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Ten Rules for the Sale of a Business (Part One)

Sooner or later the owner of a small business should begin to ask this question:
What is the best way for me to leave this business when I am no longer capable of running it or lose interest in it? There are three possible answers to this question. First, the owner can slowly wind down the business until it disappears. Second, the owner can plan to sell or give the business to someone else. Third, the owner can abruptly cease to be involved, either by sudden illness or death, or by locking the door and walking away. If the goal is to maximize the owner’s return on years of investment in the business, only the second of these choices makes much sense. This note focuses on that choice.

The first rule for the sale of a business is to sell sooner rather than later. Fire sales normally do not bring maximum value because all the bargaining leverage is on the buyer’s side. And once potential buyers perceive that the owner needs to sell they may approach the situation with the belief that the price will go down if they wait long enough. Furthermore, as explained in more detail in subsequent parts of this note, the preparation for the sale of a business takes a lot of work.

An owner will need time to get the business ready. Postponement of the preparation process amounts to a gamble that the owner will have the physical and mental ability to complete the process. Ray Kroc, founder of McDonalds famously asked, “Are you green and growing or ripe and rotting?” In the context of a business sale, Mr. Kroc’s question can be rephrased in this way: “What happens to the perceived value of a business which seems to be on its way down?” Not only will potential buyers be increasingly less interested in paying top dollar; clients and customers will begin to look for alternatives; employees may decide it’s time to reconsider talking to that friend about a job with a different company; marketing will grow more difficult. In order to avoid these problems an owner needs to sell when buyers still perceive the business as “green and growing”.

For most small business owners, the best way to maximize the owner’s return on his or her investment is to sell the business to a trusted employee. An employee-buyer offers multiple advantages to a seller. The first of these is that inertia works in the seller’s favor. Since most people don’t delight in switching job the employee-buyer will most likely want to stay put and can best assure that result by buying the business. The second advantage is that the owner greatly reduces the chance of post-sale claims about failures to disclose material facts about the business, if the buyer has worked in the business for many years. A third advantage is that the selling owner is in a better position to determine if the buyer is capable of caring for the business the owner has created. This is not necessarily a financial consideration (though it may be) but it is often important for an owner to feel that his or her “legacy” will continue after the sale.

Selling to a trusted employee obviously requires the existence of a trusted employee who is capable of and interested in buying the business. Such employees don’t “grow on trees”. Finding and grooming a capable successor can take years and normally involves gradual process of sliding the successor employee into increasingly more responsible positions within the company. This process can involve negotiations with the employee well before it time to start selling the business. For example, the owner may well want the employee to sign a non-compete agreement as a precursor to the increased customer or client exposure the employee will need if he or she is going to be able to sustain the business. If the owner has a group of key employees to whom the business might be sold, the process of preparing these employees to work with one another as owners becomes more complex and requires more time.

The sale of a business is a complex process, fraught with risks for the seller. But like any business transaction it is likely to work more smoothly if the seller has a good plan. The trick is start planning far ahead of the actual event.