The Role of Disclosure in the Due Diligence Process when Selling a Business

The Role of Disclosure in the Due Diligence Process when Selling a Business

The Role of Disclosure in the Due Diligence Process when Selling a Business

A business owner who would like to sell their business how they go about the sale can be the difference between a dream ending and a nightmare. There are some things you should know before selling your business.

It is important that the buyer and seller know what’ being sold, bought and what known circumstances might affect the performance of the business after the sale.

If you’re selling a business your best friend is DISCLOSURE! That’s right disclosure. The role of disclosure in the due diligence process is important when selling a business.  You may want to sell your business but when you do, you also don’t want to be in court a year later with a buyer trying to get the money back.

Disclosure is a part of the Due Diligence process. Due Diligence can vary greatly from deal to deal but one thing that doesn’t change is the obligation for disclosure.

Disclosure needs to be methodical and complete. During a sale, many business owners ask, “why is the buyer asking so many ridiculous questions?” As a seller, you should answer honestly and if you don’t know the answer tell the buyer that also.

Buyer Beware: Unfortunately, there are some sellers in the world who would rather look the other way, close the deal and worry about it later. As a buyer, you need to do your homework before finalizing the sale.

Disclosing Material Information

You should also be aware of material information that you should tell the buyer even if they don’t ask. What might that be?

Before the sale, you are talking to your largest customer and they say something like “Joe, just thought I’d let you know, starting in January we won’t need your product anymore.”

Some sellers might think closing on the sale before the buyer finds out is the best course of action, but it is not. In this case, you need to put in writing this information for the buyer. Could it kill the deal? Yes, but that might be better than the legal entanglements after a sale.

Here is what you want to include in disclosure:

  1. Any information the buyer asks for
  2. Any information about actions or impacts that might materially affect the business after the sale

There are plenty of situations that could occur. For example, let’s pretend it’s 2 weeks before the sale of your business is scheduled to close. Your top salesperson comes to you and says, “I’m pregnant, and after the baby comes I’m going to take a couple of years off if you need to fill my position I understand.”

Yep, you need to tell the buyer that. Losing your best salesperson is a big deal, even if you think they are easily replaced. Any small details that could possibly bring a wave of hurt to the company needs to be addressed before the sale.

When you decide to sell your business, you need to go through your business with a fine-toothed comb and be prepared to disclose and discuss.

 

Remember: Bad news about your business before the deal closes is a price problem. Bad news discovered after closing is a legal problem.

 

Buyer’s Responsibility

Along with the seller’s disclosure, the buyer has a responsibility as well. They need to put in the effort and do the homework to ask the right questions so all parties understand.

An experienced and qualified Business Broker can assist the buyer and seller in the Due Diligence process but the obligation for full disclosure is the responsibility of the buyer (who is spending a lot of money) and the seller (who is getting the money).

The Importance of Maintaining Confidentiality in the Business Sale Process

The Importance of Maintaining Confidentiality in the Business Sale Process

When a business owner decides to sell their business, one of the biggest issues discussed with Sunbelt Business Brokers is how to maintain confidentiality during the process. When a business owner states they want the business sale to be done confidentially they mean they don’t want the employees, customers, vendors, lenders, etc. to know the business is being sold or even that it is for sale. In addition, confidentiality means that none of the important and confidential information about the business should be tossed about carelessly and wind up in the hands of someone that could use the information to harm the business and the seller. The protection of confidential information is a very important element of buying a business in Texas.

Confidentiality Agreements

Confidentiality Agreements (CA) are also often called Non-Disclosure Agreements (NDA). Nearly every business owner and business broker will want a potential buyer to sign a Confidentiality Agreement before releasing information specific to their business. In all likelihood a CA will need to be signed before the buyer is even told the name or location of the business. It is very important that you, as a buyer, understand the requirements in the Confidentiality Agreement. You will be expected to honor what you sign and commit to do. Failure to honor the terms of the confidentiality agreement could subject you to legal action and possible damages. If you are unable to understand the terms and commitments in the Confidentiality Agreement please seek appropriate legal advice.

Common Elements in Confidentiality Agreements

Time Frame: You will be expected to maintain confidentiality for a specific time.

Return of Materials: You will commit to return or destroy the information at the request of the seller. This includes all hard copy and digital copies. The seller can insist that you do this at any time the seller chooses. Also, you will likely be required to confirm in writing that you have destroyed the information.

