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Seller Question #6: How do I Maintain Confidentiality When I’m Selling my Business?

Maintaining confidentiality during the process of selling your business is critical – there is simply no sugarcoating this statement. It does a business owner absolutely no good, and in fact can be potentially damaging to the business, if employees, customers, competitors or vendors find out your business is for sale.

Buyers and Confidentiality

Buyers happen to be the group of people that require the most confidentiality management, but at the same time require the most access to confidential information. A key thing to consider when developing your confidentiality plan for buyers is the old Stephen Covey adage, “begin with the end in mind.” That is to say that whoever buys your business will ultimately have been provided full access to all of your confidential information by the time closing rolls around.

With that in mind, you have to determine at what point in the process it’s appropriate to disclose different kinds of information to buyers so that they can progress through the evaluation of your business and ultimately close. At some point in the process of evaluating and purchasing your business, buyers may want to:

  • Visit your facility and meet you
  • Review your financial statements and other detailed financial records
  • Have access to detailed company information, like payroll, insurance and debt sources, to name a few
  • Know who your customers are
  • Possibly meet some of your customers
  • Meet your key employees and ensure they want to stay with the business
  • Talk to your vendors
  • Talk to your landlord
  • And many, many more…

Just take a second to think about the kind of information and access you would want if you were buying your business, and it becomes easy to see how much confidential information must be disclosed to actually close a transaction. This list could be much longer!

So what becomes critical to a successful transaction is developing a customized plan that allows buyers to get what they need in order to move forward through the process of evaluating and purchasing a business. But at the same time doing this in such a way where your confidentiality is properly maintained at all times and information is only released when it’s appropriate.

Employees and Confidentiality

When it comes to confidentiality, determining how to handle your employees is probably the biggest balancing act you’ll have. On one hand, you want to be honest with your employees and not deceitful, but on the other hand employees should be on a “need to know” basis, with you deciding when they need to know.

This is also a major topic of conversation for buyers. The majority of buyers would love to have access to your employees very early in the due diligence process, but in most cases that’s just not prudent on your part to allow. One of buyers’ biggest fears is that employees will leave when the ownership changes, so they’d like to get some sort of reassurance prior to closing that this won’t be the case. But at the same time, owners don’t want their employees finding out the business is for sale too soon, out of the fear that it may scare them and cause them to look for other jobs.

As a general rule, if a business has some key employees that are vital to the success of the business, it can be a good idea in many cases to inform those employees about the sale and introduce them to the buyer at the appropriate time. Typically, the timing for this is going to be in the weeks leading up to closing, when everyone is confident the deal is going to go through. Ultimately, every business, owner and buyer is different, so every deal will dictate the “right” time to tell employees based on these different players.

Customers and Confidentiality

You don’t want your customers to know you’re selling your business because you don’t want them to worry about changes to the quality, consistency and continuity of the product or service you provide them. If customer confidence starts to waiver, your business could potentially be damaged – either immediately or in the future.

So when should customers find out the business is for sale? The answer here depends greatly on your business and the types of customer relationships, contracts and/or history it maintains with those customers.

In some cases it may be important for a seller and buyer to meet with a customer during the due diligence process. For example, if a company has a contract with a customer that accounts for a large percentage of the business’ revenue and that contract must be transferred, there’s a good chance the buyer is going to insist on getting that transfer approval prior to closing. In other cases customers may never be “officially” informed the business was sold, by design, because the buyer felt confident that a smooth transition is all that was needed to keep the customer happy.

Generally speaking, the best method to deal with customers in a business transition like this is to make it a non-event. There are ways that you can introduce the new owner to key customers without as much as raising a red flag, and then you slowly transition out of that relationship while the new owner takes control.

Competitors and Confidentiality

If there is one group of people you want to maintain confidentiality with more than any other, it’s your competitors. I can’t think of a single good reason to ever disclose your plans to sell your business to one of your competitors. Rest assured, if your competitors find out you’re selling your business, it won’t be long before your employees know, your customers know and your vendors know – because it can potentially benefit your competitors for all of those people to find out.

That’s why it’s critical for the listing and marketing program you develop makes confidentiality the focus of every step. There is a good chance your competitors will catch wind that a business like theirs is for sale and they will probably go do a little poking around to see if they can figure out who it is. So it’s imperative that the marketing for your listing is professionally created to protect you from this type of snooping.

You’d be shocked how many listings out there blatantly divulge the identity of the business that’s for sale. The trick is to provide enough information to potential buyers for them to get interested in learning more without giving away the farm – that’s where true professional representation can be worth its weight in gold for you.

