The valuation process for service-based industries is often different than it is with product-based industries. A focus on customer service and competitive offerings is of the utmost importance. For service-based businesses that have established reputations, profitability, and a unique competitive advantage within their area, valuations are usually highly favorable at the current moment. In this review, we discuss the valuation and sales process for service-based businesses specifically.
About Service-Based Industries: Here is What You Should Know
Many mom-and-pop businesses are growing into larger networks and more established names within their community, particularly those that have more sophisticated management, systems, and processes (Business Reference Guide). Overall, service-based businesses offer excellent sustainability over the years (relative to product or software-based businesses). A focus on workforce quality and exceptional customer service is essential.
How to Determine The Value of Your Service-Based Business
There are many factors that influence the valuation of a service-based business. For instance, companies who rely upon contractors and subcontractors must show that the contractors are legal and treated well by your company to achieve full value on the market.
In general, a service-based business valuation is largely dependent upon the quality of the company’s employees. A company that shows high turnover rates may see less favorable sales value than those with an established long-term workforce. Of course, with service-based businesses, high turnover rates are common, and this must be explained to potential buyers during the sales process. Many buyers are attracted to service-based businesses because they are more recession-proof and provide stable income when managed properly.
We strongly recommend a market-based valuation if you own a service-based business and are considering a sale. This involves the calculation of your seller’s discretionary earnings (SDE) and earnings before interest, taxes, depreciation, and amortization (EBITDA), which is then multiplied to your industry’s rule of thumb data.
How to Sell a Service-Based Business in 7 Steps
Below we have laid out a seven-step process for selling your service-based business. Although this serves as a useful guide to get you started and allows you to learn more of what your sales experience may entail, the specifics depend on your industry, business type, and sales goals. We strongly advise working with a business broker who understands the sales process for service-based business. They can help you personalize a sales plan. With that said, the seven steps you can expect are:
- Determine your company’s worth
- Plan your exit strategy with a business broker
- Prepare your legal, financial, and operational documents
- Seek potential buyers in a confidential manner
- Screen the initial offers and begin the negotiation process
- The buyer signs a letter of intent (LOI) and begins due diligence
- Close the sale and transfer ownership of the company
Step 1: Determine Your Company’s Worth
As discussed, it is important to receive a professional valuation, rather than estimations of your company’s worth or opinions of value. Without a reliable valuation, you run a greater risk of not selling due to a high and unjustifiable asking price or selling below your company’s worth. Therefore, the first step you should take is to reach out to a reputable broker who can provide an accurate and objective valuation for your service-based business.
Step 2: Plan Your Exit Strategy With a Business Broker
Next, you will need to plan what you wish to accomplish by selling. For instance, perhaps you have owned your company for an extended period of time and have accomplished all you want to accomplish professionally, in which case you decide to retire and spend more time with loved ones. In other instances, the seller may have other business ventures in mind. Whatever the case may be, establishing your long-term vision and sale goals is an important step to take.
Step 3: Prepare Your Legal, Financial, and Operational Documents
You will also need to prepare your company documents; this is the last step before you officially list your business for sale. Moreover, this is an important step to take as it helps ensure smooth and fast negotiation and due diligence processes. The list of documents you will need is based on the types of services you offer and the specific details of your company. For instance, if you have a patent or copyright, then you will need a patent, then you need the paperwork for it. With that said, some of the documents you can expect to prepare are:
- Legal documents: business licenses, patents, trademarks, copyrights, and lawsuit history details
- Financial documents: federal tax returns, profit and loss (P&L) statements, balance sheets, cash flow statements, asset lists, and inventory lists
- Operational documents: employee records, employee contracts, customer lists and contracts, supplier lists and contracts, workplace policies, and vacation and PTO information
Step 4: Seek Potential Buyer in a Confidential Manner
Your broker now gets to work and seeks potential buyers for your service-based business. They do this in various ways. Experienced and proven brokers have a deep list of connections with potential buyers in service-based industries. They leverage only private channels (i.e. databases, etc.) and ensure any potential buyer who views your company’s information keeps things confidential.
This step may also involve the use of non-disclosure agreements (NDAs). This is a document that anyone who views your confidential information memorandum (CIM) must sign. It states that they will not disclose information that they find in the CIM, video interview, or in any document you present to them during the offers stage.
Step 5: Screen The Initial Offers and Begin The Negotiation Processes
The broker will screen the offers as they arrive. This may be necessary as it is not uncommon for some service-based business owners to receive dozens of initial offers. Although video interviews allow you to stay in negotiations with as many as possible, you may need to weed out the unqualified buyers or the ones with whom you would prefer not to sell.
It is also important to choose a business broker who understands how to negotiate in a professional and effective manner. The final offer should ideally be more favorable for you than the initial offer, and the one you accept should be for fair market value and according to the non-financial goals you have set for the sale.
Step 6: The Buyer Signs a Letter of Intent (LOI) and Begins Due Diligence
Once you officially accept someone’s offer, you will have them sign a letter of intent (LOI). This document establishes the terms of the purchase. Although most LOIs are non-binding, it helps secure the deal, in which case you can feel more comfortable moving forward with due diligence. During due diligence, you can expect the following:
- The buyer will review your company documents (the ones you prepared in step 3)
- The buyer may provide a list of questions for you to answer
- You and the buyer may meet regularly (virtually or in-person) to discuss the progress of due diligence
- The buyer may visit your facilities and meet with business partners (or other important members of the company)
Step 7: Close The Sale and Transfer Ownership of The Company
Lastly, you will need to close the sale. Much of the work has been done by this point, but there are still a few actions you will need to take as the seller. In many cases, the LOI can be used as a template for the purchase agreement, although there may be some minor changes. The purchase agreement is drafted, presented to the buyer, and then signed during the closing meeting. Also during closing, the buyer will complete the payment to acquire your service-based business. This may involve a direct payment or the release of funds from an escrow agent.
After the payment, you can begin transferring ownership of the company. This starts with updating business information and providing the buyer with full access to company facilities, security systems, etc. You may also need to train the new ownership; the details of training should have been solidified during the negotiation and due diligence stage. Some sellers may remain involved for a year after the sale, whereas others are not needed for the transition much at all.
Contact Our Business Broker for a Free Business Valuation
Are you considering selling your service-based business? If so, then contact our office here at SIgma Mergers and Acquisitions. We help business owners sell for fair market value and help ensure they have a pleasant experience throughout the process. We would like to get started with a free, no-obligation business valuation, which allows you to determine the value your company has on the market.