Relationships require an understanding of each other’s roles.

While some business transfers can be like speed dating and a shotgun wedding, most others will have more of a courtship. In either situation and any in-between, understanding each other’s objectives and needs will bring a more organic transition between parties.

There is an emotional attachment to most small business transfers.

The seller has most likely grown the business from the ground up. The buyer is about to make the most important purchase and possibly decision of their lives. Both points of view are emotionally charged and stressful, though for very different reasons. Being aware of each others’ emotional investment can defuse a situation before it can have a negative effect on the sale price or deal structure.

Requesting information is not only necessary but a good tool to get to know your buyer. 

From the buyer side perspective, they will most likely need to have more money down than the seller needed when they started the business. This means that they will need to have a top-notch credit score and financials. Since most business transfers will include some type of financing, a lender will also want to make sure that their borrower has some knowledge of this particular industry or at least know how to run a business. A resume will be their documentation of their life in Corporate America that will be a tool for the seller and the financial institution. Even though having a good financial standing and resume are important, it still does not guarantee that the buyer is a good prospect. If you see that the buyer is investing “resources to make a significant initial injection and have money for working capital, you can be assured that he will do everything it takes to continue the success of the company.”

Talk it out to see the buyer side perspective.

During face-to-face meetings between the seller and the buyer, it is a good time to reach out to the buyer to find out their intentions. Much information has already been disclosed by the seller, so the buyer will most likely be doing most of the talking. When asking the buyer their intentions for the business they are buying, they might not know entirely. However, how they respond will “reveal why he thinks the business is a good fit for him.” Keeping both sides open about their goals for the transaction will provide a smoother experience where everyone is able to get what they want.

Providing information when requested is key.

Throughout the process, the seller will be required to provide the buyer with information, not just turn in monthly financials. These demands will be on-going and can seem to have no end. Since every deal is different, it can be impossible to predict all the information that is needed ahead of time, even with a strong support team. Your team should be hyper-aware that providing information as soon as possible is paramount. They will continue to have their own workload, such as the CPA, but if these requests are delayed, from the buyer side perspective, this can be interpreted as there is something to hide or an unwillingness to sell to the buyer.

Many business transfers will involve a seller staying on for a period of time with the new owners to ensure that they are fully self-reliant. This is a true relationship, and when it is built on seeing each others’ situation from the others’ point of view, the transfer process will result in achievable goals for both parties. It might even result in friendship.

 

To learn more about the buyer’s perspective, EXIT- A Business Owners Guide to Selling a Company, a book by Alex Vantarakis can be purchased in paperback form or as a download.


By Anthony Cullins

Seven (7) years ago, The Vant Group represented a seller who was anxious to sell his business so he could enjoy the fruits of his labor.

Like most sellers, he had a number in mind that he wanted for the business and was not too keen on the deal structure so long as the purchase price matched the desired asking price. We were able to secure a buyer who offered the seller the number he wanted, however, it included a significant amount of seller-financing. Despite our urging for the seller to consider slightly lower offers with more guaranteed upfront, the seller decided to take the higher seller financed offer.

Everything was going great for the first few months. Then about six (6) payments in, the payments stop, and the buyer goes into default. The TVG client spent eight (8) months and over $100,000 in litigation costs to resume control of his business, which by then revenue was down 50%.

Solution

The TVG client worked hard to re-establish his business and slowly built the business back with revenue and cash flow stronger than before. TVG successfully helped the client sell the business again (with very little seller note).

Key Takeaways
  • Price is one thing but the terms are another. You have to balance both.
  • Trust your gut in judging the character of a potential buyer.
  • Chose a business broker with care and listen to their advice.

By Anthony Cullins

No one wants to be blindsided by real estate issues during a business transfer.

Many business owners use leased real estate to house their company. There are benefits to having someone else deal with the maintenance, general upkeep, and curb appeal. Make sure to do your due diligence if you ever what to sell your company, because leased real estate adds homework to a business transfer.

Before ever putting your business on the market, you need to be familiar with the legal language in your lease.

Most facility leases will address the issue of assignability of the lease.  Many will allow the lease to be assigned but usually “only with written permission from the landlord.” You also hope to see the phrase that the landlord’s permission “shall not be unreasonably withheld.“ In addition, there may be provisions explaining that the landlord needs to approve a new tenant. There also may be notification time frames stated, as well as the landlord’s required response time. It is also possible there will be transfer fees associated with obtaining the landlord’s approval.

