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How to Sell a Small Business: Pt. 1 – Early Preparations

by Lemuel J. Lim LL.B.(Hons)(UK), LL.M. (UK), LL.M Tax (US) at Genesis Law Firm, PLLC

Curious how to sell your small business? This article is the first in a comprehensive series on this subject and focuses on early preparations – being well prepared before you begin to negotiate with a buyer. The topic is of paramount importance. Early preparation is so important that failure to do so can mean the seller may lose out on getting significant value for the business being sold. A lack of early preparation can also prolong the time it takes to sell the business and increase the costs involved. In this article, we give you 3 helpful things a seller could do before selling a small business.

Picture depicting how to sell a small business: three helpful tips

I. Appoint an Internal “Dealmaker”

Research and experience show that the appointment of one person who will act as the ultimate “dealmaker” will increase the chances of a smooth sale. Even in closely held businesses, there may be more than one owner or stakeholder who has an interest in the business. For the sake of order, it is important to appoint a person in the business who will be the designated leader. This person will act as the primary point-of-contact with prospective buyers, and will also be the “go-to” person for the seller’s lawyers and advisors. Misunderstandings and miscommunications often happen when the buyer, their advisors, and even the seller’s advisors are confused as to who will deliver the official position for the business.

In some situations, the co-owners of the business may decide who amongst themselves will be the official dealmaker. In other situations, none of the co-owners may feel confident enough to be the person to champion the sale. Co-owners may therefore choose to appoint a trusted employee to be the dealmaker. Either scenario is acceptable. Here are some helpful pointers to note when deciding who to appoint:

  1. the dealmaker should have a commitment to understand basic aspects of the sale process with the help of advisors. The process of selling a business can sometimes present many technical complexities and challenges. No one expects a small to medium-sized business to have a key person in the business to be an “expert” in mergers and acquisitions. So long as the appointed dealmaker has the commitment to carefully consider advice and put in the hard work to understand the sale process, this should put the sale process in good stead;
  2. the dealmaker should understand the goals of the sale. By the time the dealmaker is appointed, he or she should have an intimate understanding of why the business is being sold and what the goals of the stakeholders are;
  3. the dealmaker should know how to make the best use of the talents and knowledge of the co-owners and employees of the business. Everyone has different gifts, talents, and experiences that they bring to the business. The dealmaker should have the instinct to know who, when, and how to approach co-owners and employees in the business for required information;
  4. the dealmaker should have formal authority to represent the business and be clear on what powers and restrictions they have. It is good practice for the stakeholders of the business to pass a formal resolution or sign a written document to authorize the dealmaker to represent the business in the sale. The written document should clearly set out how much discretion the dealmaker has to make decisions alone, what the dealmaker cannot do, the budget the dealmaker has for expenditures related to the sale, and any matters the dealmaker must bring to the attention of the stakeholders for approval.

II. Early Preparations for Due Diligence and Creating a “Data Room”

The moment a business affirmatively decides they want to sell up, the business should immediately prepare for the due diligence process. Due diligence is the stage in the sale process where the buyer will conduct a “deep-dive” investigation to understand the benefits and risks of buying the business. Many small to medium-sized businesses underestimate the amount of work that goes into putting together information for the prospective buyer. Starting this process as early as possible is imperative.

One of the first things a buyer will typically do is to take a look at the business’s governing documents, financial statements, and other important information about the business. There is a lot to say about the process of due diligence so we will dedicate a separate article to give a more detailed explanation. For the moment, just know that the seller should do at least two things:

  1. ensure that all the documents the buyer needs to see are brought into a centralized access point such as a “virtual data room” or even a hardcopy folder;
  2. create a short summary factsheet to give an overview of key information about the business.

A. Creating a Virtual Data Room

The most important thing to remember here is that all relevant documents must be well-organized and secure in a need-to-know environment. If the business is simple, it may be possible to put together all the documents into a single hardcopy folder. In reality, this is only suitable for very small businesses with a very simple business model.

Most of the time, the information the buyer will need is so extensive that you will need to furnish the information in electronic form. The medium to hold the information is entirely up to what the business owners are comfortable with.

Some business owners are relaxed about security issues because the business has little by way of trade secrets or highly sensitive information that form a crucial part of why the business is successful. In this scenario, some business owners are comfortable with simply packaging the information into a USB drive or a CD-DVD to give to prospective buyers.

On the other hand, some business owners may be very concerned with information security because they are hesitant to disclose highly sensitive information. In fact, there may be some information that is so sensitive and critical to the well-being of the business that a business may not disclose this sensitive information until very late in the sale process. Even then, a business may decide to disclose only after a potential buyer has made a firm contractual commitment to buy the business.

For these types of business, it may be worthwhile to spend money to purchase a “virtual data room.” Virtual data rooms are paid web-based services that provide online document storage in a secure environment. The main advantage of virtual data rooms is that business owners can tightly control the information that is disseminated. This is especially useful for two reasons. Firstly, many business owners do not want their employees to know that the business may potentially be selling up until the timing is right. Having a virtual data room means that business owners can upload and transmit information without getting employees or IT contractors involved. This reduces the risk of advertent or inadvertent disclosure and thereby reduces the risk of impacting the normal functioning of the business.

