How to Sell a Business

On a long enough timescale, almost every entrepreneur considers selling their business. The reasons for wanting to liquidate your stake in your company vary, and include: desiring to focus on another venture, receiving interest from a potential buyer, and preparing for retirement. Whatever the reason, it is important to understand how a business sale transaction works and what major steps are involved. Below is an outline of the key stages of a business sale and some guidance on what to expect in each stage:

Stage 1: Internal Due Diligence

The key question you want to answer at the Internal Due Diligence stage is: “What is the value of the company?” To answer this question, sellers begin by conducting a detailed review of the company’s financial records and projections. Determining the value of the company also requires developing an understanding of the company’s non-financial value and of the company’s warts. Before you can entertain an offer from a buyer, you should be confident in your own assessment of the value of your business.

Selling a business is a bit like rafting down a river: you need to look ahead for the big rocks and start planning your route around them early. During the Internal Due Diligence review, you want to identify all the major items that could affect the smooth transfer of the business to a buyer. For instance:

Your company may operate in a regulated industry that requires your company to hold permits to operate. You will want to understand whether the permits can be transferred, and whether a buyer will need to separately apply for a new permit. 

Your company may be a tenant renting space under a lease. You will want to understand whether you can assign the lease to a buyer, and what level of landlord involvement will be required.

Waiting until the last minute to deal with these types of issues can capsize a deal.

The process of conducting internal diligence consists of reviewing, among other things, finances, taxes, permits, leases, material contracts, business practices, intellectual property, environmental compliance and employment matters. Many entrepreneurs use online business value calculators and/or retain a business valuation expert to drill down on a potential price for the sale.

Stage 2: Approaching Buyers; Signing a Term Sheet

If you are thinking about selling, hopefully you already have a few potential buyers for your business in mind. If not, know that the market for small businesses is typically limited. Strategies for finding buyers include: searching for other businesses in your industry that are looking to expand in your region, attending business investment networking events, looking internally at your key employees, and approaching competitors about their desire to buy you out.

When discussing the potential sale of your company, be sure to have interested parties sign a simple nondisclosure agreement. A nondisclosure agreement is especially important to have in place before sending any documentation to an interested party. 

Using the findings from the Internal Due Diligence phase, and the initial feedback from interested parties, you should work with legal counsel to draft a Term Sheet. A Term Sheet is a (mostly) non-binding document that outlines the major terms of the sale. A Term Sheet is useful in literally getting a seller and a buyer on the same page. It may take some negotiation, but once a seller and buyer are happy with the Term Sheet, the parties will sign the document and it will then serve as the guiding document for the rest of a sale.

A Term Sheet is non-binding, meaning that the parties are free to change the major terms of the sale as the transaction progresses.  Typically, the only provision of a Term Sheet that will be binding is the obligation to exclusively deal with a single buyer. An exclusivity provision locks you into a two-party negotiation with a specific buyer and sometimes is accompanied by an initial payment by the buyer.

Stage 3: Buyer Due Diligence

Once you enter a Term Sheet with a buyer, you should expect to receive requests to disclose information so that the buyer can conduct its due diligence review of the company. Typically, a buyer will ask for a very wide range of information using a diligence request list. Responding to diligence requests can be very time consuming. Generally speaking, a seller should be very responsive to diligence requests and should respect the buyer’s process. However, a seller should feel free to question the value of specific diligence request prior to expending significant time responding.

Topics for review include: corporate documentation, meeting minutes, equity documents, financial statements, asset list, tax returns, debt, leases, government permits, intellectual property, compliance with regulations, employment records and benefit programs, environmental issues, major contracts, customer information, ongoing litigation, insurance coverage and general business practices. In some cases a buyer will ask simple yes-or-no questions. In other cases a buyer may ask you to deliver copies of documents.

Failing to identify the company’s warts in the Initial Due Diligence phase can become a problem during the Buyer Due Diligence phase. A buyer wants to find all the potential issues with the company with the hopes of negotiating a lower purchase price or insulating itself from risk.

Regardless of the difficulties the bad facts may present, it is paramount that you be completely truthful with a buyer during the diligence phase. Failure to disclose material information may give a buyer the right to sue you after the sale is complete and to take back some of the purchase price.

Stage 4: Negotiating the Purchase Agreement

Once Buyer Due Diligence is underway, you, the seller, will want to work with legal counsel to prepare a draft purchase agreement for the sale of the business. Buyers usually will not comment on the purchase agreement until they have completed almost all their due diligence.

The purchase agreement may take the form of an Asset Purchase Agreement or an Equity Purchase Agreement. The purchase agreement will describe how the purchase price is paid and other related concepts like financing, earn outs and working capital adjustments. The purchase agreement will contain representations and warranties made by the seller that the buyer can hold the seller to later. The purchase agreement may contain other provisions such as agreements or “covenants” to take certain action, and indemnification and dispute resolution clauses. The purchase agreement is typically where legal counsel provides the most guidance and value. 

Negotiation of the purchase agreement usually involves a back-and-forth exchange of the document between buyer and seller until all issues have been addressed. Once the agreement is fully negotiated, then it’s finally time to sign and close the deal (and receive your check)!

The four stages outlined above are general guideposts. In many cases, some of the stages (especially the last two) will occur simultaneously. Understandably, the lower the value of the business, the less time and money is available to be spent on the process. Regardless, these general concepts of diligence and negotiation will arise in almost any business sale.