Selling Your Business: Price Isn’t Everything

Selling Your Business: Price Isn’t Everything

When business owners decide to sell, they often have a pre-determined price in mind. This price is typically presented in a non-binding Indication of Interest (IOI) or Letter of Intent (LOI), or both. However, it’s important to remember that there’s much more to an offer than just the price. While price is crucial, you need to evaluate the following four factors to ensure you have a truly good offer.

1. How Will You Be Paid?

This is critical to ensure you receive payment in full. Ideally, you’d want all cash. National surveys with M&A advisors have found that, on average, sellers receive 80% in cash and the remaining 20% in a seller note and/or an earn-out. The buyer and their lenders and investors aim to minimize their risk by transferring some of it onto you, the seller. A seller note means the business owner acts as the bank for a portion of the price, in the form of a promissory note. Terms are negotiable, typically running 3-7 years with interest rates 2-3 percentage points lower than a loan from a financial institution. The benefits for the seller include deferring the tax hit (taxes are paid the year you’re paid) and gaining interest. However, there’s a risk the buyer could default on the note.

An earn-out means you’re paid based on the future performance of the business. Sellers generally prefer earn-outs based on top-line revenue since they have no control over the buyer’s expenses. Buyers prefer earn-outs based on bottom-line net income or adjusted EBITDA, ensuring they only pay if they’re making money. Often, a compromise is reached with earn-outs based on gross profit.

2. How Much Working Capital Should Be Left in the Business?

Working capital should always be negotiated at the beginning of the process. It’s the capital a company uses to finance its day-to-day operations, defined as current assets (cash, inventory, accounts receivable) minus current liabilities (accounts payable, short-term loans, accrued expenses). The working capital left in the business can be seen as less money the seller receives. Both parties need to recognize that working capital is the business’s money, not the buyer’s or seller’s. Buyers often argue that working capital is like gas in a car; you need it to keep the business running.

3. Work In Process (WIP)

Work in process refers to goods that are partially completed and will soon be finished products. Sellers want to be compensated for project costs incurred when they haven’t received customer payment. It’s often agreed that sellers are paid in full for items delivered to the customer prior to closing, while anything delivered after closing is money for the buyer, less any costs incurred by the seller (labor, raw materials, etc.). WIP can be a heavily negotiated area.

4. Transition Pay

Many baby boomers selling their businesses want to cash in on the sale but continue working. Negotiating a satisfactory future compensation plan for the seller is crucial. Buyers expect some complimentary transitioning from the business owner. I usually advise sellers that a couple of weeks of complimentary transitioning is fine, but after that, they should be paid comparable to their salary when they owned the business. The challenge is that many business owners are underpaid, relying on tax-friendly distributions for compensation. This area often requires more negotiation than expected. An attractive option for sellers who own both the business and the real estate is to sell only the business and lease the property back to the buyer, maintaining cash flow in retirement.

In Conclusion

There are many factors to consider when evaluating an offer to buy your business. It starts with the price, but to ensure a successful sale, be prepared to negotiate how you’re paid, working capital, work in process, and transition pay. There’s usually give and take in all these areas, and if done correctly, you should be satisfied with the overall result.