Typically, if a lease is assigned to a new tenant, the original tenant remains liable in the event of a default by the assignee. The implications are if the buyer struggles after acquiring your business and stops making payments on the lease, the landlord can look to collect lease payments from you for the remainder of the lease commitment.  In the final definitive documents of the business sale, you will likely have indemnity clauses in your favor from the buyer. Though you have the legal right to do so, there is no assurance that funds will exist to reimburse you if the buyer defaults on an assigned lease. A business broker can help to structure your transfer to cover these types of contingencies, so make sure to provide them with all the facts.

There is another complicating factor.

If the buyers’ financing is based on an SBA loan, the SBA will require the lease term, including tenant options, to match the loan term. This is usually either seven (7) or ten (10) years. That can be favorable for landlords because they can use that fact to achieve longer-term lease commitments. However, the option has to be the tenant’s, so that creates an offsetting factor.  The real difficulty arises if the landlord has other plans for the leased space and is not willing to negotiate a lease term to match the loan term.  Also, some landlords will use that prerequisite as leverage to try and negotiate unreasonable lease terms.

So to recap, make sure you go through your lease thoroughly. Speak with a lawyer to clarify any language that might be confusing, and talk to your landlord in plenty of time so no surprises come to the table on your way to closing. Using the right M&A company to broker your deal will not only help to get these issues in the light of day early, but they can also structure a deal to make sure you are covered in many if not all eventualities without heartache.


By Dirk Armbrust

Challenge: A business owner was considering selling and retiring while still wanting to secure a future for his son who worked in the business

A manufacturing business owner was introduced to The Vant Group by his attorney.  The owner was approached by a private equity (PE) firm wanting to buy the business that he and his wife owned and whose son worked as a key operations manager.  The timing was good for the owner and his wife, but they were concerned about their son’s future.  Along with the normal stress associated with selling a business, they had multiple questions on their mind:

  • Would the PE firm lay off the son after the sale?
  • Would the PE firm provide an opportunity to stay and grow with the business?
  • Would the sellers be “penalized” when the PE firm adjusted the price for the son’s ongoing salary?
  • Was the PE firm’s offer strong enough to justify not listing the business in the open market?

We addressed the last two questions first.

We conducted a valuation assessment of the business.  Our analysis indicated that the PE firm’s offer was strong but not significantly above what the seller could expect from any other buyer.  We coupled this point of view with our expertise on current market conditions and salability of their particular business.  (If you haven’t heard, we are in a “seller’s market”.  There are many more buyers than sellers these days.)

Next, we prepped the owner with insight and “bullet points” to allow him to defend against the PE firm trying to reduce the sale price for the future salary of the son.  Because the son worked in an operating role and was adding value to the business, we prepped the seller for the conversation.

Then, we addressed some of the common myths associated with the M&A space.  Oftentimes, sellers worry that buyers (especially PE firms) will buy their business and then lay off a large portion of the workforce in a scorched-earth manner.  This is how M&A is often portrayed in movies, but this is the exception rather than the rule.  As you might imagine, this fear was front and center in this seller’s mind… especially when his son was in the employee population.  However, the simple truth is that today’s buyers are looking for solid, well-run businesses.  Buyers, especially institutional buyers like PE firms, would rather keep the acquired company’s infrastructure in place so that they can focus on growing the business.

Finally, we provided the seller key strategic insight on where they are today from a valuation standpoint, and what things they can do to secure a much higher sales price one to two years in the future.  Based upon this deep dialogue and engagement, the sellers decided to pass on the PE firm’s offer, and focus on growing the business together (mom, dad, and son), to reach their overall goals as a family.

This case is a representative example of how The Vant Group approaches clients.  There is often more to the story than just “how much can I get for my business?”  (Although that is hugely important.)  Things like family and succession planning issues matter.  In M&A transactions, we typically serve as “quarterback” for the “deal team”.  M&A advisors, attorneys, CPAs, wealth managers, and tax planners all have significant roles to play in this critical process.  We ensure all the players are working together to achieve the absolute best, holistic, outcome for our clients.


Does any single customer represent more than 10% of your revenues? 

From an evaluation standpoint, some prospective business buyers would consider a single customer accounting for 10-15% of a company’s sales as a major negative.  Almost all prospective buyers would consider client concentration of 30% or more in just two to three customers as a big problem that would have a significant impact on salability and/or the terms and structure of a sale.

