Seller Beware: Avoid These 6 'Gotchas' In Selling Your Business

I was working with the co-owners of a retail sporting goods shop when the topic came up about possibly selling their business to outsiders.

We discussed what a competing store in the area might want to know if they were to become a prospective buyer.

They’d probably want information on:

• Financials (revenues, profits, loans, etc.)
• Staff
• Location
• Leases of their stores
• Existing inventory

I pointed out that if the buyer was a “big box” retailer instead, the scenario could be different. When a large company wants to swallow up a small operation, there’s a David-and-Goliath situation.

Big box retailers will bring in an army of MBAs who do these deals monthly, while the small retailer may be involved in the one and only deal of an entire career. These sales happen all the time, many successfully for both parties, but it’s important for small business owners to watch out for the “gotchas” in selling their business.

Although the following list isn’t exhaustive, it may give you a feel for some of the items to address when considering selling your business.

Gotcha No. 1: The intermediary

The intermediary is the deal maker.

For example, business brokers and investment bankers often serve as the go-between with the seller and the buyer of a business. In some cases however, it is difficult to separate the intermediary from the buyer.

Consider private equity firms.

Private equity firms put together the deal, but they do so on behalf of a hedge fund, institutional investor or other capital source. Consider who the intermediary is beholden to, how it gets paid and where its loyalties lay.

If you hire an investment banker, you’ll want to know if the firm is working on your behalf to shop for the best deal in the market or is working for a major buyer who is looking to pluck small operations off at the lowest possible price.

Further, the terms of the agreement the seller has with the intermediary are crucial:

•  Is theirs an exclusive listing, and for how long?
• Will that listing affect the seller’s ability to sell to others … perhaps internally?
• Are there upfront costs, or is the agreement purely a revenue share?

Gotcha No. 2: The valuation

Valuation is a range, not a value. And until a check is written, valuation is a slippery concept.

Some buyers will start with an inflated initial offer price as a way to entice the business owner to sell. The actual sales price, however, could be lower because of flaws alleged to have been discovered during the due diligence phase.

Or, the sale price may be high, but the terms of the sale have so many hooks, such as earn-outs and non-competes, that the true economic value of the deal to the seller is much lower.

And, in some cases, a low sale price is the result of a war of attrition.

The sales process drags on for so long that the seller accepts a lower price simply because it feels like it’s too late to turn back. The lesson for sellers is to not just focus on the price but to also understand the terms and the process for obtaining that amount.

Gotcha No. 3: The sales process

Most business sales take a number of months to complete.

The initial offer may be put together quickly, but there is usually a due diligence phase where the buyer gets to check out the business and its financials.

During this period, sellers can be challenged by the amount of personal and staff time it takes to support the review. Because of this distraction, it is not uncommon for sales and profits to suffer. It’s important to avoid having this predictable downturn reflect negatively in the final price used in the sale.

Create a game plan to wall off the sales process from day-to-day operations.

Gotcha No. 4: Internal obligations

An all-too-commonly forgotten issue in a business sale is the disposition of the company’s benefits and retirement plans.

Both buyer and seller must recognize that a qualified retirement plan involves long-term legal commitments to employees. The parties must be aware of controlled group issues and exercise caution when structuring the transaction.

For example, they should consider whether there will be one or two plans after the sale.

Likewise, they must study other benefit plans. Some nonqualified deferred compensation plans allow executives to receive a payout upon a “change in control.” Is there liquidity for such a distribution, and could that clause trigger an exodus of key personnel?

Gotcha No. 5: Provisions in the agreement

Especially when Goliath is buying David, it’s important to consider the impact of contractual provisions.

For example, earn-outs are a perfectly acceptable way for a buyer to protect itself against an unexpected loss of customers.

The seller, however, needs to understand:

• How the earn-out works
• Who does the measuring
• What affect this may have on net proceeds

Similarly, most states still permit limited non-compete clauses as a way for buyers to protect against unfair competition from the seller.

Again, though, the seller needs to understand how this may affect his or her career aspirations for the future. Will the seller have to change professions, perhaps move?

Gotcha No. 6: Taxes

I saved one of the biggest issues for last.

So often a business sale is done in the vacuum of purely legal and financial issues. The seller fails to consider the after-tax effect of one sale structure versus another.

For example, selling the business for its assets rather than its stock can radically alter the tax outcomes for both parties. Or, a lump-sum sale provides peace of mind to the seller but also increases the tax bill.

A technical but not insubstantial issue is how goodwill is characterized. When the top ordinary income tax bracket is nearly 40 percent, while the top capital gain rate is half of that … tax characterization matters. Taxes need to be a strategic part of the deal, not simply the result.

The sale of your business can be a well-deserved payday. Just don’t let the gotchas involved in the sales process wreck the outcome.

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Seller Beware: Avoid These 6 'Gotchas' In Selling Your Business:



For additional information regarding Florida business sales, acquisitions and valuations, please contact Eric J. Gall at info@buysellflbiz.com or 239.738.6227. Also, visit our Florida Business Exchange website at www.fbxbrokers.com and my personal website at www.buysellflbiz.com.