BNet featured a series of 8 drawings that correspond to steps to sell a business that is worth checking out:

The Art of Selling A Business

I do have a few comments, though, about a few of the steps:

1.  The author’s first step is to “Get real about what your business is worth.”  While I agree with the author that a business owner should definitely develop an understanding of what their business is likely worth, the tip of “Buy lunch for a mergers and acquisitions professional or business broker and ask them for a guesstimate of what a business like yours is fetching these days” is NOT a good idea.  Here’s why:  there are many issues that could have a significant impact on your business’ value.  A casual conversation over lunch with a M&A advisor or business broker won’t provide a very accurate estimate of value, and may result in a “guesstimate” that is dramatically higher or lower than what your business is realistically worth.  Instead I would suggest hiring the business broker or M&A advisor to do a thorough review and valuation of your business. This review should be far more than simply looking at the past two year’s financials and making some quick calculations and applying a multiplier to it.  The business broker or M&A advisor should develop a strong understanding of your business, including, amongst other things:  the business model; risk factors; differentiators between you and your competitors; business strengths; the overall competitive environment; opportunities for growth; historic and probable future growth; trend analysis; ratio analysis; diversification of revenue by product and service; intellectual property; the quality, breadth, depth, and retention of staff; and threats to the business’ long-term success.  Without knowing these types of things, an estimate of value will be little more than a guess.

The cost of this can vary dramatically depending on the advisor, the scope of their review, and the complexity of the business.  Most businesses with under $20 million in revenue should expect to pay between $3,000 and $20,000 for this type of review, and (if planning for a future sale a few years in advance) annual updates can be done for a lower price.  My company, Codiligent, charges a flat fee of $3,500 for such a review for 90%+ of businesses (the remaining 10% may be more involved and thus cost more).  Furthermore, if an analysis client turns into a business sale client in a relatively short period of time (or longer period if the client does annual updates to the analysis) then Codiligent will credit a large portion of that analysis to any closing commission earned.  I believe that most business owners will find that this is money well-spent:  you’ll not only have a much more accurate idea of what your business may sell for, but you’ll also have a better understanding of issues that may negatively impact value and marketability.  If that information results in you making changes to the business and then selling a couple of years from now and those changes result in price that is even just a couple of percentage points higher, it may pay off handsomely.

2.  Another point that the author makes is that if you can “Disappear for a While” and the business operates fine without you being present, then it is a good indication that the business can be successfully transferred to a buyer, and thus will be more marketable.  This is great advice.  If you find that your business doesn’t run well when you are gone, then it is probably time to work more on your business’ systems before selling.  A few books I’d recommend related to systems include Sam Carpenter’s “Work The System”, Michael Gerber’s “E-Myth”, James Womak’s “Lean Thinking”, and Jeffrey Liker’s “The Toyota Way.”

3.  In the author’s step 5, which is “know when you lose your leverage” he points out that a no-shop clause in a Letter of Intent (LOI), while usually necessary, will take away some negotiating power, and his tip is “Expect the offer price to drop by 10-20 percent after you sign the LOI and be pleasantly surprised if it doesn’t.”  While I don’t disagree with the author’s premise, did you know that Codiligent’s business seller clients, on average, have experienced less than a 1% price renegotiation between LOI and closing? I believe that one of the reasons my firm is so successful in maintaining prices is that we approach business sales differently than most brokers and intermediaries.  Most business sale intermediaries, unfortunately, do a poor job of packaging the business, which means that a business buyer will still need to do significant discovery of material facts as part of the due diligence process, rather than primarily being about verifying material representations already made.  Adverse findings during due diligence often results in either a lower price being negotiated or, even worse, an aborted deal.  In contrast, Codiligent provides a far more comprehensive confidential information package which includes most of the material disclosures necessary for a buyer to make an informed buying decision BEFORE a LOI is signed.  That doesn’t mean that we will necessarily give out ALL confidential information in the package prior to due diligence.  For example, we may promote that a business has some excellent clients, but we don’t necessarily have to reveal their names.  Instead of naming the company’s top client, XYZ Company, we instead may say something like “The top client, which accounts for 8% of this business’ overall sales, is a privately-held, $200 million+ in revenue business in the food and beverage industry located in the western US.”

In any event, the author of the BNET article’s other points are good ones, and you may enjoy the art that accompanies them.