Prior to selling your business, any efforts to reduce customer concentration by diversifying your client base will be beneficial to salability, valuation and maximizing the cash received at closing. If there is a customer concentration concern, a lender may decline the loan or will likely only approve a partial loan to the buyer. This reduced loan amount also reduces the amount of upfront cash that a seller can expect to receive at closing.  To address customer concentration issues, most prospective buyers will try to structure a “contingent earn-out” that is paid to the seller over time and is dependent on the future revenues or profitability derived from the company’s largest customers.  If one of those customers is lost, the seller may never receive the contingent portion of the negotiated purchase price.

Here is a good article that further speaks on the topic: How business owners can mitigate the risk of customer concentration


Printing Money May Not be One of the Options for Financing a Business Transfer, but There are Options Out There.

For small to medium-sized businesses, there are several types of funding sources for financing a business transfer.

Each type is governed by the same basic factors, such as; transaction size, asset base, type of company and cash flow.

When beginning this step of the business transfer, it is good to know that delays in the financial process can be avoided early if certain precautions are taken. So before discussing a buyer’s main funding options, there are some overall matters to consider or prepare.

  1. Buyers should make sure to check their own credit and clean up any outlying issues.
  2. Personal financial statements are also important to have totally complete and ready, crossing all the “T”s and dotting all the “I”s.

A top level view and take away points for each of the main funding options

All Cash Sale

Most sellers will, of course, be favorable to an all-cash offer. It is also a given that an all-cash offer can come with a steep discount. This discount is about 40% of that of a suitable offer with financing.

Owner Financing

Another alternative to bank financing is owner financing. Not all transactions are acceptable for institutional financing, and if an owner is not willing to discount their asking price 35-40% for an ALL Cash Sale, then owner financing might be the only other option for financing a business transfer.

SBA Financing

The Small Business Administration (SBA) is a federal agency that will guarantee a portion of an approved loan. Financially, they only consider the EBITDA and the adjusted EBITDA. They use a strict debt coverage ratio to ensure a borrower will be able to repay the loan, pay themselves a salary and have enough left over for emergencies. Along with cash flow, the SBA looks at the buyer’s industry experience as part of their approval process. A buyer should make sure that the bankers and intermediaries they are using are familiar with this process.

Earn Out

An earn out is a negotiating tool that can off-set the sales price and allow a portion to be paid at a later time with specified positive revenue within a specific time period. If profits decrease, then the earn out percentage decreases. However, if the profits are higher than projected as negotiated in the terms, the earn out does not increase. The reason the earn out will stay at the same amount is because the increase is considered the result of the buyer’s efforts. Therefore, it also justified the higher price the seller was asking. By keeping to their guns, in this scenario, this option works well for both sides.

Conventional Financing

This financing is against the assets in the business or personal assets to collateralize the loan. Financial institutions often heavily discount the value of the assets to protect the bank’s risk. These loans are a great option for lines of credit and real estate loans.

To learn more about funding and financing a business transfer, a copy of Entrance – A Guide to Buying a Business by Alex Vantarakis can be purchased in paperback form or as a download at The Vant Group – Book page.


Who is Your Buyer?

Before starting the selling process, determining where your potential buyer will come from will put you ahead of the game. Know who your buyer really is.

Each business transaction is different, but there are common factors to any deal. There are certain main aspects of a buyer, each with their own list of pros and cons to consider, which typically are:

  • Do they have industry (whichever type your business falls under) knowledge/experience?
  • Are they a first-time buyer?
  • Will they need financing?

A business broker should be able to give a preliminary idea or priority list of the most likely types of buyers. By knowing the type of buyer, the seller will have a better understanding of their needs or constraints when it is time to make or close the deal.

Broken down to the main or top-level categories, there are essentially six (6) different types of buyers. Again, what is a “pro” for one type, might be a check in the “con” bucket of another type.

Is Your Buyer the:

Corporate Executive

A usual concern for this type of buyer is whether or not they are trying to relocate or stay in their current geographical location. These are often first-time buyers, but make sure they are serious. A business transfer requires a doer, not a dreamer who is not ready to leave their current state of employment.

Competitor or Vendor

This can be the best idea or the worst idea. Though they will have knowledge of the industry, if the business transfer is not a quick process, a competitor can cause harm in the marketplace to drive down the revenue. However, due diligence should be cut markedly. Depending on their motivation, they could pay a considerable amount more than asking or their situation might not require inventory that could be on hand and therefore result in not wanting to pay top dollar.

