Toronto business and technology lawyer, Sukhi Hansra, of Hansra Law, discusses the key consideration for business owners and entrepreneurs when selling a business.
The Process of Selling a Business
Selling your business can be one of the hardest decisions any business owner or entrepreneur has to make. After all, it takes countless hours, time, and money to get a successful business up and running. It’s not surprising then that many business owners either don’t think about selling or make preparations for a potential exit.
There are often several reasons for why a business owner may want to sell their business, such as downsizing or upsizing, expansion and retirement. Even if you don’t plan on selling your business in the short-term, it is important to consider the worth of your business in preparation for an eventual exit, or to consider the future transfer of the business to a family member.
Preparing to sell a business can be both an exciting and complex experience. On one hand, it can be a life-changing event that may put you in a great financial position. On the other hand, it requires serious consideration, planning and preparation to obtain full fair market value for your business. To maximize your business’s value, you’ll have to plan and prepare beforehand. Here’s a list of factors to consider when selling your business.
1. Plan Ahead and Get Organized.
Selling a business is a process that takes time. Additionally, there is a considerable amount of paperwork and money invested by both parties to ensure that each party is getting what they bargained for. For example, before you can close your transaction, the purchaser will typically conduct due diligence on your business to confirm what they are buying and the obligations that they will take over. This may also involve the nature and extent of any contingent liabilities and litigation risks involved with the purchase of your business.
As a seller, you want to ensure that your corporate records, files, contracts and books are in proper order so you do not raise any red flags during the purchaser’s due diligence. Anything from a gap in your corporation’s financial records to an unfavorable contract may be enough to turn a buyer away. This will in turn reduce the value of your business and make it harder to attract other suitable buyers.
2. Understand and Negotiate the Terms
The sale of a business is not as simple as handing the keys over to the buyer and then going your separate ways. There are two main types of business transactions: asset sales and share sales. In an asset sale the seller will typically retain all liabilities in the business, while a share sale would confer significant tax advantages to the seller. It is important to establish the type of transaction you are entering into as early as possible. If you have a strong preference towards one method over the other, you may be able to employ unique negotiating strategies. For example, some sellers offer a discount on the sale price if the buyer agrees to do a share sale.
Several other considerations that can be negotiated between both the buyer and seller are the specific terms of the purchase agreement, the valuation, purchase price, non-competition clauses and confidentiality considerations. Always ensure that you have adequate protections and understand the consequences of the sale transaction.
3. Establish a Fair Sale Price for Your Business
Generally speaking, the bulk of negotiations will focus on the business valuation and sale price of your business. If the shares in your business are not being publicly traded (i.e., your company is a privately held Canadian corporation), any attempts to accurately valuate the business may be highly speculative. This is because publicly traded companies have been vetted by the public markets and can easily be compared to competitor companies. For more information on how to conduct a business valuation, please see our previous Legal Guide on 5 Ways to Valuate Your Business During Uncertain Times.
If you and the prospective buyer can’t agree on an accurate valuation or purchase price, consider inserting an earn-out clause – a tool used in M&A agreements to bridge the valuation gap. An earnout clause provides that the seller may obtain additional payment from the purchaser after the transaction has closed if the purchased business achieves certain defined thresholds (usually financial) after the closing. Some common ways to structure earn-out calculations are gross revenue, EBITDA divided by profits, royalties earned or the achievement of certain milestones.
4. Prepare a Letter of Intent
Once you and the seller have a general idea on the key terms and structure of the transaction, you can prepare and submit a Letter of Intent to express formal interest in purchasing the business. A Letter of Intent to purchase a business is a short document outlining the intentions of the parties and the basic elements of the proposed transaction.
Some key items that are typically negotiated and inserted into a Letter of Intent include a list of assets or shares being purchased, the purchase price and how it will be paid (full cash buyout, bank loan or monthly instalments), the proposed closing date, negotiation and investigation time periods (often called due diligence periods), exclusivity periods, assumption or termination of employees, non-competition and non-solicitation agreements.
Selling a business is an exciting but complex process for any business owner or entrepreneur. Although the above points are good considerations to begin thinking about selling your business, it is always best to consult someone that has prior experience with buying or selling businesses, such as a business broker or business lawyer.
For more information, please see our Legal Guide on How to Purchase an Existing Business or How to Negotiate the Purchase or Sale of a Business to learn more about the process of a typical business transaction and negotiating the terms.