Selling A Business: Under the Hood
How does a business get sold and what goes on under the hood during the transaction?
Tom, an Engineer working at Boeing, is sitting in his cubicle browsing business ads over lunch on BizBuySell.com and finds an amazing classic car restoration business for sale. As a passionate classic car enthusiast, he thinks, I've accumulated some savings, I wonder if I could buy the business and work here until the business takes off and I can eventually transition to it full-time? I wonder how this all works?
Most people haven't had much exposure to how businesses are bought and sold, so here's how it works:
BUSINESS VALUE IS ESTABLISHED: The business is valued by a broker or consultant working with the seller so you, as a buyer know what the business is generally worth based on industry and market standards. But, like any home sales, there are many variables, so anything is negotiable!
BUYER IS FINANCIALLY QUALIFIED: Like real estate, a buyer might be qualified to finance a home based on their income, credit score, assets. However, unlike home purchasing, there are two additional variables with business purchases: 1) Industry Experience and 2) Seller Financing. Even if you don’t think you can afford a business with what you have in the bank, you can borrow against assets like your 401K or stock options (LRS can help you set that up. They set up mine so feel free to ask me about details and options). You may also request some financing be held by the Seller. Any remainder can be financed by a traditional or SBA loan.
AN OFFER IS MADE: Many know of Letters of Intent, a statement of intention to buy the business at a certain time with certain conditions. Similarly, with slightly stronger intent, a Contingent Offer to Purchase can be made where, upon satisfaction of specified contingencies (such as obtaining financing, approval for lease transfer, inspection of building) the business will be purchased on a specified price on a specified date. The transaction is not binding until a Waiver of Contingencies is signed by the Buyer. A Broker typically will draw up these documents and you can have them reviewed by an attorney or CPA.
The buyer and seller may have a meeting during the time of the offer so questions around operations and the lifestyle of the business can be understood.
DUE DILIGENCE BEGINS: This is the period aimed to erase Buyer’s concerns and contingencies. Documents are supplied for review, lists of questions and answers and exchanged, culminating in the signing of the Waiver of Contingencies. An example of some documents that are requested: List of Key Customers; Contracts; Equipment list and value, maintenance records, tax returns.
PREP FOR CLOSING: Many documents are files with the City, State, and Federal agencies as we prep for closing day. Records are obtained on both parties to ensure no debt is going to follow the buyer and vice versa. Pre-paid items such as rent and taxes are prorated, employee contracts with the Seller are closed up. There is a final amount due at closing that is supplied to the Buyer who brings the amount as a cashier’s check to the closing. This cashier’s check is often a compilation of personal funds, bank loan and may have a partial Seller note to offset the balance due.
CLOSING! Buyer and Seller arrive at closing and sign necessary paperwork. Personal IDs are verified and a cashier’s check is placed in a Trust Account to be disbursed to Seller as soon as taxes are verified a few days later. Buyer walks away from the Closing Meeting with the keys to their business to open the same day or next day. (See Employee Question Below)
What goes with the business and what stays with the Seller?
While everything is negotiable, most of what you see goes with the business especially if it was used to generate revenue in the previous year. This includes employees. The Buyer is not obligated to retain all of the employees but typically keeps them on until they have transitioned the business.
Items on the Balance Sheet such as cash balance stay with the Seller as do liabilities such as credit card debt. Accounts receivable is typically negotiable depending on the nature of the business and how much of the product has been delivered to the customer. Generally, the entity who delivered the product/service might request more of the AR but will also be responsible for collecting it. Sometimes AR is sold to the Buyer at a discount to collect.
Inventory goes to the Buyer during the sale but is usually a price added onto the selling price since inventory varies. The price of most businesses is the price WITHOUT inventory, unless otherwise specified.
Many components stay with the business but are transferred in name to the buyer for equipment leases, vendors/service contracts, certification/credentials.
What’s negotiated are items such as gift cards (paid for but not redeemed), unfinished work-in-progress.
Buyers generally get their own: Liability insurance, employment contracts with the employees, Point-of-Sale systems, bank accounts, specialized credentials that follow an individual not a business, if any are needed.
What if the buyer doesn’t know the business or how to run it?
Generally, a transitional training period is provided by the Seller to the Buyer which can range from 2 weeks in a business like a restaurant or retail to 3-6 months in a business such as manufacturing or services.
The Buyer also has the option to offer the Seller a Contractors Agreement if they want them to stay on longer. This is a paid contract that is negotiated as part of the sale. Your broker can also complete these agreements for you with a few questions such as rate of pay, length of tenure, responsibilities, and which terms will satisfy the contract.
What counts as “Inventory” and what are “Supplies” and “FFE”?
These are commonly misunderstood terms. The only thing that counts as inventory are the items that have a margin attached to them. Cups and fruit for a smoothie bar, shampoo for a salon. If you sell it for a profit, it’s inventory. If you use it in your business (receipt paper, cleaning items, but it’s not directly sold then they are Supplies. If it’s a fixture in the business such as shelving and computers (again, not resold), then it’s “Furniture, Fixtures, and Equipment (FFE)”.
All of the components of the business sale are allocated by a CPA along with your broker to help you properly allocate the price paid for the business across: Inventory, Supplies, Assets, Real Estate, Goodwill, and Non-Compete.
When does the buyer get to speak to employees?
Divulging a sale to employees can sometimes be risky and cause disruption, so until the business transaction is closed, many choose to keep the sale quiet until then. This is negotiable, but a best practice is at close of business before the day of closing or the morning after closing, the Buyer and Seller go in together and notify employees, emphasizing minimal disruption to them during what’s hoped to be a smooth transition. Employees mainly want to know whether they will have a job, so the Buyer should swiftly interview and draw up new employment agreements with the employees. Generally, these agreements keep a similar pay grade for a time until they can be adapted based on performance and new management structure.
Can franchises be sold?
Most can, yes. There is a transfer clause in most franchise agreements which may include a transfer fee (usually under $20K), which can be negotiated as part of the sale. The Buyer will still need to qualify under the Franchise Agreement and obtain necessary training but buying an existing franchise can be a cost-effective way to obtain a franchise that is already successful!
How does the lease get transferred?
Most leases have a transfer clause stating that a lease cannot be transferred without the express approval of the landlord. Most landlords are supportive of a transfer to a party with good credit and payment history. It is essential to get an approval of transfer before proceeding to closing.
If you have further questions, please reach out!