Existing Employee(s)

A great option for bank financing if they can come up with the funds for securing the loan. Being that they are already invested in the business, they are of lower risk. If they are not able to come up with these funds, owner financing should be expected to be on the table. So it is fundamental to know if the business is being sold to a business minded individual.

Investment Group

They are always looking for a good deal but are not interested in handling the day-to-day responsibilities. If a good management team or the owner is staying on in some capacity to run the business, the deal is more likely to sell for asking price.

Intergenerational Buyer

Keeping a business in the family can be ideal. A good rule of thumb is to use an unbiased third-party company to handle the valuation before a deal is put on the table. Family transactions can carry the added weight of emotion, so using separate attorneys and CPAs as any other business transactions is recommended. Because of familiarity, it can also lengthen the time for an accepted offer. Make sure to set clear expectations so relations are not damaged in the process.

Foreign and Public Companies

This is a very unlikely buyer for small businesses. The larger the transaction, the more viable an option this buyer type becomes. Being in contact with this type of buyer will require clear mediation to determine what each other’s requirements of the deal really are.

To learn more about how to find the right buyer for your business, pick up a copy of EXIT– A Business Owners Guide to Selling a Company, by Alex Vantarakis.


Closed Deal Case Study: Unrealistic Expectations of Business Value

Challenge:  Business owner neglect led to a significant revenue decline without understanding the impact on the business value

A business owner that sold home décor contacted The Vant Group (TVG) to sell their business. The business was over 10 years old and the owner was becoming distracted by other life ventures.  Due to this, they started to lose interest in the business and revenues began to decline.  Eventually, it dropped to 25% of previous revenue, and the decision was made that it was time to sell.  The owner’s expectations of the business value were based on the profitability of the business when it was in its prime.  Unfortunately, the value of the business was now significantly less than had it sold before the decline in revenue.  After understanding their current value with a valuation of the business, they chose not to market the business for sale and hold on to it.

Approach:  Value is set by what the buyer is willing to pay

A year later, TVG received an email from a buyer that was looking for a type of business with very specific criteria.  The profile fit the home décor business and TVG contacted the owner of the business to ask if they would be interested in talking with this buyer.  Unfortunately, they had allowed revenues and profits to decline even further during that year. The buyer put in a Letter of Intent and the seller countered.  The buyer was not willing to pay what the counter offer proposed as the seller was still unrealistic about the current value of the business.  Many months went by and finally, the buyer decided to give another offer.  There were several months of back and forth on the offer.  Eventually, the seller had decided to move from Texas to another state.  The seller realized that they needed to sell the business before they moved.  At this point, the seller became realistic about the offer they had received.  Though they had not put their business up for sale and had let their business decline, fortunately, they contacted TVG and allowed this guidance to provide an offer through the TVG connections.

Result: Closed in one month after terms were agreed upon

The seller now needed a quick sale and realized that the deal terms and purchase price offered by the buyer were their best options. The buyer and seller settled on a final purchase price, terms of the sale which included a consulting agreement and future earnings, and which inventory items would be included in the purchase.  Luckily, they were able to sell their business within a few weeks of selling their residential home in Texas and make a clean break to their new state destination. Without the help of TVG, they would have never sold their business, and it would have died a slow death.  Now, their original designs and home décor items have been placed in willing and capable hands. They will also be able to see the business they founded gain back the level of recognition and profitability it had once known with the goal of even greater growth.


As a Business Owner – Salary, Draw or Both!

When looking at a balance sheet, there are a few ways an owner can receive compensation at the end of the day.

How to go about this should involve an accountant and an attorney who is on the payroll or ones that are entrusted to give sound advice.

Depending on the structure of the company, the owner might be limited to the ways they are able to bring in a personal income from the business. Uncle Sam has regulations in place for owner compensation which is different as a sole proprietor, to a partnership, or to being incorporated or an LLC.

One way for a business owner to be compensated is with a salary.

This method includes the owner to pay employee taxes and employer payroll taxes. However, if you are an S-Corp or C-Corp, you do not have a choice and must receive a regular salary. If you are an officer of an LLC, which most owners are, then this method also applies. The company’s legal and accounting team will be able to determine the limits which best suit the business so not to overtax the owner.

Regardless of the business type, a salary has other benefits that are not directly related to the money received. It is one way to separate personal and business finances. This keeps the red flags down so Uncle Sam is less likely to audit from irregular cash flow. It can also help to regulate smaller businesses and be a source to offset other expenses. Another benefit to taking a salary is when the time comes for a business transfer or taking out a business loan. Especially if the compensation is comparable to a position the owner is doing in place of hiring an employee, this will allow EBITDA calculations to be easily obtainable in this respect.

