The reader is advised to first read the initial article in this series which describes the basics of selling one’s business to employees or members of one’s family (“insiders”) since many of the basic rules and requirements that apply to those transactions apply to sales to non-employee non-family outside companies or persons, be they competitors or people wishing to enter your field of business by purchasing your company.
This article, however, shall discuss in some detail the unique issues that confront the Seller of a business who seeks to sell out his or her majority interest or all of his or her interest in a company to such outside investors. It shall be assumed that the reader has already read and understood the initial article. It shall also be assumed that the underlying purpose of the sale is to allow the seller to retire from the business, either immediately or after a year or two of transition.
PROBLEMS IN SALES TO COMPETITORS
The most obvious potential buyer to approach is the existing competitors to the business. Such competitors not only are usually expert in your field, but have the added advantage of eliminating your company as competition thus might be willing to pay an additional sum for that additional advantage.
But such sales have numerous pitfalls, especially in the initial stages:
- During the due diligence stage of the transaction, you will normally be compelled to reveal detailed and complete information concerning your company to the very people who are most likely to use it against you if the deal does not culminate. Such items as pricing, profit margin, vendors, customer information, liabilities, trade secrets, etc. are sooner or later made available to any current competitor who is a potential buyer and unless by that time the deal is already fixed, you can find yourself drastically damaging your current competitive position at the very moment you seek to sell the company.
- Equally damaging is the knowledge leaking out that you wish to sell your company. Your competitor will possibly spread that word which will dismay your current employees and perhaps alienate your customers and vendors.
- The time of due diligence is also an excellent opportunity for your competitor to raid your best employees or discover better ways to better compete with you and, in the case of competitors from other locales, gives them an excellent way to be educated into your market perhaps without having to buy your company if they call the deal off after due diligence.
- There is the fact that by approaching your competitors you indicate a desire to retire from the world of competition with them and that alone may eliminate much of the value they would pay for your business. Assuming you are a strong competitor to them, they may conclude that you are eliminating yourself already, that anyone else who buys you will be easier to compete against, and conclude that it is cheaper merely to let you self destruct by selling to a less experienced new investor.
- A competitor will often purchase the company for the primary purpose of closing it down. Their main goal was eliminating you as competition and it is quite common, after little effort, for the buyer to simply close the doors, cherry pick the best employees, and your company ceases to exist. Assuming you take pride in your company and wish it to survive your departure, this could be quite a blow.
- Assuming the company purchasing your company is a much larger one, which is often the case, the skills, the methods, and the entire ethos of the business may be wrong for your business. By far the majority of small companies purchased by larger ones are immediately altered beyond recognition, with the long established business practices of the smaller company being drastically rearranged to conform to the larger bureaucracy and goals of the larger company. This can be a heart braking for the owner and the employees as they see what made the company unique and successful ignored or destroyed by the larger entity. One can wonder why a large entity would buy a company only to destroy its essence and its character, but a large company executive once responded to the writer that most such purchases are done to buy customers and an employee or two, not to adapt a system that is probably inefficient for a large company.
- Assuming you are receiving part of the purchase price predicated on the success of the now purchased company (e.g. receiving a percentage of future sales or profits) it is clear that many of the above problems could drastically reduce the ultimate price you get for the sale of your company.
PROBLEMS IN SALES TO NEW OUTSIDE INVESTORS
There are also problems in seeking to sell to non competitors who have concluded that they wish to enter your field of business by purchasing your company.
- Unlike sales to employees or competitors, you are probably going to sell to relatively inexperienced new comers to your field who must either retain your services for a significant period so that you may orient them into the business, or will face a severe disadvantage in competing with established companies.
- Realizing the lack of experience of the new owner, key employees may either depart for more established companies or demand much higher salaries to remain.
- Often the buyer wishes terms for buying the business and often seeks to have the seller finance in whole or part much of the cost of the sale. (This issue is discussed in detail in the previous article relating to sales to existing key employees.) There can be little question that given the increased risk described above, there is also a good chance you will not receive the full purchase price unless you can somehow obtain security from sources outside the business itself.
- Unlike sales to competitors, the new investors may have never worked well together before or may not have the requisite skill sets or disciplines necessary to effectively run the business. You know your competitor can run a business: you don’t know that about new people to the market. Again, if you are making a cash sale and care little if the business survives, that matters not one wit. However, if you are financing the sale or are emotionally attached to the continued existence of the business you created, the dangers of problems in a new business must be considered.
- Business brokers are often used by both buyers and sellers and while that is a topic in a separate article, suffice to state that while they serve an often useful purpose, they are expensive (usually about ten percent of the sales price) and often give inappropriate advice since they only get compensation if a sale succeeds. Thus, dangers that may exist for you if you proceed with the sale or reasons to reject an offer or simply advice to give up the concept of sale and return to the successful running of the business can not be expected when dealing with a broker.
Thus a good attorney and a good CPA are vital experts to bring on board from the very beginning of the process of sale-including review of the broker’s proposed listing agreement. Do not use the preprinted sales forms supplied by the typical business broker: such forms are usually too general to give you the protection you require and may end up costing you far more to enforce than an agreement written by experienced legal counsel.
