If you are considering selling your small business in Colorado, there are many steps to consider to market your business most effectively. From valuing your business to finding a buyer, small businesses interested in selling should do their research and prepare.
This article will help you think about the different steps involved in selling including:
- When to Sell
- How to Value Your Business
- Finding a Buyer
- How Long It Takes to Sell a Business
- Seller Financing
- Legal Steps
You should always consult an experienced business lawyer before embarking on the sales journey to understand exactly what you need to do. Our lawyers here at Newburn Law have years of experience helping our small business owner clients evaluate and sell their businesses.
When to Create a Sales Plan
The first step a business owner should take when considering selling their business is to create an exit strategy. If you are considering selling your business, you should begin necessary preparations a year or two in advance of your desired sale. This period will allow you to compile all the required documents and strategize about potential negotiations.
Some experts say that planning ahead beginning three years before you hope to sell will allow your business enough time to clean up documents, build standard operating procedures, and train a manager capable of maintaining performance after you leave. Potential buyers will also want to see at least three to five years of profit and loss statements and tax returns. Therefore, keeping accurate, up-to-date books and records of your business's operations is crucial.
When is it best to sell your small business?
To maximize your profits, you should try and sell your business at its peak performance but while showing the potential for future growth. This requires valuing your business's profitability and earnings, forecasting future earnings, and being prepared to sell at your best.
However, when to sell is also largely dependent on your personal needs. Are you looking to make a professional change? A lifestyle change? If so, this may also impact when the best time to sell is.
Big events, such as the COVID-19 pandemic or major changes in the industry you operate in, may substantially impact your business's value. Therefore, if you experienced any negative impact on your business from the recent pandemic, waiting for your business to recover may be worthwhile before entering the market.
Further, if your business is part of an industry that is experiencing a downturn, try and avoid selling during the downturn.
How to Value Your Business
To make the most money from the sale of your business, you must determine what your business is worth. Many service providers in Colorado perform business valuations and can be useful for getting a professional estimate. The Denver Metro Chamber of Commerce provides some tips for evaluating your businesses' value:
Fair Market Value
The Denver Metro Chamber of Commerce defines the Fair Market Value of a business as “the price a willing buyer would pay a willing seller, where both parties have reasonable knowledge of relevant facts.” To arrive at your Fair Market Value, you can use one of the following approaches:
- The asset approach totals the value of the assets of your business as if each was being sold individually. That number is then subtracted by the businesses liabilities. This method does not cash flows or growth potential. For example, aggregating the market value of all of the equipment in a gym and subtracting any liabilities (such as amounts remaining due under any lease) would give you an asset approach valuation. The asset approach typically provides the lowest valuation.
The income approach uses complex calculation methods to determine the present value of the income stream and indications of future income. This approach uses a financial model to determine the future net income stream of a business on a monthly or yearly basis and discounting those cash flows back to the present using a discount rate appropriate for that business. In the gym example, this would involve forecasting future revenues (say from membership dues), subtracting future forecasted expenses, and discounting those future cash streams back to the present to give a net present value of the business. The income approach is typically used for non-sales valuations (such as in a divorce) and typically results in a higher valuation than the asset approach.
- The market approach compares the value of your business to that of a company of similar size and industry. To do this, a net income number (typically either the last completed fiscal year or projections for the next fiscal year) is multiplied by a number, often referred to as the "multiple," specific to your businesses industry. For example, the average multiple for a gym is 1.5 - 3 on the trailing 12 months depending on the quality of the earnings. So, if the gym in our example made $200,000 last year, the market approach would return a valuation between $300,00 and $600,000. The market approach is the most common used in the actual purchase and sale of businesses and typically results in a higher valuation than the asset approach and one comparable to the income approach.
While many of these approaches can help you determine the value of your business, it is to your benefit to measure your business by each method and market off whichever approach offers the best valuation.
Documentation for Valuation
A buyer will not likely take your word for your valuation. Therefore, you must be prepared with all the necessary documentation to substantiate your business's worth. As mentioned, buyers will likely want to see:
- At least three to five years of financial statements
- At least the last two years' tax returns
- A list of all property, including intellectual property owned, by the business, with acquisition dates, depreciation schedules and maintenance reports
- Business forecasts, business plans, and organizational documents
- Owner's discretionary earnings
These documents should be enough for an analyst to determine your business's past and potential future earnings, but be prepared to offer additional information upon request.
Finding a Buyer
Finding a buyer for your business requires knowing what potential buyers are looking for. To determine the right buyer for your business, you must prepare research ahead of time to decide how to make your pitch.