Another way for a business owner to be compensated is with an owner’s draw.

For sole proprietors and partnerships, this might be the only way they receive compensation in the beginning. When growing a business, it can be difficult to factor in a salary too. However, when taking an owner’s draw, regular payments are still a good idea for the same reason as with a salary. Unwarranted audits are hardly welcomed, especially if they are easily avoidable. A simple way to calculate a draw is to gather the common personal bills and business receivables that can also be logically documented. These can include shareholder distributions, auto expenses (insurance, gas, loan payment), insurance and medical payments, and cell phone bills to name a few.

What about both?

When taking a salary, additional compensation in the form of a draw is also possible.

The right calculation for each company will vary. There are tax implications for each way of handling how compensation is received. Taxes are owed on profits and revenues which is where the draw is coming from, and taxes are owed on salaries in the form of employee taxes and employer taxes. Bring in the company’s legal and accounting personnel to answer what these implications are as they will be the ones handling the questions once tax time comes around. Knowing the entrepreneur salary options is the first step, having a solid team of business advisers is the safest step.

For further reading that asks all of these questions and more is, The Entrepreneur Salary: How Much (and When) Do You Pay Yourself?


By David M. Wang, Esq.

Collective Insights on business ownership has David Wang posing the question to business owners, “Should I Give Employees Equity in the Business?” with added food for thought from our in-house attorney consultant.

 

Many business owners need to find ways to recruit and retain employees. The cost of training employees is high, and finding a great employee can be difficult and time-consuming. The reoccurring idea to solve this problem is handing out equity. In other words, giving them a participation in the upside as a way of recruiting and incentivizing employees to stay. However, giving employees a piece of the upside is the most complex way to give employees equity. There are many things to consider when making a determination to go this route.

Giving equity is a taxable transaction. You are giving an employee an asset of value.

It may not be cash, but the tax code treats it as income. Outright giving the equity to an employee means that the company will need to do a valuation to determine the value of that equity. That valuation has a cost. The employee will report that equity as income and have tax liability for the value of that equity. The employee will not see getting the equity as a positive experience unless you pay for that tax liability.

Many business owners ask about granting options.

Their friends that work for Texas Instruments and Frito Lay get stock options. Stock options work for a publicly traded company because the employee can sell the stock to convert their stock compensation to cash. This cash can go toward the purchase of a car and pay the taxes associated with getting the stock. The equity of privately held companies does not have a market, and you do not want employees selling your equity to just anyone that will buy it. This means that equity in a privately held company cannot be converted into cash. In fact, the equity in most privately held companies does not produce any cash until there is a sale of the company, which in many cases is a long time or never.

The most complex part of giving equity is how you get it back when the employee takes another job, is fired or laid off.

Most businesses do not want employees to be able to keep the equity after they stop working for the company. The concept is that the employee needs to be employed when the equity becomes cash. This means that you will need to have buy-sell terms that deal with the employee quitting, getting fired for cause, getting laid off, getting divorced, dying and becoming disabled. These terms will need to include what triggers the buy-sell terms (i.e. what is “cause” and what is “disabled”), how to determine the purchase price, payment terms of the purchase price, and other important terms. Then, the governing documents (i.e. company agreement for a limited liability company) need to take into account voting rights of the employee, manage participation, tax treatment and other complex issues.

As you can see, giving an employee equity is complex and must be documented with solid agreements. You cannot go with an “understanding.” Employees will remember the “understanding” the way they need to remember it. Getting all of this squared away could mean a few thousand dollars in legal fees and other professional fees, including valuations.

One way to look at equity is that the only people that should be equity holders should be people that are your true business partners.

True business partners, in this sense, means that they are people that can and will borrow from their 401K to make payroll. They are people who will not “go get a job” when the going gets tough. The investment that is required to take on and deal with a partner is significant and that person should be worth that investment.

So when asking, “Should I give employees equity in the business?” the decision should include a conversation with your attorney and CPA for why, how and which ones. You can also consider giving employees participation in the upside through bonuses and profit sharing plans. These alternatives are usually easier to structure, give you more control, and can require less in professional fees. These alternatives can be explored in future articles.

 

David M. Wang is a partner of Grable Martin Fulton, PLLC. He is a business attorney with over 21 years of experience. He can be reached at (214) 334-4755, or dwang@grablemartin.com.

 

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