pressure on the purchase price based on the blemishes and warts uncovered during due diligence.

Once the LOI is signed, two things can happen.  Either a Purchase and Sale Agreement (PSA) is negotiated and signed, or due diligence begins and the PSA is negotiated while due diligence proceeds.  If the buyer needs financing to make the purchase, or if an escrow company is involved, the lender and escrow officer will almost always require a signed PSA.  In this case, with the PSA signed before due diligence, it will (should) contain a bunch of contingencies that enable the buyer to back out if they discover something that kills the deal for them, or if something makes it impossible for them to proceed, like being denied financing.  This process is a little like online dating.  Your public profile looks good.  Someone swipes right.  Unlike online dating, you go exclusive right off the bat.  Then, on the fifth date since you deactivated your profile, the buyer decides the fact you get those white crusties in the corners of your mouth is a deal breaker.

As the seller, you want to make your business as (actually) attractive as possible.  It’s like staging a house for sale – there should be no dirty dishes in the sink or oil slicks in the garage and the whole thing should smell like freshly baked cookies.  Make sure your books are clean, your tax returns are accurate, you have reliable recurring revenue, and there isn’t anything that could bite the buyer in the future.  Whether the buyer is at risk depends in large part on whether the deal is a stock purchase or asset purchase, but that distinction is covered in a different article.

The PSA is where the rubber meets the road with the deal.  Many sellers rely far too heavily on what’s in the LOI, forgetting that it’s nonbinding.  The PSA truly represents the details of the contract.  There are countless pitfalls with a PSA on both sides.  Many of them surround representations and warranties – where each party makes statements the other relies on to decide whether to go through with the deal.  As you might expect, the seller makes most of the representations because the buyer bears most of the risk.  The seller will often represent and warrant that there is no outstanding litigation or claim against the company.  But what happens if an employee files a wage claim right before closing?  The buyer may warrant that it is an entity in good standing.  What happens if that isn’t true?  Arguably, an entity that doesn’t exist can’t enter into an agreement, so the seller could be hung out to dry after taking the business off the market.

Here are a few cautionary tales to illustrate:

1. Buyer is borrowing the money to buy the business.  A signed PSA must accompany the buyer’s loan application.  The PSA requires the seller to take the business off the market for three months, or up to six if the bank takes longer to process the application.  Seller doesn’t ask for an earnest money deposit, can’t entertain other offers, and has to turn away several other prospective buyers. After the buyer extends the off-market period for the full six months, he is ultimately denied the loan.  Meanwhile, the seller has kept the business on ice for six months, has been mentally checked out of running it, hasn’t done much to continue building the business under the assumption he’d be selling it, and now those other prospective buyers have moved on.
2. Seller is ready to retire and wants to sell his business.  He has no recurring revenue or hard assets to sell; just a customer list.  What’s that worth to a buyer?  Without the guy who has the relationships, there is no guarantee the customers will stick around with a new company.  The buyer solves this issue by requiring the seller to stay on to help the buyer retain those clients.  Of course, the seller could have continued working with the clients without having sold the business and become someone else’s employee.  Speaking of…
3. Sellers almost always underestimate the profound shift from running their own business to working for someone else.  It’s a bit like selling your house to someone else yet still renting a room.  You spent weeks picking the perfect shade of mint green for the bathroom that they just painted a garish yellow, and why did they feel the need to dig up the landscaping you worked tirelessly five weekends in a row to install with your own two hands?  As the seller, you provide value in helping the buyer maintain what they paid for, but you have to keep your mouth shut about how they continue raising your baby.

I could go on for days about other things to think about as a seller – noncompetes, earnouts, holdbacks, contingencies – suffice it to say it’s important to understand all the aspects of selling your business and make sure you arm yourself with advisors who can protect your interests.