Restrictions on Use of Information: Confidential information can only be used by you to evaluate YOUR interest in purchasing the business. For instance, you cannot “pass it along to a friend that might be interested in purchasing the business. You won’t even be allowed to state the name of the business for sale to non-professional advisers. You can only release the information to your professional advisers(CPA, Attorney, etc.) who you must then advise that the information is bound by a confidentiality agreement. Furthermore, you will be responsible for what your advisors do with the information. Make sure you tell your advisors the information you give them is bound by a Confidentiality Agreement.

Employee Contact: You will likely be prohibited from talking to or contacting employees without permission of the seller. You will also likely be prohibited from hiring employees or providing information to anyone who could use it in another business to hire or recruit the seller’s employees.

Vendors, Suppliers, Customers, Lenders Contact: The same restrictions as Employees, basically, without written approval from Seller you cannot contact any of these parties nor provide information so that others can.

Important Note: There are many different forms of Confidentiality Agreements, some have many more terms and very different terms than above. Make sure you read the agreement carefully and thoroughly understand your obligations before signing any Confidentiality Agreements.

Buyer Insider Tip #1: In order to buy a business on the best price and terms it’s important for the buyer and seller to establish a good relationship. A buyer can get an advantage over other buyers by telling the seller they understand the need for confidentiality and that they will absolutely honor the non-disclosure agreement. The seller will appreciate it and will likely be more comfortable releasing the critical information you expect to receive.

Why is Confidentiality During the Business Sale so Important to the Seller and Buyer?

The sale of a good business is not like the “going out of business sales you see on TV. If there is a going out of business sale the business owner has no interest in preserving the ongoing value of the business. Their only concern is selling the inventory and fixtures. In selling a good business the buyer and the seller both have an interest in preserving the value of the business in the process. Obviously, the Buyer wants the value of the business preserved so that its continued success is possible.

Employees

When word gets out that a business is for sale often the employees assume the worst. Employees may assume the buyer is going to fire them. When buying a business a significant part of the value is in the trained employees. A business buyer does not want the employees to quit. The employees and buyer have a common interest to keep the employees employed in the business. If the business sale rumor causes employees to look for other jobs then the seller is harmed and the buyer is also harmed.

Buyers occasionally want to talk to employees before they buy the business to make sure they aren’t going to quit. This is almost always a bad idea for the buyer and the seller. What we have found works best in most cases is that the employees aren’t told of the business sales until the sale is complete and then the buyer and seller together announce the sale to the employees.That way the seller can endorse the buyer and the buyer can assure the employees that they all have jobs. This sudden announcement might seem uncomfortable but actually, it eliminates uncertainty for the employees that might be created if they hear the business is for sale weeks or months before an actual sale.

Buyer Insider Tip #2: As you near the actual purchase date work closely with the seller on a plan to announce the purchase to employees. Experience tells us you want to make the sale announcement on the first day of the work week so that you, the buyer, has all week to start building a relationship with the employees. You probably don’t want to announce a sale on Friday afternoon then send the employees home for the weekend to sit around worrying about things.

Vendors, Suppliers & Lenders

If suppliers hear a business is being sold they may choose to alter their credit policies until the new owner is in place. If a seller has a vendor that normally sells a product to the business and allows the business 45 days to pay the bill and, because of a rumored sale, changes its policy to want payment in 10 days, that could have a significant and harmful impact on the day-to-day operation of the business.

Customers

For retail businesses, the buyer usually has no concern about the need for contacting the customers before the business purchase. However, for business-to-business companies, there are often concerns and issues to be addressed. If the business has significant customer concentration issues (i.e.,one customer represents 50% of the total sales of the business) the buyer may want to have some assurances that the business will continue after the sale.These assurances can be provided in a number of ways. Examples are contracts in place and/or service agreements that can be assumed by buyer. The Seller and Buyer must work together to determine how to accomplish the goals of both parties how to complete the business sale without damaging the business and also assure that the buyer has a good opportunity to continue the relationship with the customers.

Business Insider Tip #3: Virtually all business sales have a few areas where the buyer and the seller need to be creative to resolve a risk issue for the buyer that is a confidentiality issue for the seller. Buyers who work with the seller openly, reasonably and respectfully usually end up with the most favorable solution.

