Demystifying the business sale process.
For many SME business owners, starting down the route of selling can look like a bewildering process. It was for me, so in this article I attempt to break it down for you.
No two deals are the same, but like all well-trodden paths the sale of an SME business usually follows a pretty predictable pattern – with the same milestones identifiable on every journey.
When I start working with a client, I’m always sure to walk through this process with them so they are mentally prepared. I ask them to continually maintain an awareness of where we are on the journey as things progress. This provides motivation at tough times; they can see just how far they’ve come.
1. Arriving at the decision to sell
Usually with the help of an advisor, you review where you are. You might perform a SWOT analysis of the business, collate your key financials, and establish your ‘story’. All of this is vital. I always say better to do it now in an orderly fashion, rather than cobble it together as the process unfolds.
At this point, you also establish what you are selling. Is it a share sale, and are all shareholders aligned? Is it an asset sale; appropriate if you wish to divest part of the company? In professional services particularly, you may also be looking for a merger or enhanced income exit.
Now you can start to define your target buyer profile. It could be a competitor, a trade buyer, private equity, financial investor – national or international.
This can be done in as much detail as you wish. There is no shortage of brokers, valuation agents, accountants and blokes down the pub that will be happy to value your business for you. If it strokes your ego, you can fixate yourself on the highest number you hear, as many people do.
My advice here is to keep it simple. Unless you have very complex affairs or a specialised asset base, it’s best to establish a realistic range with the help of a professional.
The golden rule is that the structure and timing of any consideration is just as important the headline ‘price’.
I really don’t want to go into detail on valuations here. There are a million articles on this subject, but in short the valuation of your business is likely to be a mix of:
· Multiple of sustainable cashflows (EBITDA profit usually, but convention dictates other measure in certain sectors, notably Gross Recurring Fees for professional firms for example)
· Net Asset Value – particularly where you have extensive fixed assets or property
· DCF, discounted cash flow modelling. This involves more geeky investment appraisal techniques such as Internal Rate of Return (IRR) and Net Present Value (NPV) which requires a cost of capital (discount rate) to be applied. Unless sophisticated financial buyers are involved such as private equity, you can ignore this unless it comes up. 3. Information Memorandum
We create the ‘sales document’ which we will use to market your business. It contains 5-20 pages or slides and showcases your business to prospective buyers. It will cover the market you operate in, your key strengths, historical financials and an outlook for the future.
This only gets sent to vetted buyers later on and is always subject to a confidentiality agreement.
Sometimes we can create an anonymised, slimmed down version called a ‘teaser’ which we can send to anyone and everyone. I like this step as it is a chance to stand out from more conservative businesses, but it’s not always appropriate.
4. Marketing Process
We can now start contacting prospective buyers to generate interest. This can be done on-market through websites or brokers. This is good for certain sectors like pubs or care homes where swift, sensible sales can be secured very quickly through a well established market. Alternatively, it can be done off-market where we use a network of M&A professionals to discreetly approach potential trade buyers or investors.
5. NDA – Non Disclosure Agreement
This is simply a confidentiality agreement where, before we send any information about your business, the enquirer agrees not to use the information for any other purpose nor pass it on.
Many might say it’s not worth the paper it’s written on, but it’s industry standard and anything people have to sign personally tends to focus the mind. To dispense with NDAs would come across as sloppy, so regardless of whether it is enforceable, it is a must.
6. Manage interested parties
Like anything that is for sale, you’ll get tyre kickers or competitors in the industry sniffing out information. This is where you need a robust gatekeeper to assess anyone that requests information. We will have established the buyer criteria in advance, remember, so we can remain tight.
What we are trying to achieve is a healthy range of interested parties simultaneously so we can be in control of the sale process. We don’t want overload, but this is a supply/demand situation if ever there was one, so we are trying to create a ‘market’. Several active bidders is a nice target to aim for.
7. Negotiation – ACT I
There are many brokers out there that simply pause at this stage. I know from my experience on the buy side. It never ceases to amaze me. Their job is to sell your business, and yet sometimes, once they’ve emailed the Information Memorandum, that’s it! No follow up, no invitation to progress, no feed back requested. I find this incredibly disappointing.
Needless to say, I believe in a different technique.
This is the stage where buyers need to be carefully handled. We need to establish their motivations and find out what their options are. We also establish their misgivings, if any, and assess their appetite for risk. We can then point out the advantages of your business and how it fits their acquisition profile.
Make no mistake, this is a sales process. It requires sensitivity and professionalism, but perseverance and persuasion as well.
8. LOI – Letter of Intent
When the buyer is ready to make an offer, this is where we ask them to lay down the terms. It could simply be an email; it’s not binding. But I would expect it to be carefully thought through and contain sufficient detail for the us to compare like for like with others.
Of course, all LOIs do not arrive at the same time for easy comparison, so it’s a case of careful bidder management so we can synchronise their arrival ideally.
