Selling a Business? Avoid These Four Big Mistakes
Key Takeaways:
- Key personnel in a company must be well-prepared for the sale of that business.
- Company financials must be strong and well-documented for potential buyers to get and stay interested.
- Support from the right team is usually essential to having a smooth and successful sale of a company.
Successful entrepreneurs spend much of their lives building valuable companies. Eventually, many of them end up selling those businesses.
In some cases, no one else is available to carry on the business. Other times, health problems interfere. Often, an opportunity to sell comes along that is just too good to pass up.
When businesses sell, owners potentially can become seriously wealthy—perhaps even joining the ranks of the Super Rich ($500 million or more in net worth). The better the preparation and sales process, the more likely the company will fetch a good price—and the more likely the owner can walk away with enormous sums.
Of course, the opposite is also true: If business owners make big mistakes when selling, they risk leaving lots of money on the table—and failing to walk away with the amount of money they probably deserve, given their efforts over years and decades.
We know which outcome we’d prefer—and which you’d like to see happen if you’re a business owner who one day cashes out!
With that in mind, here are four types of mistakes the research tells us can derail a sale—along with advice on how to avoid them.
Mistake #1: Failing to effectively negotiate with providers
We all know that very often the amount of money a company is worth is strongly influenced by the negotiations between the buyer and the seller.
But it’s not only negotiating with the potential acquirers that is important. Relatively few successful entrepreneurs negotiate with their own professionals involved in the transaction.
Example: Many business owners look to investment bankers to find possible buyers and to facilitate the sale. However, relatively few business owners initially think of negotiating their agreements and contracts with investment bankers. Some possible mistakes in these agreements include:
- An excessively long timeframe that the investment bank has to exclusive rights. Sometimes investment banks might ask for two years, when six months or so is more the norm.
- Paying the same commission for the investment bank to raise debt (easier to do) as to raise equity (harder to do).
- A lack of reciprocal indemnifications. While the investment bank requires the company to indemnify it for misinformation provided by the company to potential buyers, the company should be indemnified by the investment bank for providing misinformation to potential buyers.
How big a problem is this? It turns out that nearly 80 percent of corporate attorneys say that poor negotiations with providers are common or very common. A mere 6 percent said poor negotiations were uncommon (see Exhibit 3).
Mistake #2: Failing to properly prepare key personnel for the sale
Very often, the success of a business is dependent on its key personnel—including senior executives and top salespeople. Making sure those people are incentivized to stay with the business and its new owners can be critical to the sale (and the sale price).
There are many ways to incentivize key personnel to stay and help facilitate the transition of ownership. Employment contracts with bonuses are commonly used. Another approach: Offer “exit event stock options” that can only be exercised if the company is sold or goes public.
A related consideration is non-compete and non-solicitation agreements. It can be smart to create severance plans for key personnel that require them to not compete or solicit personnel or customers during the period of the severance payments.
As seen in Exhibit 4, failing to prepare key people within the company was cited as a common or very common problem by 72 percent of surveyed lawyers. Just 12 percent said it was an uncommon problem.
Mistake #3: Failing to financially prepare the company for sale
Making sure the company’s financials are as appealing to an acquirer as possible can translate into a significantly higher sales price. It’s no different, really, than fixing a broken door and applying some touch-up paint before you put your house on the market.
And yet, we see that a substantial percentage of entrepreneurs do not initially do as good a job as they could when it comes to preparing financially. A fifth of the corporate attorneys said this is a very common problem (see Exhibit 5). More than half reported it to be common. Fifteen percent said it was occasional, and approaching 10 percent said it was uncommon.
Some ways to better prepare a company, financially, for a sale include:
- Improving the balance sheet. From doing a more effective job with cash management and accounts receivables to expunging nonperforming assets, a company can better manage its financials.
- Addressing the cost of funds. The right loan covenants, for example, can make a significant difference when selling a company. The overall intent is to maximize the working capital arrangements.
- Lacking audited financial statements. Failing to have audited financial statements increases the likelihood that entrepreneurs will have liabilities after the sale closes.
Mistake #4: Failing to eliminate likely deal killers
There are a number of possible deal killers that can derail the sale of the business and also do not fit the previous categories.
If the company has existing tax problems, for instance, buyers will likely be reticent and push down the price. Example: The owner is paying family members for services at a much higher rate than the owner would pay a capable third party for the work. Along the same lines, if senior executives or family members are using assets of the company without reasonable compensation, there may be gift tax implications.
Another possible deal killer occurs when a company has material violations of federal, state, or local environmental laws and regulations. The potential buyer will have to fix the environmental issues—and the cost to do so is often hard to quantify or predict.
About a quarter of the corporate attorneys reported deal killers are very common (see Exhibit 6). A third reported them to be common. Somewhat fewer corporate attorneys said deal killers were occasional, and 12 percent said they were uncommon.
Implications for business owners
Business owners who are selling their companies have one shot to get it right—there are no do-overs. Therefore, it’s crucial to avoid mistakes that can diminish the company’s value in the eyes of buyers and make it harder to sell.
Typically, the types of mistakes outlined above occur when business owners rely on low-quality professionals to guide them through the sales process (or worse, when entrepreneurs try to “go it alone” when selling). Support from a team of superior professionals is essential in most cases to getting the highest possible price for a business—because that type of team can spot these mistakes before they occur or correct them. Often this team will include a corporate attorney, an M&A advisor or investment banker, and a specialized accountant.
The upshot: If you’re planning to sell your business in the near future—or even if that step may be years away—it can make sense to assemble a team of professionals to help you navigate the route. Indeed, the earlier the better in many cases. By getting a team in place in advance of the sales process, you might spot big potential problems in your business—and address them well before buyers come knocking! The end results could be a smoother transaction and more money in your bank account. (Just remember problem #1 from above and negotiate your terms well.)
Action step: If you have questions or concerns about selling a business, contact your legal or financial professional to explore the topic further.
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