What Steps Should You Take Before You Buy or Sell a Business?

For a business owner looking to sell their business, this transaction will likely be the biggest liquidity event of their life and the culmination of their life’s work. Starting a business, growing it, hiring trusted team members — for many, their business is the crowning achievement of their professional life. And for buyers who are looking to get into new markets or expand, acquiring a business can be a means of achieving their long-term goals for themselves and their family.

Today’s landscape

The environment we’re in is hot. The private equity industry has $2.5 trillion in potential cash ready to be deployed. Companies are operating at capacity, employment rates are high, performance and production are soaring, talent is at a premium and access points to entry are limited. Banks are willing to lend, private equity firms are flush with cash, and strategic buyers are looking at every opportunity. And there are many entrepreneurs who are already working through the layers of compliance, legal issues and terms of a business sale transaction. This makes it a prime time to buy or sell.

Multiples

Given the cash-rich environment, multiples (business valuation ratios) are historically high, routinely reaching 9.5, 12, 13 and higher. Strategic buyers, more than private equity firms, are driving the trend because access points are limited and cash is readily available. If people want a company in a given market, or a presence in a specific industry, they are going to pay up for it. Companies that were trading at multiples of 4 just 10 years ago are routinely getting 6.5 times their EBITDA (earnings before interest, taxes, depreciation and amortization) valuation. Even if you’ve never thought about selling your business, the multiples people are willing to pay are high enough that, depending on your long-term goals for yourself and your business, you might reconsider.

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In many scenarios, buyers are able to create negotiating leverage with cash and employing scheduled hurdles, as well as through protective measures like thorough due diligence on the business and its assets so that any liabilities are understood and factored into their evaluation before the parties even begin negotiations.

Business valuation

In the current accelerated environment, entrepreneurs should pay special attention to business valuation and forensic accounting to help prepare their business and balance sheets for the sale. Buyers should do the same to understand the hidden liabilities and tax implications of a potential acquisition.

A trend we’re seeing now is that while business owners are doing a great job delivering value to their clients and growing their businesses, rarely are they coming to the negotiating table with their tax liabilities and financial statements in good order, or even in compliance. Because of the shorter duration of transactions in the market we are currently in, frequently dropping to 120, 90 and even 60 days, the quality of due diligence that entrepreneurs are conducting in advance of the sale is lacking. A few years ago, sellers would hire an independent third party to conduct an audit of their previous three years of financial statements, but now, due to the accelerated pace, audits might go back one year, if they are conducted at all.

Diligence also includes looking closely at the structure of the firm, from employees, assets and forecasting to external issues, such as competitors, potential disruptions, tariffs and regulatory issues. Another key component of diligence buyers and sellers must conduct is a quality of earnings (QofE) report (which examines if anomalies have impacted a company’s bottom line) and a thorough review of the company’s ownership structure.

Taking the time to kick the tires before you go down the road of exclusivity and letters of intent is of critical importance to not just the sale price but may also serve to eliminate tax and legal complications down the road.

Diligence

Transaction lawyers assist business buyers and sellers establish terms that maximize not only the price but also identify and mitigate risk factors, such as labor, tax exemption and compliance issues. QofE reports and even deeper dives, like verifying the accuracy of earnings and researching their sustainability, can prevent litigation subsequent to the signing of a letter of intent. It’s entirely possible for a deal to reach the letter of intent stage only to be blown up when a QofE report reveals a discrepancy.

In order to make a successful sale or purchase, you need to conduct your due diligence well in advance of the transaction to give yourself leverage in negotiations and to prevent surprises. To be in a good position to sell your business, everything needs to be properly filed, executed and in compliance. Think of your business like putting a house on the market. You need to do an inspection and spend some money enhancing the curb appeal, identifying areas that require additional capital and, in some cases, trimming the fat. If, for example, you are selling an S corporation, make sure you’ve actually filed your election paperwork.

Another critical aspect of the transaction sellers and buyers often need help with is drafting or even reading the agreement — it is incredibly important to surround yourself with a team to help you manage all of the information, sequencing and terms so you are not overwhelmed. If the seller was a top line salesman, it’s highly unlikely they will take the time to carefully read the agreement, and even if they were a detail-oriented engineer, they might read everything and be overwhelmed anyway.

For a buyer or seller, the key is to conduct extensive diligence on the business in question well in advance of signing a letter of intent or even beginning negotiations. Know the business’ assets, vulnerabilities, marketplace, potential for growth and quality of earnings before you get into a sales discussion. Be aware of the risks and leave yourself enough time to fix them. Because if the team on the other side of the table discovers something new, they are going to hit you over the head with it.