A Prepared Business Owner’s 9 Step Strategy to Sell a Business

A Prepared Business Owner’s 9 Step Strategy to Sell a Business

As every entrepreneur knows, selling a business is a big event, a milestone toward the next phase of life.  The majority of business sales are triggered by unexpected events in the owner’s lives. If you’re not prepared to sell, it is more likely that your transaction will be at a greater disadvantage, potentially reducing your overall valuation or causing a more problematic sale. It is very easy to get caught up in the daily business operations, leaving you more vulnerable should an unexpected event occur. Plan ahead with an exit strategy.

Planning Ahead: A Business Value Insurance Policy

Business owners buy insurance in hopes that they don’t need it, but when they do need it, they are very happy they have it. Often the insurance is for events that might cost them as little as $1,000. Being prepared to sell your business when you’re not planning to sell is like having a “Business Value” insurance policy. Without preparation (your insurance) you are “uninsured” for the loss of business value, which can cost hundreds of thousands of $$ or more.

1) Financial Statements.

Make certain your financial statements for at least 3 years are accurate, accounting practices are consistently applied year-to-year and all of the assets and liabilities on the balance sheet are accurate.  Here’s a good guide to what’s important in your business accounting.

2) Dispose of unused equipment.

Scrap or auction it, but get rid of it. You’re selling a business, no need to have useless equipment lying around.

3) Clean out dead or slow moving inventory.

Business owners often think that obsolete inventory doesn’t cost anything to keep on hand and maybe one day you’ll get a call from a customer needing that exact item. Get an accurate count of all your inventory, then get rid of the slow-moving or stagnant items.

4) Make sure your employment practices are documented and applied properly.

Is overtime being paid properly? Are your 1099 independent contractors classified properly? Have your employees been screened appropriately for their jobs?

5) Check your books.

Make sure the expenses recorded on your financials are all legitimate business expenses. The cleaner the books the higher the price.

6) Clean up any old partnership or ownership issues.

7) Make sure your tax payments are all up-to-date. Sales tax, FICA, etc.

8) Get an appraisal.

Have a business valuation or business appraisal done on the business so you can determine if the value of the business is adequate to provide the cash needed to secure your future.

9) Talk to your accountant.

Look at your corporate structure and determine what tax issues will need to be resolved to maximize the after-tax proceeds in a sale. Are you still a C Corp? If so, talk to your accountant to see if changing to an S Corp would benefit you in a sale.

Reduce the Risk

Why do these things increase the value of the business?  Because they reduce the risk to a buyer of a business. The lower risk for the buyer, the higher price a seller can expect.  In my 20 years managing business sales, I have found that the most successful business sales are completed because a business owner was PREPARED to sell when the opportunity arose.

Business Owner Year End Tax Planning

Business Owner Year End Tax Planning

A common comment we hear from business owners who contact Sunbelt Texas about selling a business is “I didn’t know a year (or 2 or 3) ago I would be selling my business so soon.”

Before you file your taxes, keep in mind that a buyer and the buyer’s lenders will look very closely at the financials of a business for 3 full years. That means that if you sell your business in 2020 or sooner, the Tax Return you’re about to file could have a significant impact on the value of your business.

Do your business tax returns clearly and accurately reflect the earnings of the business?

Tax Planning for a Future Sale

Here are 4 areas that we often see need significant improvements to obtain the highest value in the sale of a business. Talk to your CPA about how you can move ahead to increase the value of your business.

Inventory

  • Do you have an accurate inventory count and value booked into your financials?
  • Is all of your inventory in “good and saleable” condition?
  • Do you actually know what your inventory value is?
  • Have you written off the old and obsolete inventory?

Accounts Receivables

  • Are all your receivables good and collectible?
  • Have you written off the A/R you know your odds of collecting are remote?
  • Do you have customer deposits intermingled with the accounts receivables?
  • Do your receivables reflect what is actually owed to you by the customer? (We see companies that when they get a customer deposit for a job, they book the whole job as a sale and book the deposit as a partial payment even though they haven’t actually earned the sale yet)

Employees

  • Are your employees classified correctly 1099 vs W-2? Are your 1099 contractors really employees who should be classified as W-2 employees. (This is a very big issue and the government has an active program to crackdown on this….and the penalties can be severe).
  • If your 1099’s are really 1099’s, do they have an entity (i.e., LLC, S Corp, etc) you pay?
  • Do you have a properly written and valid independent contractor agreement with them?
  • Are your W-2 employees correctly categorized as hourly vs salaried and paid accordingly? You don’t want to lose a claim where, after years the employee claims you owe them thousands of hours of back overtime pay.