The Colorado Association of Business Intermediaries (CABI) provides information on how to find a buyer and develop a buyer profile. A few key elements you should evaluate when looking at buyers are:
- Gauging the seriousness of a buyer; and
- Understanding the reasons the buyer may pursue your business (include early retirement, job dissatisfaction, being laid-off, desire for control over their lives, or desire to do their own thing).
Understanding the motivation of your potential buyer can help you make the best strategic negotiation decisions.
Money is often not the only reason for purchasers of small businesses. Therefore, consider the following traits of a willing buyer:
- The buyer's desire to buy a business
- The buyer's urgency to buy a business
- The buyer's need to buy a business
- The buyer's financial resources
- The buyer's ability to make their own decisions (i.e., do they need approval from a board, other individuals, or other entities)
- The buyer's reasonable expectations about what business ownership can do for them.
Questions a Buyer May Ask
You must be prepared to answer many questions from a potential buyer as they gauge whether they want to purchase your business. Frequently asked questions include:
- How much will the business cost?
- What is the company's core product or service?
- What is the annual increase in sales of the service or product?
- What is the debt of the business?
- What can the buyer do to add value to the business?
- What is the value of the business's IP?
- What are the barriers to entry in the business' industry?
Inability to answer these questions could be costly to negotiations; showing a potential buyer diligence and confidence can be crucial to marketing your business. Importantly, misrepresentation of information must be avoided to maintain your reputation and avoid possible legal repercussions.
The Importance of Cash Flow
Having all the documentation from a valuation will be very important to the buyer, who will most likely be looking for cash flow. Cash flow is more than just profit. Cash flow includes where payments are made and to whom.
Buyers may be curious if you have made any big-time purchases, the cost of particular goods, or how many employees need to be on staff. Additionally, you want to portray your business in the best light possible to potential buyers. Consider tidying up your business, repairing signs, maintaining your inventory, and ensuring you don't let your business slide during negotiations.
How Long Does It Take to Sell a Business?
Studies show that selling a business typically takes about 8-10 months. However, that number seems to increase yearly. Factors that slow the process include overpricing your business from the start and not having all the necessary information for the buyer. Exercising preparedness by following the steps above for valuing your business and having the appropriate documentation will facilitate a faster sale.
Should you hire a Business Brokerage?
Selling a business can be an incredibly intimidating process. Specifically for first-time sellers, an experienced business brokerage may be helpful throughout the process. Because of their expertise, hiring a business brokerage can help you sell your business more effectively and for a higher price. However, business brokerages will generally take a commission from the sale.
If you are thinking about hiring the services of a business broker, you should interview various brokerage firms, asking questions to understand if:
- The broker is willing to defend the value of your business
- The broker will run a full-time campaign to sell your business or has a rolodex of potential buyers available already
- The broker has experience offering compelling offer summaries for potential buyers
- The broker has an effective screening and qualifying system for potential buyers
- The broker has systems in place to protect your confidentiality
- The broker will attract the right type of prospective buyers
- The broker has experience with digital platforms to manage the process effectively
While a business broker can be extremely helpful with the sale of your business, an experienced lawyer is also critical ensure all of the legal processes are in place. The legal side of the sale of a small business is the most crucial to ensure you are shielded from any future liability and receive the best value for your business.
Seller financing is a good way to facilitate the sale of your business for a buyer who cannot afford it outright. Seller financing is essentially when the seller provides the buyer with a loan so that the buyer can purchase a portion of the purchase price on that loan. The buyer will pay back the loan like a typical loan, and the seller can collect interest.
Financing your sale in this way can have significant benefits for both the buyer and seller, including accumulating interest for the seller and reducing the cost of the initial down payment for the buyer.
Seller financing can be a tricky transaction. Therefore, you should always have knowledgeable finance lawyers create, review, and negotiate these agreements for you.
When you decide to close on the sale of your business, several legal steps will require the help of a qualified attorney. There can be many legal documents involved in the sale of your business, including:
- Letters of Intent
- Asset Purchase Agreements
- Purchase and Sale Agreements
- Acquisition Agreements
- Merger Agreements
- Redrafting of Operating Agreements or ByLaws
- Creation of New Formation Documents
- Lease Agreements
- Sale Agreements
- Business Bill of Sale
- IP Allocation Agreements
- Unanimous Consent Documents
An attorney can help sell your business by performing or providing corporate formation support, contract negotiation and drafting, valuing the business preparing financial documents, and closing and post-closing support.
Legal documentation can be complex, and having the support of a good attorney can help you avoid pitfalls during the sale of your business.
If you are considering selling your small business, contact our lawyers at Newburn Law today to understand how we can help get you the most value for your business.