One side note on this topic – what if a competitor is truly interested in buying your business? How do you handle that? This gets back to the idea of professional representation – in our office specifically, the marketing programs are developed in a way that is suitable for competitors and general buyers alike, and before any buyer receives confidential information we know who they are?

Vendors and Confidentiality

Vendors, suppliers, service professionals – these are all groups of people that are important to your business and will also be important to the new owner of your business. So they will need to be brought into the loop at some point about the sale.

While these groups may seem harmless and would never pose a confidentiality problem, it’s exactly that type of dismissive attitude that makes them so important to manage. Most of the time a business owner will confide in a vendor that the business is for sale, or simply mention it in passing, not really thinking about the potential ripple effect it could have.

Don’t forget who these vendors also have relationships with – they may talk to your employees, they probably work with your competitors, and they may even deal directly with your customers. So there is a high risk that a vendor could innocently pass along some very confidential information to a key person.

With that said, there does come a time where you need to start talking to vendors about transferring accounts and agreements from you to the new owner – just make sure that happens at an appropriate time in the process.

I could literally host a multi-day seminar covering the ins and outs of confidentiality as it relates to the sale of a business – this is a topic that is that important. Whether you’re considering selling your business this year or in 10 years, it would be prudent to contact a reputable business broker, like Sigma Mergers & Acquisitions, today for a no cost, no obligation business valuation. This is not only a great way to examine your business’ value, but also a way to discuss the unique confidentially challenges your business may present, and start building a plan for how to manage those.

 

Seller Question #5: Why Should I Consider Seller Financing?

Generally speaking, there is an overriding negative connotation amongst business owners when it comes to the subject of carrying a note as part of a business sale. While many of the seller financing horror stories floating around the golf course and dinner party are true, when seller notes are structured properly with equitable terms, they can be invaluable tools to closing a successful transactions.

In this article, we’ll explore some of the most common objections to seller financing and then provide some counterpoints to those objections to give you something to consider and maybe a new perspective.

OBJECTION: I'll get less cash at closing

Correct. That’s a fact. So what could possibly counter that point?

How about if I told you that yes, you’ll get less cash at closing, but in exchange you’ll actually be getting a higher sale price for your business?

The fact is, that result is overwhelmingly common. Surely you’ve heard of the old “cash discount” in some form or fashion – the same principle actually holds true when it comes to business acquisitions also. This is the case for two main reasons.

First, if a buyer is willing to pay cash for a business, he or she is undoubtedly going to assume the seller’s desire for a larger amount of cash at closing will outweigh the seller’s desire to get his or her asking price. So the buyer offers a lower cash price. But if you’re willing to carry a note, the buyer loses some of his or her negotiating leverage. Sure, you get less cash at closing, but you’ll end up with a higher sale price overall.

Second, if a seller is unwilling to carry a note, this negatively impact the buyer’s confidence in the business and the sale price, so the buyer ends up offering a lower price to account for that perception of increased risk. But if you are willing to finance a portion of the sale, it actually increases the buyer’s confidence in your business and its value, and he or she is more likely to agree to a higher price.

OBJECTION: It will take longer to get my money

Again, correct. No argument here. If you choose to carry a note as part of your business sale it takes longer to get paid.

With that said, think about what seller financing really is – it’s just an investment in your business. If I were to ask 1,000 business owners to rank what they felt the most confidence in between the the stock market, the real estate market, the energy market, the bond market – any market out there – or their businesses, I’d bet a dollar that the vast majority of them would have their businesses at or near the top of that list.

Most likely you are going to invest a portion of the proceeds from the sale of your business, so why not invest in something you truly understand better than anything – your business? Also, typical seller financing is going to range from 24 to 60 months and 5% to 8%. Where else are you going to be able to invest in something you have intimate knowledge of, and at the same time get a guaranteed return like that?

Another benefit to the delayed receipt of your seller-financed portion is from a tax perspective. If you sell your business for $1 million cash, you pay taxes on that $1 million that year. However, if you sell your business for $1 million with a five-year $250,000 seller note, you’ll only pay taxes on $750,000 this year, then on $50,000 per year for the next five years. Depending on your tax bracket, this could prove to offer considerable tax savings.

Yes, seller financing means it takes longer to get your money, but you’ll net out much better in the end when you consider the proceeds from interest and the deferred taxes on your note.

OBJECTION: The buyer might not pay me

Correct. Just like when a bank lends money to you for the purchase of a car or a house – there’s no guarantee you will ever pay them. But what does a bank do to counter that risk? It has security interest(s) as collateral.

