By Tim McDonald
For centuries, the maxim caveat emptor (let the buyer beware) has been a principle of law in commercial transactions. However, if you plan to sell your business, it’s best to be guided by a equally important dictum: caveat venditor (let the seller beware). How do you qualify a prospective buyer to know that he is, indeed, what he claims to be: someone who is genuinely interested in buying your business and has the capacity to do so?
Having an experienced professional vet prospective buyers is a good first step. In addition, be careful what you say. Quite naturally, you are full of enthusiasm about your enterprise but don’t let praise and sales puffery morph into misrepresentation or fraud. Misrepresentation is a false statement that induces someone to enter into a contract. You make a statement believing it to be true, but it wasn’t. If you make that statement knowing it to be… uh… not true, you have just crossed the line into fraud. So think before speaking.
You should expect a serious buyer to do due diligence and to ask questions. Put yourself in his shoes and provide the information needed for a qualified buyer to make an informed decision. Take a leaf from the book of public companies and compile a “Fact Sheet” or “Investor Highlights” that sets out the reasons why your company is a good buy. In addition, have a credible story for why you want to sell.
How well is your business doing now?
This question can be answered with financials and bank statements. A serious buyer would like to see, at least, audited income statements and balance sheets for the past three years, and possibly five. Bank statements should verify the cash flow. Tax returns will act as a further check on the veracity of the information and show you have no outstanding tax liabilities.
The issue of valuation will, of course, be at the forefront and there are several methods to arrive at a fair price. One simple way to approach what is a complex topic is to separate the present earning capacity of the business from its future prospects. Then a fair price would be the expected earnings in the coming year capitalized at a discount rate that reflects the risk of your business plus the present value of growth opportunities, if any.
If your business has the capacity to grow, that could add substantially to its value. Indeed, the high valuation of many public companies are based on their growth prospects. If you can show a feasible route to expansion, given the competitive landscape, you will, most likely, be adding value to the transaction process. Your Fact Sheet might contain “forward-looking statements” under the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements regarding your business strategies, estimated potential market size and future development.
A buyer will expect you to sign a covenant not to compete as part of the sales agreement. A covenant not to compete is, essentially, a contract in restraint of trade and will only be valid if it is both reasonable and in the public interest. A buyer cannot expect that you will sit on your hands and not use your knowledge and expertise in the future.
Intangible assets are, sometimes, the most valuable assets in a business. They are non- monetary assets without physical substance and include customer lists, trademarks, internet domains, and intellectual property. Important contracts with customers or suppliers also constitute intangible assets and so too does hard-to-quantify goodwill.
Receivables are intangible but not intangible assets. They are financial assets with a dollar value. Generally, small business sales are undertaken as asset sales rather than sales of an entity. If your business is viewed as a collection of assets, you can decide which assets are for sale and which are not. And you may hold on to the receivables and collect them yourself. If you are selling the business as an entity, receivables must be included since they are a vital part (working capital) of the entity.
Lease issues are important. A landlord can make or break a deal. You must get the landlord’s agreement to assign the lease so inform him as early as possible, particularly if the remaining term is short. Try to get some idea of his thinking. What are his requirements for a new tenant? He will want to be sure that his new tenant can pay the rent and may apply a qualifying condition, such as that annual net income must be three times the annual rent.
Nevertheless, although laws vary from jurisdiction to jurisdiction, the general principle is that a landlord cannot unreasonably withhold his consent. It is generally thought to be unreasonable for a landlord to withhold consent in order to improve his bargaining position. He cannot, for example, demand a higher rent as a condition for approving the assignment. That is partly because under an assignment, you remain a party to the lease and if the tenant fails in any obligation, such as paying the rent, you will be liable.
Skeletons in the closet
A buyer will, most likely, consider whether to treat the transaction as a collection of assets sales or as a single business entity. The choice will have important tax consequences. Acquiring the business as a single entity is, superficially, simple. However, bear in mind that not all of its liabilities will appear on the balance sheet.
The buyer may have all the financial information he needs but, if he’s shrewd, he will know that there’s more to a business than an income statement, balance sheet and cash flow statement. He will know that buying a business requires further due diligence. To make an informed decision requires an assessment of the business’ competitive position, its market, and potential future risks. He will realize that to avoid misfortune down the road calls for preparation, bearing in mind the old saw: if you fail to prepare, you must prepare to fail.