Nevertheless, the article does point out that it has been a much more difficult market in which to sell businesses.  This is due to a combination of factors including:  lower or inconsistent financial performance from companies being listed; difficulty with obtaining bank financing; lower buyer price expectations for well performing businesses; buyer uncertainty caused by the economic and political climate; buyers with less capital; etc.

In light of this, if you are selling your business it is more important than ever to make sure that you have high quality business sale representation.  A business broker who does little more than place a 1 paragraph ad on a business sale website; has a business information package that consists of only xeroxed financials and a page or two of information on a business; arrives at a simplistic estimate of value; and fields phone calls and emails from prospective buyers is not likely going to help you achieve success in this market.  A business owner who wants to sell will want to employ a business broker who develops a thorough understanding of their business by doing a complete quantitative and qualitative analysis; understands business valuation and can provide a rational defense of value; develops persuasive and complete non-confidential AND confidential information packages; advertises and markets the business in rigorous ways (rather than rely solely on passive on-line advertising); does persistent follow-up with prospective buyers; is skilled at negotiation; and can assist buyers with financing.  Codiligent strives to provide this higher level of service – check out our 3-minute movie at the following link to learn how Codiligent provides the level of service necessary to increase the probability of selling in this tough market:  www.codiligent.com/impactmovie

The following Ma & Pa Kettle video reminds me of some deal structure negotiations I’ve been involved with:

Because of this perception many business owners believe that they can either successfully sell their own business or that the selection of a business broker is less critical than it really is.

The reality is far more stark.  Depending on the study or statistics I’ve seen over the years, the average percentage of businesses that are actively marketed that actually sell ranges from about 1%-30%.  In a recent article titled “Will you be able to sell your business?” by Anne Fisher she claims that rate is between 0.5% and 1%.

So, how do you make sure that your business is one of the few that actually sell?  Here are some suggestions:

1.  Start planning for a business sale 3-5 years in advance of when you want to sell.  Start openly sharing information with a quality business broker 3-5 years in advance and ask him or her for guidance in what needs to be done to make the business more marketable and valuable.  This isn’t something that can usually successfully be done within 1-2 years of a sale.

2.  Make sure that you are using a quality business broker.  Business brokerage is highly unregulated, and in many states almost anyone can pronounce themselves to be a business broker.  So what does a quality business broker look like?  That’s a more difficult question to answer because there are a variety of factors that could impact competence and quality.  Following are a few tips in ascertaining the quality of a business broker:

• Generally, it would be preferable for a business broker to have a MBA with strong knowledge of finance, valuation, law, negotiation, operations, and marketing.
• Professional backgrounds may vary but it is more likely that an appropriate skill set will have been developed by a broker who previously worked in a field such as loan underwriting, business appraisal, financial analysis, mergers & acquisitions, capital formation, or strategic planning than if their background were in a far less related field such as residential real estate sales, elementary school teacher, car salesman, or former deli owner.
• Because business brokerage is an easy entry business, but a difficult business to succeed at, it may be wise to give greater consideration to business brokers who have been in the business full time for at least 2 years.
• When you called or emailed the broker were you able to get ahold of him or her, and/or did they respond in a timely manner?  How responsive will the broker likely be to inquiries from buyers of your business?
• When a buyer seeks more information after seeing an ad or marketing piece on the business, what additional information is provided by the business broker and is it quality information?
• Does the business broker anticipate spending significant time in developing an understanding of the business before trying to actively market it?  Some business brokers will tell business owners that they can have ads up within 24 hours.  Yet, in order to effectively sell a business you must first understand it.  A broker who will rush to bring the business to market without first analyzing and understanding it is not indicative of a broker that will likely achieve optimal results for a client.
• Is the business broker going to do more than simply place ads on business sale websites?  While many small businesses DO lend themselves to being marketed to general financial buyers via ads on business sale websites, most often there are other appropriate ways to broaden the marketing reach.  If a business broker plans on doing little more than placing an ad on BizBuySell.com and one or two other business sale websites, then they probably aren’t providing comprehensive representation.
• What information is contained in the business broker’s ads and information packages for other businesses?  You may be shocked by the lack of content when looking at business sale ads from many less competent business brokers.  In fact, many business sale ads contain less information than you would typically find in the sale of residential real estate.  It’s not uncommon to see a short paragraph of information, the revenue for the business, but no price or cash flow listed.  A competently represented business’ ad should give the reader a decent understanding of what the business does, what makes it unique, what the benefits of owning it are, opportunities for growth, and what its most recent financial performance has been.