The same principle applies for seller notes on business acquisitions. This is where an experienced broker can really add value to your transaction – making sure you are properly protected if you choose to carry paper.

If drafted properly, a seller note should include a security agreement that collateralizes the assets of your business that are being conveyed to the buyer. It should also include a personal guaranty from the buyer for the amount of the sale price in excess of the asset value. If losing the assets o the business they just bought isn't incentive enough to pay you, then risking their personal assets can be.

Additionally, the seller note should have a clear definition of what constitutes buyer default. In the unlikely event a buyer does stop paying on the note, you need to be able to act swiftly and decisively to foreclose and reposes the assets and the business. Then you can straighten things out and sell it again if you wish!

OBJECTION: The buyer could run the business into the ground

This is another correct statement. Whoever buys your business could fail miserably, causing the business to close down and leaving you with very little value to take back.

While this scenario is more unlikely than anything we’ve discussed in this article so far, there are still some safeguards you can use as protection from something like this.

The most obvious and most important is simply to evaluate your buyers. No one knows better what it takes to successfully run your business than you do. So make sure that you feel confident in the person or people buying it.

If you’re going to carry a note for someone and expect to get paid back, he or she needs to have the skills to operate your business. That doesn’t mean you need to think they’ll be more successful than you, and it doesn’t necessarily mean they have to have direct industry experience – it just means you need to feel good about their abilities.

Another thing you should require that will help you avoid a situation like this is for the buyer to provide you periodic financial statements on the business so you can monitor how they are doing. Typically these are done quarterly. So if you start seeing a disturbing trend or noticing the buyers are struggling, you can offer your assistance to help straighten things out. What better way to protect your investment than to be able to be hands-on if needed?

OBJECTION: The buyer can just get a bank loan

In some cases, bank loans are simply not available. This has more to do with the quality of your business and the accuracy of your financials. But let’s assume your business and your buyer do qualify for bank financing – that doesn’t mean seller financing is off the table.

In fact, more times than not there will still be a seller note in your deal even if the buyer gets bank financing. This is the case for two main reasons.

First, it gets back to confidence. Not only might the buyer feel better about acquiring your business if you are willing to carry a note, but the bank often has the same opinion. Everything about the deal feels stronger from that side of the table when the seller has some skin in the game.

Second, many transactions “need” seller financing to make the numbers work. It might be because your business has a lot of goodwill and not a high tangible asset value, or it might be because there is a risk the bank sees in your business that it wants to mitigate by making you have an interest in the future success, or it even might be because the buyer is a little short on the down payment and the bank needs your note to bridge that gap.

The good news in these types of situations is that your note is going to almost always be much smaller than it would have been if there was no bank involved. Generally speaking, a seller note on a bank deal will be about 5% to 10% of the sale price, while a deal with no bank involved could be as high as 50%.

Seller financing is definitely one of the biggest lighting rods when it comes to selling your business. While there are some fundamentally factual objections against carrying a note, there are also just as many logical and proven solutions to counter those objections making seller financing a tremendous tool to have t your disposal.  Whether you’re considering selling your business this year or in 10 years, it would be prudent to contact a reputable business broker, like Sigma Mergers & Acquisitions, today for a no cost, no obligation business valuation. This is not only a great way to examine your business’ value, but also a way to see what type of seller financing options make sense for your business to maximize its overall value.

 

Seller Question #4: How Important are my Business Tax Returns?

“I make a lot more money than my tax return shows.”

If we only had a dollar for every time we’ve heard that!

Most business owners wage a constant battle between clean, accurate tax reporting and tax liability minimization. No one likes to pay taxes, so this struggle is understandable, and most business owners will focus on what costs them money today (paying taxes) rather than what makes them money in the future (selling a business).

If you ever plan to sell your business, there are some details about your tax return you need to pay special attention to if you want to not only maximize your business’ value, but also to make your business attractive and financeable. It’s not an exaggeration to say that the pennies you save today on your taxes will cost you dollars in the future when you decide to sell your business.

We’ve identified and discussed five important considerations business owners should make when deciding how to manage their financials and file their tax returns, an how those considerations can effect their business valuations.

Access to Acquisition Financing

Without question, the most critical role a seller’s business tax return plays in an acquisition is to help a buyer secure financing to purchase your company. The vast majority of transactions utilizing some sort of third-party lending source are going to rely on the business’ tax returns to justify that loan. Most lenders don’t even consider what your income statement says – they base their loan amounts and lending decisions off tax returns.

While your income statement will almost certainly be the financial report most buyers focus on because of the level of detail it offers about the business, the financing buyers need to buy your business is going to depend largely on your tax return.