Secondly, a decent virtual data room can help the seller to control what information a potential buyer may see and to track what information prospective buyers have seen. The seller can use tracking information to analyze the prospective buyer’s behavior in order to predict what further questions the buyer may wish to ask. The seller may also be able to gauge how interested the buyer is in buying the business.

So what data rooms are out there? The classic data room designed for mergers and acquisitions is a web service called Intralinks. Their quotes are on the higher end of the spectrum and may only be suitable for businesses with a lot of sensitive information to manage. To give a very ballpark example of their cost structure, Intralinks can charge 30 cents per page for a 3-month period. So if you have a PDF document of 100 pages, you will pay $30 just to upload that 100 page document for 3 months! Given the fact that due diligence documentation can sometimes run into the thousands and tens of thousands of files, the final cost can be extremely high.

There are also other data room providers that may be able to offer more reasonable pricing for small to medium-sized businesses. For example, FirmRoom are able to offer the option of fixed cost pricing which can be useful for cost certainty. Other potential providers to consider include Prism, IBM M&A Accelerator, and DatasiteOne. Of course, a seller could always use low cost options such as Google Drive or DropBox but business owners will have to carefully consider the risk tradeoffs of using such platforms compared to dedicated M&A data rooms with more security functions.

B. Summary Fact Sheet and Management Presentation

When putting together information, a good practice for sellers is to compile a summary fact sheet of the company. This is a very helpful document to make potential buyers aware of before dumping them with a truckload of information.

The summary fact sheet should contain a very short high level summary and include information such as the legal structure of the business, the governance structure (who the co-owners are and any non-executive board members who provide oversight to the business), key appointment holders (who the executive heads of the business are, who the in-house lawyer is, any key employees, etc.), and key service providers (e.g. CPA Firms, etc.). If the business is backed by institutional investors such as venture capital firms, hedge funds, or private equity firms, these are also typically disclosed. The summary fact sheet can also contain other key information too. The bottom line is to ask yourself: “what information should I include so that my potential buyer can get a decent overview of how the business is organized?”

Providing prospective buyers with an oral presentation complete with informative visual imagery can also play an important part in the sale process. This is especially so if the proposed sale of the business is via a competitive bidding process where the seller may not have a prior relationship with the potential buyer.

Many businesses underestimate the amount of work that goes into preparing for an oral presentation and slides. To make a truly slick slide presentation, sellers should expect to go through multiple revisions of the presentation deck in order to “get it just right.” Management should also put in substantial effort to rehearse the oral presentation. Remember: where there is no prior relationship, the formal presentation is one of the greatest opportunities to show potential buyers how attractive the business is and to instill confidence in the seller’s management. Once the seller’s management is ready to present, the seller’s law firm will customarily host the management presentation to potential buyers at their offices.

III. Deal with the Scary Stuff

If you wish to sell your house at the highest price obtainable, a prudent seller will obviously try to fix or mitigate any flaws that may scare potential buyers away. Selling a business is no different. Exactly what will “spook” a buyer is a subjective matter. Sellers should carefully reflect on where the “scary stuff” in the business are. Once the really scary stuff is identified, immediate remedial measures should be taken to resolve these issues. If there is nothing that can practically be done prior to the timed sale, sellers should be prepared to give an account to prospective buyers if they are asked. If necessary, a business should seek appropriate legal advice to understand how these “scary” things would impact the sale.

The following are some starter questions business owners may wish to ask themselves when they embark on their investigations into the scary stuff:

  1. Books and Records. Are the books and records up-to-date? Has the business missed any relevant filings with federal and state agencies? Is there anything in the books and records, or in state filings that may lead to accusations of misreporting?
  2. Licenses and Permits. Are the necessary licenses and permits required for the business in order? Has the business failed to renew any required licenses or permits now or in the past? Has the business unlawfully operated in an area where a license or permit is required but was not obtained? Does the business foresee that a regulator may intervene or block the sale of the business because of some aspect or conduct of the business?
  3. Real Estate and Equipment. Is there something about the real estate and equipment that might scare a potential buyer away? Are there any liens or other kinds of charges on equipment and real estate that might scare buyers away?
  4. Employees and Benefit Plans. Does the business need to resolve any employee disputes or grievances? Has the business, now or in the past, violated any employment laws? Are the employee contracts and handbooks in order? Does the business have a “toxic” work environment that needs correcting?
  5. Key Relationships and Contracts. Does the business need to resolve any customer disputes? Are there any scary problems with suppliers and distributors that need attention? Does the business need to renegotiate, replace, or exit any onerous contracts?
  6. Products and Services. Are there any major problems with products and services? Are there any product liability issues? Are there any health and safety violations now or in the past? Are there any legality issues with the products and services?
  7. Litigation and Audits. Are there any pending or contingent litigations that need to be addressed? Do I need to conclude or resolve any audits?
  8. Environment. Are there any environmental audits or orders that need to be addressed?
  9. Tax. Are there any late tax filings? Are there any tax controversies with federal, state, or foreign governments? Are there any tax liens?
  10. Debt. Are there any covenants or terms in the business’s debt financing that may hinder the potential sale?

We hope you found this article helpful. Our firm believes in making quality information available online free of charge; and, in that vein, we’ve written on numerous related topics. We encourage you to visit our firm’s business resource page.

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