Owner Benefits and Compensation –
This is VERY important and can dramatically affect the value of your business:

  • Are the compensation and benefits received by the owners easily identified and properly booked on the financial statements and tax returns?
  • Do you have significant expenses that are not directly related to the business, expensed through the business that are buried in the company expenses?
    • Travel?
    • Entertainment?
    • Expenses run thru company credit cards?
    • Personal vehicles?

Tax Planning Action Item:

If your objective is to sell your business one day then you should get your financials in condition for easy due diligence and maximum value. “Burying” personal expenses in the business financials will reduce the business earnings and reduce the value to a buyer.

Our advice is for business owners to take any compensations as salary, bonuses and draws. Running non-business expenses through the business financials creates problems for proving the earnings in due diligence and raises the risks associated with potential tax liabilities

Conclusion

The most important element of business value is clarity of the business earnings and reduction of the risks associated with all aspects of the business. A buyer will only pay for the earnings that can be proven and the risks a buyer sees drives the multiple buyers will pay for a business.

A business with the lowest perceived risks will command the highest price multiples when being sold.

A Practical Guide to Seller Financing

A Practical Guide to Seller Financing

Selling a business is one thing, getting paid on the sale is another.  The options available for financing the deal are dependent on the business and the buyer. Here are some things to be aware of if you find yourself with a chance to sell your business.

Seller Financing:  The good, the bad and the uh oh

Seller Financing as the ONLY Financing

The Good:

  1. Seller provided financing opens the sale up to a wider range of buyers (though not necessarily higher quality buyers).
  2. Without a 3rd party lender (SBA, Bank, etc) the deal can likely get to closing faster than if bank financed
  3. Buyer usually isn’t as price sensitive since there usually isn’t a 3rd party valuation
  4. You may be able to cross-collateralize or obtain cross default agreements to tie up assets.
  5. If you get a personal guaranty from buyer you may have better chance to get paid.

The Bad:

  1. If the buyer defaults on the note it can be expensive to try to collect
  2. If you worry as much about the note payment as you did about the business are you any better off?
  3. Unless done properly there can be all kinds of tax issues

The Uh, Oh:

  1. If the buyer has a lease on facility you may need a landlord subordination agreement or you won’t be able to get to the collateral or worse, you might have to pay the back rent in order to get to your collateral.

Hints:

  1. Get the landlord subordination agreement at the time of the sale.
  2. If you can, cross default the lease and note so that if buyer is in default on either they are in default on both.
  3. Make certain to file a UCC1 on the collateral assets so the whole world knows your note needs to be paid before the assets can be sold.
  4. Try to get a really high default interest rate on the note so that the financial pain of default is high.
  5. Consider a sub-lease to the buyer rather than buyer getting a new lease. That way you retain control of the facility and can act faster if you need to intervene.
  6. Try to get collateral other than business assets. Does buyer have a vacation home? Other assets?
  7. Guarantors – get as many guarantors as possible also make sure spouse signs guaranty if required in your state.
  8. Require buyer to provide financial statements and tax returns to you for as long as the buyer owes you money so you can keep an eye on the business health.

Seller Financing with Other Types of Financing

SBA Loans with subordinated Seller note:

The Good:

  1. The Bank is likely to screen the buyer more thoroughly than most sellers
  2. The seller note is likely to be less than 10% of the total selling price.

The Bad:

  1. The bank will look very carefully at the business cash flow (several years), seller financials need to be in good order.
  2. Bank will require a 3rd party valuation to make sure the price the buyer and seller agreed to is fair.
  3. SBA limits any “after the sale” arrangements between buyer and seller.
  4. The seller note will likely have a period (usually 2 years) whereby the seller gets NO payments and only interest accrues.
  5. If buyer defaults on seller note the Bank will limit what actions the seller can take to get paid.

The Uh, Oh:

  1. Because of the restrictions in the bank subordination agreement the seller note is usually the first obligation that goes unpaid.
  2. If the seller stops paying you it’s usually a sign of other significant problems with the business.
  3. If the buyer stops paying the note the seller recourse is basically limited to enforcing the personal guaranty.