Selling a business is more difficult than most entrepreneurs realize, but with some planning a few years in advance and the engagement of a professional business broker your odds of success will be significantly higher.  While it is hard to put an exact number on the probability of a successful business selling since all businesses are different, it will likely be more in the 50%-85% range than in the overall business sale success rate of 0.5%-30%.

Unfortunately, there are flaws with this “no asking price” business broker rationale:

1, Buyers naturally tend to justify why something should sell for less, not more, just as Sellers naturally tend to justify why something should sell for more.  The act of a buyer having to figure out what to offer and developing the rationalization for a lower price will help to solidify a buyer’s belief of the lower price, and absent compelling business valuation methodology that demonstrates a higher price, chance are the final price will be lower than if a realistic price was established and promoted up front.

2.  The market for small businesses isn’t an efficient market.  Each business is unique, there are a limited number of buyers and sellers, there are a limited number of business sales, there’s a low level of liquidity for a small business (you can’t decide to sell now and ten minutes later sell the business for cash as you would be able to do with liquid securities of publicly traded companies), and there isn’t complete and accurate publicly available information on the company being sold or other similar businesses that have sold or are being sold.  Consequently, the inefficient small business “market” may not accurately price what is being sold.

3.  Many prospective buyers won’t participate in evaluating a “no asking price” business.  Many motivated buyers will ignore advertisements and marketing materials for businesses absent a stated asking price.

I suspect that there are more self-interested reasons that cause some business brokers to promote a “no asking price” strategy:

1.  They don’t risk not getting a listing if a seller’s price expectations are higher than they believe they will be able to achieve.  If a seller believes that their business is worth 8x EBITDA, and the business broker believes the business is likely worth closer to 3x EBITDA, it avoids having the business owner seek another business broker who has a valuation expectation closer to their own.

2.  Business brokers are paid on commission and only get paid if the business sells.  Consequently, many business brokers would rather leave some money on the table but increase their likelihood of getting the deal done, then to achieve the best possible price and terms for their client.

3.  It requires less up-front work and business valuation knowledge from the business broker.  When Codiligent business brokers analyze a business there is a significant amount of time and thought that goes into evaluating the business and looking at multiple approaches to value.  In contrast, a “no asking price” strategy doesn’t require the business broker to do any evaluation or possess any knowledge or expertise about business valuation.

Generally speaking, I believe that most sellers will achieve a better outcome by utilizing a stated asking price based on expert advice from a knowledgeable business broker or business appraiser.  However, there are a few circumstances when, in fact, a “no asking price” strategy may be more effective:

1.  The business is distressed and is cash flow negative.  A distressed business will likely struggle to attract significant buyer interest, and valuation will be subjective and/or based primarily on the value and marketability of the business’ discrete assets.  Consequently, a “no asking price” strategy may generate more interest and may even result in a higher price than anticipated.

2.  A business with less than a two-year operating history.  For many profitable businesses that have less than a two-year operating history, the first year or two often have poorer financial performance than they will experience in the future.  Traditional valuation techniques may value such a business lower than what a buyer would pay who sees strong potential growth and profitability based on early stage trends.

3.  A business that has a very rapid growth rate and potential for significant scalability in a large or fast-growing industry, particularly in a hot economy.  For example, a business may have had $1 million of cash flow last year, and had 100% growth for each of the prior two years.  Perhaps there was an indication that it likely could have grown at a much more quickly if it would have had more access to capital.  So, what is the appropriate way to value such a business?  It can’t be based on past financial performance since this would significantly under-value the business.  Projecting 100% growth next year may be too low particularly if the buyer brings access to more expansion capital or marketing synergies.  What type of growth rate can be realistically projected in year 2 post acquisition?  What about year 5?  A seller who has a business like this may find strong competition amongst buyers and a much higher price than many business appraisers using traditional valuation techniques would come up with.

Private Equity Group #1000007147

This firm is looking for manufacturing, distribution, and services businesses throughout the USA with $5-75 million in sales and $1-5 million in EBITDA.  Other things it looks for are: a proven product or process; long term growth prospects either organically or through acquisitions; and management’s desire to build the business’ infrastructure into an industry leader.  This private equity group is not interested in healthcare, technology, or real estate.

Private Equity Group #1000005055

This group is looking for businesses with $2-20 million in revenue, with minimum gross margins of 40% and minimum EBITDA margins of 12%.  Other criteria include: industrial or commercial customer base (no consumer products); proprietary or unique technology (no commodities); three years of sales and profit growth (no turnarounds/startups); national and/or international market; and unrealized growth potential.  In particular, it is interested in light manufacturing and distribution businesses.  It is NOT interested in consumer products.

