By Karen E. Klein With investment capital and private funding down this year, and the IPO market suffering, more companies are thinking about growing their business by snapping up competitors or purchasing outfits in related areas. In fact, an April survey found that 38% of small and
midsize companies plan to make an acquisition in the next five years.
This news is welcome to many entrepreneurs who are looking to retire, move into another industry, or just throw in the towel on business ownership. But even in this favorable merger-and-acquisition climate, most small-business people are woefully ignorant when it comes to selling their companies. Bob Klein, an M&A specialist and president of Business Search in Irvine, Calif., says that if more business owners knew how to show off their companies in the best light, they would sell them more quickly -- and make more money on the deal. Klein expounds on his views in the following Q&A:
Q: Why are entrepreneurs so ill-prepared when it comes time to sell, and what are the repercussions?
A: It's like anything else -- they don't plan far enough ahead, so they jump into the sales process very naively, and they commit a lot of errors. Selling a business is something most small-business owners have not done before and it's something that they haven't taken the time to learn to do right.
Q: How should an owner plan ahead for a sale?
A: Before they put their company on the market, they need to talk to their accountant about the tax consequences of selling. If they're unprepared for the taxes they'll have to pay on the sale, it could be a very unhappy shock. They should also have an attorney available to work with them on contract details, and a business broker or M&A specialist who has been in business themselves, understands their particular industry, and has a good deal of experience.
(The typical broker's commission, says Klein, is typically 10% to 12% on a selling price of $1 million or less. For higher selling prices, brokers generally charge a sliding-scale commission after the first $1 million, on which they charge 10%.)
In a lot of states, the only requirement for representing oneself as a business broker is having a real estate license. In other states, there are a lot of unlicensed people, like consultants, representing themselves as brokers. These people are not qualified to represent a seller or buyer, and those who use them are not likely to get the full value out of their business sale, which is a terrible shame.
The other thing I suggest to both buyers and sellers is to talk to an SBA lender early on. It will really be helpful, because a loan officer should have referrals to experienced professionals and a lot of good information for both sides. Also, with an SBA loan, the seller can get most of his money in cash up front.
When a buyer purchases a company without a loan, they typically want to put 30% to 50% down and have the original owner carry the rest of the purchase price. With an SBA loan, sellers often get 90% in cash. They may be asked to carry 10% so they stay financially involved with the company for a limited time, in case a legal or tax problem from the past comes to light after the purchase.
Q: What do the pros do to get a business ready for a sale?
A: Typically, we start with an analysis of the company, a restructure of the profit-and-loss statement, and a professional appraisal. The restructuring of the financial statements comes about because most private companies have a lot of "add-back" items on the books. These are expenses that the company is taking on that are technically unnecessary for the operation of the business: The owner may have a company car, for instance, or relatives on the payroll. Those things give a false picture of the company's cash flow.
The professional appraisal is very important, and it should be done by
someone with marketplace experience. Again, SBA lenders in your area should have referrals to qualified business appraisers. CPAs can do business valuations, but they sometimes use methodology that doesn't take the real-world comparison into consideration. We find that a lot of sellers pull an arbitrary figure out of the air and put it on their company. Turns out they've either overpriced it and it won't sell, or underpriced it and they end up walking away without getting what it's really worth.
(According to Klein, appraisals can cost from $3,000 up to six figures, depending upon the size and complexity of the business. Some brokers charge less for the appraisal when it is part of a package of services being offered for a commission.)
The problem is that finding comparison numbers for small-business sales is very tough unless you're actively helping clients buy and sell companies all the time. Even when you can get comparisons, they can be misleading. I had two sheet-metal stamping companies, each doing about $5 million a year in sales. One was making $2.5 million profit annually, the other was making $200,000 in profit, so although they were similar in size and industry, one company was worth a whole lot more than the other.
The second part of this interview will appear July 17, when Klein will address the two biggest factors in making the most on your business sale: Showing your business and relating to potential buyers. Have a question about running your business? Ask our small-business experts. Send us an e-mail at email@example.com, or write to Smart Answers, BW Online, 6th Floor, 2 Penn Plaza, New York, NY 10121. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.