Revolvers (also known as Asset Based Loans) – with associated seller note

Definitions: a “revolver” is a bank loan or financing company loan that gets adjusted every month (or week or even day). These revolvers are tied to accounts receivable (a/r) and/or inventory and are a % of those items. For example a common revolver term is a bank loans the business up to 70% of current accounts receivables and/or 20% of good inventory at cost.  (The a/r % is high because a/r is highly liquid and can be collected quickly. Inventory is much more difficult to liquidate and has high costs associated with liquidation i.e., warehousing, transportation, auction costs etc.)

The Good:

  1. A revolver is flexible in that if funds cashflow when the business is growing.
  2. A revolver usually has fewer covenants.
  3. The “credit worthiness” of the business is less stringent than normal bank standards

The Bad:

  1. The seller note will lose a/r and inventory as collateral.
  2. The revolver lender usually can “pull the plug” at any moment
  3. The cost to the borrower can be significantly more expensive than an SBA term loan.

The Uh, oh:

  1. Revolver loans normally have many fees and opportunities for lender to squeeze a few more dollars out of borrower
  2. Revolvers are famous for high cancellation fees if you want out of the deal.

Credit Card Loans Against Receipts – along with seller financing

Description – With these loans a lender “forecasts” your credit card receipts and lends you money in advance, then when the customer credit cards are process for the business sales then the money is redirected to lender to pay off the loan they advanced. Generally speaking these loans are used for retail stores, restaurants, etc with high % of credit cards sales and highly predictable and regular sales. Take the time to calculate the real costs of this kind of financincing, it can get expensive quickly.

The Good:

  1. If you have high volume of regular credit card sales these loans are not difficult to obtain
  2. The cashflow is steady

The Bad:

  1. These loans can be very expensive
  2. The CC lender gets paid before the seller note by taking their money out of the sales revenue.

The Uh, oh:

  1. Because these loans have a claim on all revenue it is very unlikely any other 3rd parties would provide financing.
  2. The process of payment takes control of cashflow out of biz owners hands (which could be a good thing in some cases)

If you are selling a business you’ll need to risk adjust the price depending on the financing structure that the buyer and seller agree to. Also, make sure to get good legal and accounting advice to understand what the net value is. And finally, look closely at the risks associated with any financing arrangements.

5 Tips to Sell a Manufacturing Business

5 Tips to Sell a Manufacturing Business

Congratulations!  You’ve decided to sell a manufacturing business but before you jump in with both feet, we suggest you settle in to take stock of your business, systems and current processes. While it may seem like a simple route to just list your manufacturing business for sale in Texas, there are far more complexities at stake. All industries, including manufacturing, have unique characteristics that need to be considered as you prepare for the eventual sale.

Some of these items take a significant amount of time to implement so a business owner would be wise to begin working on these elements well in advance of attempting to sell their company. Your due diligence and careful review of your business NOW will help to secure the opportunity for higher valuation.

  1. Work-in-Process Accounting: Work-in-Process can involve substantial assets and liabilities. In addition, these numbers are moving nearly every day. Labor goes into the project, more materials, customer progress payments, etc. Buyers won’t go for the “eyeball” estimate for the money. Implement industry standard work-in-process systems and have the discipline to accurate accounting.
  2. Proper Management of Customer Payments: This is associated with #1. Far too often we see customer deposits or progress payments just booked straight into accounts receivables. We’ve even seen progress payments booked as revenue. Part of a business sale often involves working capital adjustments, if you are mixing a/r and sales that should be in the work-in-process calculation the problems multiply.
  3. Safety: Make sure your safety processes and procedures are up-to-date. Many buyer will conduct a due diligence “OSHA Style” audit to make certain there are no hidden liabilities. Also, for obvious reasons, take meticulous care to document and track any and all job injuries and accidents.
  4. Contracts with Customers:  Whenever possible have your contracts with customers written so that they are assignable. Also, look to limit “change of control” clauses that create risks when buyers take over the contracts in progress. Get a review by a good contracts attorney.
  5. Environmental:  If you haven’t had a Phase 1 Environmental Survey done on your property in the last 10 years it might be a good idea to make sure no issues have inadvertently crept into your operations.

Preparing for these 5 items will not only significantly reduce the time and friction involved in due diligence but will increase the odds that your deal of your life will make it to the closing table.

Sunbelt Texas has 20 years experience, the decision to sell a manufacturing business will create value for the business owner if done properly.

For more information about Preparing Your Business For Sale feel free to contact us. Email Info@SunbeltTexas.com