Private Equity Group #1000004694

This private equity group is looking for businesses in a variety of industries located throughout the USA that have $5-50 million in revenue, and at least $1 million of cash flow.  Other things they look for include: capable management and/or reasonable owner transition; and defensible niches with opportunities for significant growth.

This company seeks businesses located in the Western USA with $3-50 million in revenue and $1-5 million of EBITDA.  Other criteria include: organic and/or acquisition growth potential; strong management team; highly differentiated business model, products and/or services; strong market position with identifiable barriers to entry; and limited customer concentration.  They are interested in the following industries: retail; consumer products and services; business services; healthcare services (especially skilled nursing facilities); education and training services and products; light manufacturing; and value added distribution.

Private Equity Group #1000000308

This firm is looking for businesses with $7-25 million in revenue, and $1.5-5 million in cash flow.  Not interested in manufacturing.  Prefer business services such as data services, safety services, transportation services.  Looking for outgoing or retiring owners.  Geographically:  CA, WA, OR, CO

Private Equity Group #1000002648

This group is interested in businesses with revenue from $10-250 million, and EBITDA of $1-25 million located throughout the USA in the following industries: aerospace & defense; business-to-business services; commercial manufacturing and distribution; consumer products (including both branded and private label); energy; healthcare and medical device manufacturing; industrial equipment; logistics and transportation; media and communications; and security infrastructure manufacturing and services.

Private Equity Group #1000007156

This company is looking for businesses throughout the USA and Canada with $2-100 million in sales with historical operating margins exceeding 10% in the following industries: meat products, specialty printing, wellness centers, bathware, and specialty health networks.  Additional criteria include: predictable future cash flows; a proven model, with product acceptance and strong market position; measurable earnings growth opportunities through acquisitions, organic growth, lean manufacturing and other cost improvements; a broad, talented management group; and makes use of professional resources.

Following is a webinar put on by USC’s Marshall School of Business on September 18, 2009 that discusses Due Diligence.  While this information is geared toward buyers of larger businesses, it will give you a better idea of what buyers tend to look at when conducting Due Diligence.

However, since you never know, I called this business broker.   After I asked him a few questions he admitted that he didn’t have any particular buyer in mind, and that, rather, there are institutional investors and strategic buyers in his database for which this business may be appropriate.

So, the reality is that this broker was hoping to get the business owner to list his business for sale with him, in anticipation of later finding a buyer.  I’m sure that the business broker had a carefully worded, but misleading, script that caused the prospective seller to perceive that there is a particular buyer interested in his business such as: “I’m working with a buyer who is looking for businesses in your industry.  The characteristics of your business appear to be a perfect fit for 100% of his acquisition criteria.”  So, here’s the reality: all of us who professionally sell businesses have many buyers in our database and the specificity of acquisition criteria vary greatly from buyer to buyer.  Right now I could pull dozens of buyers’ contact information from my database that have told me they are interested in businesses in a particular industry, but that give few other criteria then the general business size and a US location.  Since I only represent companies with under $20 million in revenue, there’s a good chance that if your business is, for example, a manufacturing company, located in the US, with less than $20 million in revenue, then I have several buyers who would only have those three stated acquisition criteria.

Since most relevant information needed to make an acquisition decision about a small closely held company is private, most prospective buyers simply wouldn’t have enough information to form a strong opinion of whether they would want to acquire a company absent more information.  So, the idea that there is a legitimate buyer out there that has a high probability of completing the deal based on a low level of quality information, is almost always more fiction than reality.  Sure, if a broker, does his job correctly there may, in fact, be buyers in his database that will become interested in the particular business – but to imply that there are one or more buyers who have a high degree of interest in your specific business prior to reviewing basic information is very improbable.

Consequently, I find this practice to be unethical and misleading.  A more honest way to do this would be for a business broker to simply say, “I have a variety of buyers in my database.  Many have expressed interest in businesses that have characteristics similar to yours.  If you are interested in selling your business, I believe some of the active buyers I know would be interested in your business.  Furthermore, I know how to get businesses like yours the attention of other quality buyers.  Would you like to meet to discuss how I may be of service?”

Integrity is of utmost importance in getting a business successfully sold.  If a business broker starts out his relationship with you under false pretenses, how will he interact with buyers?  Relying on trickery and clever, technically correct, but misleading representations is not a recipe for business sale success.