SOLUTIONS TO CERTAIN PROBLEMS
Many of the problems can be minimized if not entirely solved. Before confidential information of key value to a competitor is made available, one seeks a written commitment that the transaction will proceed to conclusion assuming the due diligence results in substantiation of represented financial facts. Essentially, before giving the information, the seller tells the buyer that sales have averaged X amount, that liabilities are less than Y amount, and that X number of customers exists, and buyer must proceed with the sale if the due diligence establishes the truth of the representations.
Further, a written negotiations confidentiality agreement is executed by the proposed buyer as to the entire negotiations and discussions so that the very fact that the sale is contemplated must be kept strictly confidential until it is completed (and if not completed, forever) so that the seller has a chance to help transition employees and customers. Liquidated damages can be placed in such a confidentiality agreement so that the possible buyer faces significant cost if it violates the obligation.
Inexperience of the new investors can also be partially surmounted by a carefully constructed transition period in the agreement during which the seller acts either as a employee or consultant for the company, not only training in techniques, but introducing the newcomers to key vendors and customers.
Often a large buying company will state that they wish to keep the entire structure of the old smaller company intact, retaining old management as employees for months or years, thus reaping the benefits of the old expertise while allowing much increased funding to be available. (While the author has often seen this plan made, the sad fact is that large companies very seldom can work effectively with smaller companies and more often than not friction leads to conflict and the submersion of the old structure into the larger structure.
As an experienced business person, the seller can often investigate the background and proposed purchasing structure of a newly created company and determine if certain obvious issues may be eliminated by restructure or other means. Assuming that the new buyers will not alter the structure or cash out entirely the seller, the seller could even consider rejecting the offer. The writer once saw a seller insist that a tie breaking method be implemented in a proposed buyer’s structure and when they indignantly refused, the seller sold to an established competitor instead at a lesser price.
A common mistake made by sellers is to become so attached to the concept of sale that they begin to ignore the business or let word slip out so that employees or customers know that such a sale may take place. This is particularly common when a possible deal has progressed to serious negotiations. The seller would be well advised to remember, however, that, “It ain’t over until it’s over.” Absent a fully executed agreement, the buyer can always drop the deal without liability and by that time the seller may have lost important customers or employees or neglected the business so long that its attractiveness for the next potential buyer may be nil. Indeed, even after a deal is signed, a collapse of financing or disability of one of the buyers can cause the entire plan to be abandoned and while the seller may have a contract to rely upon for damages, if the financing collapsed there may be no money in the hands of the buyers to obtain.
The key is to maintain flexibility, not to stake all on a single solution or ignore the most basic lesson of business: adjust quickly to changes in the business and the market and do not put yourself into a position in which there is no escape. If you are selling your business, keep it alive and well as if you were not selling it until the sale is not only consummated, but you have received the consideration for the sale that was promised.
Quite often it is the seller who changes his or her mind after checking out the market or reevaluating what life might be like after sale. In such instances, it is vital that the process of seeking a sale of the company has not seriously damaged the business. As a wise business man once told the author, “ My biggest mistake in twenty years of business was in deciding to sell then deciding not to sell. By deciding to sell, I undercut the business and in deciding the price offered was too low and I should keep the business, I was forced to personally pay the entire cost of my past mistake.”
BASIC RULES OF SELLING TO OUTSIDERS
The generalized lessons of the above can perhaps be simplified as follows:
- Sell as if you were not going to be able to sell; keep the business intact.
- So long as the sale may not occur, obey rule number one.
- Your competitor is perhaps the best person to sell to unless the sale falls apart…in which case your competitor was the worst person to negotiate with.
- So long as your economic well being depends upon the success of the new business, take an active interest in its chances for success. If you think it will not succeed, either get security unconnected to that business or drop the sale.
- Decide how important it is for you to keep the business alive after you sell it and keep your employees gainfully employed. Decide if the destruction of your business by the buyer after you have been cashed out really matters to you.
- Use the best drafted agreements you can buy to protect yourself and get as much tax and legal advice as you can: but remember, you know the business better than anyone else and to sell to people who will fail is seldom a good idea.
- If you are a small company being purchased by a large company, expect massive changes to be imposed no matter what the buyer states or intends.
- And remember, if you sell a majority of the stock, your protection is probably minimal minus very good contracts and you should seriously consider selling all your stock instead.
- Get good tax advice before the details of the sale are worked out. There may be ways to save large sums of money. Get good legal advice from the moment you decide to explore the possibilities of selling your business.
Selling a business is as difficult as starting a business and should be approached with the same advance planning and careful use of expertise. It is likely that your efforts during the sale, when combined with the need to keep the business healthy during the often prolonged sale process, may be more exhausting than anything you have done in the business for years. It should not be seen as the time when you may relax as much as the time when you should apply those skills you have developed over the many years you owned a business to achieve a successful negotiation.
It is not uncommon for a sales effort to take three to five years and even after a willing buyer is found, the transactional process itself may take six months or more and be combined with a year or two of required consulting. Only if you understand the magnitude and degree of commitment necessary to achieve a sale should you seriously undertake the task.