If you missed part one of this article, it was published in ENX’s June 2022 issue and covered these mistakes to avoid:
- Running the business to pay no taxes
- Taking business value advice from peers
- Engaging the first unsolicited offer
- Not having your books in good order
- Thinking you can go it alone
For many business owners, the sale of their organization culminates a lifetime of work. While it can be the most rewarding sale you’ll ever close, it can also be disappointing if it doesn’t go as desired. The key to achieving a successful sale is advance planning and avoiding the following mistakes that can have an adverse effect on the outcome.
Making the emotional shift too early—Selling your business can be an emotional roller coaster. It starts with anticipation and a desire to move on to the next chapter of your life. This desire to move out of the business can lead to making the emotional jump too early.
The best leverage you have is the willingness to walk away if the deal isn’t right. I’ve seen owners agree to terms they wouldn’t have if they were more patient. They’d mentally sold the business already and were simply waiting for the process to catch up. But there’s quite a lot to work through and negotiate in the sale of a business, and these negotiations often continue right up to the close.
I’ve also seen business owners let the business coast while working through due diligence. They stop making pro-survival, growth-oriented decisions and taking definitive action to keep the business strong. This creates two issues. First, it allows the business to slide, potentially giving the buyer leverage. Second, it creates the need to play catch up if the sale falls through.
To remain in the strongest position possible, you must continue to run the business as if you weren’t going to sell it.
Telling employees too early—One of the biggest struggles many owners have when considering a sale of the business is how to handle the staff, especially long-term key employees. Most owners feel guilty about negotiating the sale and not telling their people. It could feel like a betrayal of those who’ve been a big part of your life.
However, telling employees early in the process creates several problems. The biggest of which is making them nervous—human nature kicks in and the first thought they have is “I’m going to lose my job,” even though this is rarely the case. Nervous employees can make rash decisions, such as finding another job. Telling employees also opens the door to them telling others. Keeping the transaction confidential is important; the more people who know what’s happening, the greater the chances of word getting out.
Lacking specifics in the letter of intent—The letter of intent (LOI) is the high-level agreement between the parties. It typically outlines information such as purchase price, payment terms, employment arrangements and more. It also includes technical items such as how working capital, indebtedness and other key assets and liabilities will be handled up to and after the close.
It’s important to ensure there are enough specifics in the LOI to avoid surprises as you move through due diligence. One example of an item that would seem to have little impact if not negotiated in advance is the purchase price allocation. However, this can have a significant impact on your taxes. In much of the allocation, the buyer and seller are on opposite sides of the tax impact. Take fixed asset value, for example. If a buyer wants to allocate more for fixed assets than you have on your books, it will result in a revenue recapture for you that will be taxed as ordinary income rather than the lower capital gains rates. This one item could cost you thousands of dollars in taxes.
Using an attorney with little or no M&A experience—A business sale is a technical transaction with many moving parts. A misstep in the legal agreements could be costly and can open you up to significant risk going forward. You must have an attorney who is well versed in M&A transactions to ensure a good outcome. It’s also helpful if he or she knows the industry and business model.
I recall one transaction in which our client insisted on using his local attorney to represent him in the purchase of a business. This attorney, he said, was one of the best in the state. Unfortunately, the attorney’s lack of M&A knowledge led to a major mistake on the purchase agreement—a mistake that allowed the seller to pocket $65,000 in accounts receivable that should have gone to the buyer.
There are countless other examples of how the legal agreement can work against you if not properly negotiated. It’s interesting to note that the reason some business owners prefer to use a local, less-experienced attorney is because of a lower hourly rate. However, in my experience the total legal fees spent on a transaction are typically lower when a seasoned M&A attorney is used, as the work is done in far fewer hours.
Not trusting your gut—This last mistake is one that applies to all aspects of business. Simply stated, if things don’t feel right, they probably aren’t right.
As covered earlier, selling a business can be emotional. You’ve spent a lifetime building it, and as you work through the sale, you’re investing a lot of time and money. The further you get into the process, the more invested you become. I’ve seen situations in which red flags appear and are brushed aside or minimized to keep the process going.
While it can be expensive to walk away from a transaction mid-stream, convincing yourself that “all is okay” can be far more costly. If your gut is telling you something is wrong, take it as a sign to dig deeper, and be willing to truly confront what you encounter. Due diligence is a process undertaken by both sides to prove out the value and long-term viability of a transaction. If it turns up data that makes you doubt your initial decision, be willing to trust your instinct and pull the plug.
Understanding these common mistakes will have a positive impact on the sale of the business. The key is starting early—the time to prepare for a business sale is at least three years out. While a business may be sold without that pre-planning, it’s not ideal. Avoid these mistakes and you’ll reap the rewards.