With this said, don’t feel like you have to show a huge profit on the bottom line just so your business can qualify for acquisition financing when the time comes. The topics below discuss some things to keep in mind about what goes on your tax return and how to present it.

 

Start with EBITDA

Let’s start with EBITDA, which stands for “earnings before interest, taxes, depreciation and amortization.” EBITDA is a figure that represents the profitability of your business with non-cash expenses removed, such as depreciation. While this calculation is one of the most widely accepted and requested indicators of a business’ value, it becomes more relevant to business valuation as companies increase in size.

Regardless of your company’s size, though, EBITDA is important to understand because some these non-cash expenses can significantly lower your tax liability while not making impact on your business valuation.

For example, let’s say your tax return net profit is $250,000, while your tax return shows an interest expense of $50,000, depreciation of $100,000 and amortization of $10,000. As far as the IRS is concerned, you’re paying taxes on that $250,000 profit, but buyers are going to use your $410,000 EBITDA as a building block to determine your company’s value.

So don’t be discouraged or concerned if your net profit is lowered because of these types of non-cash expenses – they actually work in your favor all around.

Legitimate Owner's Expenses that Reduce Profit

EBITDA is easy – it’s all spelled out right there on the tax return for everyone to see and calculate. But there are some other expenses a company can incur that will have a similar impact on your taxes and business value. We call these “owner’s adjustments” or “seller’s discretionary expenses.”

These are expenses the business pays for, but while they may be expenses not uncommon for a business to incur, thee particular items are not really necessary to operate the business – at the end of the day, these expenses benefit the owner.

Some are very legitimate owner’s adjustments that the business covers, such as the owner’s salary, health insurance, life insurance or retirement contributions. Others may be a little less obvious discretionary expenses, such as sports tickets, club memberships or family vehicles. There may even be non-critical family members on the payroll, along with their benefits.

These are some examples of expenses that look legitimate on the surface, but when you really understand what they are and who they benefit, you realize they are not items the business needs to operate. So after we’ve calculated EBITDA, we add back these adjustments and discretionary expenses. This gives us a figure referred to as “seller’s discretionary earnings (SDE),” “cash flow” or “true owner’s net profit.” There are several terms for it, but they all mean the same thing.

At Least Make the Money Easy to Find

For some business owners, just the EBITDA items, owner’s adjustments and discretionary expenses aren’t enough. These owners run even more personal expenses through their companies’ books. While we don’t suggest doing that, if you choose to do so, at least make these items easy to identify and validate.

Some examples of what these might be include home improvements, personal hobbies or vacations – clearly personal expenses, but run through the business nonetheless. If you decide to expense items like these, don’t bury them in a way that they can’t be identified, because if you want to have a remote chance of getting credit for these items relative to your business value, you can’t be the only one who knows where they are.

We highly recommend avoiding having personal expenses like these included in your financials when you’re trying to sell your business, because the likely negative impact it will have far outweighs any positives. The old saying “cutting off your nose to spite your face” applies here, but instead it’s “saving your quarter to cost you dollars.”

Buyers' Confidence in your Business

The final critical point about your business’ tax return and its importance actually has nothing to do with revenue, expenses, add-backs or the business value calculation – it has to do with buyer perception of and confidence in your company and you.

A buyer’s confidence in your business, while it can’t be quantified, does impact the ultimate value that buyer will place on the company. One of the key drivers of buyer confidence is the quality of the financials. There could be two nearly identical businesses on the market at the same time – same industry, same geography, same reputation, same revenue and same margins – but one company has “clean” tax returns with easily identifiable and reasonable owner’s adjustments, while the other has significant amounts of personal expenses littering different categories.

Without question, the business with the clean tax return is going to sell for  higher price and have a better chance to qualify for financing, while the other business will struggle to find a buyer willing to pay close to what that company is really worth. Additionally, don’t discount the confidence buyers can potentially lose in you individually if they perceive your “funny” financials to be an indication of your honesty and ethics as a person.

Every business and owner is unique and certain circumstances will dictate how tax returns are compiled and reported, but these five points are important to consider, as we see them impacting values time after time. Whether you’re considering selling your business this year or in 10 years, it would be prudent to contact a reputable business broker, like Sigma Mergers & Acquisitions, today for a no cost, no obligation business valuation. This is a great way to examine your business’ value and identify strategies you might could implement on your tax return to ultimately increase your sale price.

If you have questions like these and what to discuss how the different answers impact the value of your business, please reach out to us and we’ll be happy to help. As always, one of the first steps in this process is to have us provide you with a no cost, no obligation business valuation.

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