9. Heads of Terms
Once an offer is accepted in principle, we move to formalise the offer. This involves a legal document called Heads of Terms (HOTS) or Heads of Agreement. This lays out everything that has been agreed, and goes into more detail on matters like restrictive covenants, earn-out mechanics, warranties and indemnities.
For the most part it still isn’t legally binding – you can both pull out. Some parts are legally binding though, such as the exclusivity lock out period (where you agree to pause negotiations with others) and any further confidentiality commitments.
HOTS can be done without lawyers but I rarely advise this. It’s not expensive and a good lawyer will always want to be involved from the start. Trying to wriggle out of material aspects of the HOTS later down the line is not cool, so better get it right first time with a good lawyer.
10. Due Diligence
You have now agreed on your suitor. You are engaged but not yet married. It's now time for the buyer to gain access to all your books. They will request all sorts of information about your business so they can check the integrity of what they are buying.
Anyone who has bought or sold a house will be familiar with some aspects of what to expect. There will be a series of endless checklists and questionnaires which go into incredible detail – most of which don’t apply to your business. You’ll never write “N/A” so many times in your life.
But joking aside, this is a serious process. The buyer’s lawyers and accountants will be scrutinising three main aspects:
Financial due diligence – checking you’ve paid your taxes, your finances reflect reality, all your compliance is in order.
Legal due diligence – checking you own your assets and shares, your IP trademarks and patents are in order, no employment issues, no legal claims or risks.
Commercial due diligence – more subjective areas. That you are of good standing in your industry, your products, website, reputation, marketing, PR track record and testimonials all stack up and don’t reveal any nasties.
People often think this due diligence must involve an invasion of your premises and can’t see how that would work. Don’t worry, site visits can usually be easily avoided. All requested information is placed in a ‘data room’ managed by your lawyer which gives buyers access to documentation, finances and other files. These are secure web-based locations in the cloud, managed by your lawyer.
In the old days, data rooms were actually physical rooms with rows of filing cabinets for buyers to visit and wade through documents. They strangely always had no air-con and flickering strip lamps….
Due diligence is a large part of your sale process. Buckle up as this can be the most painstaking stage. It can also be a lonely one if you are trying to keep the sale confidential from key employees.
11. Negotiation ACT II
Like home buyers after they have engaged a survey report, some buyers use the DD process as an opportunity to raise concerns. They often seek to reduce the price or amend the terms. Needless to say, it requires resistance, diplomacy and creativity to address any legitimate concerns without reducing the value achieved.
Unless there are serious (previously undisclosed) threats to future income streams, the deal can usually be kept on track. Remember that buyers will have incurred significant legal fees by this stage so will be reluctant to simply withdraw.
12. SPA – Sale and Purchase Agreement (or Share Purchase Agreement)
In tandem with DD, the lawyers will be creating the SPA which is the formal legal instrument by which ownership will ultimately transfer from one party to another.
This can be batted back and forth between lawyers endlessly if you are not careful, and unless you love reading large invoices, a little proactive management needs to be applied to the lawyers.
The document itself is usually about 120 pages for a share sale and 60 for a trade/asset sale. It will contain lots of detail around:
· Consideration quantum, timing and conditions
· Definition of shares or business assets
· Restrictive covenants (non-compete clauses usually)
· Warranties and indemnities plus any claw-back mechanism if these are breached
· Earn-out mechanism if applicable (how you get a share of future upside)
· How to deal with cash or other assets in the business post-sale
You can expect this process to last about 6-8 weeks, though with an extra pair of eyes on it and a fair bit of pressure, you could halve that. In my experience it’s all about turnaround time. If every party involved (clients and lawyers) take a week to process and reply to messages, it can drag endlessly. I advocate a 24hr reply policy from everyone involved.
13. Disclosure Letter and Other ancillary documents
Right at the end, as everything is being pulled together, some final items often come up.
The seller may have agreed to stay in service post-completion, and therefore they need an ongoing employment or consultancy contract. This is where penny pinching can creep in over terms. What annual holiday will be allowed? What about contractual place of work? Expenses policy? Better to have agreed it all upfront in the HOTs if you can, though this is not always realistic.
There may also be a settlement agreement where you resign as a Director of the old company and agree not to bring a claim against it in future. This may also be expected from family members if they have been employed. Things like company cars, company credit cards and mobile phones may have to be given up as part of this. 14. Completion!
Depending on the complexity of the sale (e.g. multi company) and the number of documents, you will need to attend your lawyers office to sign a ‘bundle’.
Completion and transfer of funds takes place between lawyers and, hey presto, the champagne can flow.
Now... the hard work begins on the integration of your business into the hands of the new owner.
If any of these issues resonate with you, and you’d like to talk, I’d be delighted to hear about your situation. Feel free to contact me.