For business owners, risk is almost always top of mind. And, the complex process of selling your company can bring a number of new problems that threaten to scuttle the deal. But as any investment banker will tell you, there are ways to limit your risk exposure during the sale process—by identifying, assessing, and resolving risks before they become an issue.
Below are six “do’s and don’ts” to bear in mind when selling your business—critical risk points that you will encounter during the process—along with tips for effective ways to mitigate those risks.
Don’t Risk Underselling! Do Get a Proper Valuation
Once you’ve set your mind on selling, the first step in the process is to establish the value of your company. Determining your company’s worth will allow you to set realistic expectations—and to get the highest possible price when you sell. If you want or need to sell for a certain amount but your business is worth only half as much, it’s better to find out now. A proper valuation will help you determine the right time to move forward.
Ask investment bankers to provide you with a preliminary valuation even before you hire them. This high-level diligence will cover topics such as your company’s financial performance, customer and vendor concentrations, legal and regulatory issues, and management depth. Investment bankers should also be able to offer an accurate view of the market and an overview of potential buyers. Who might be interested in acquiring your company? Are they the right type of partner for you? These are crucial questions, so the work you put in at this stage is well worth it.
Don’t Risk a Purchase Reduction! Do Perform Thorough Due Diligence
After you receive the valuation, your investment banker will move into the next phase of due diligence: a more in-depth review of all relevant financial and legal documents—contracts, licenses, permits, tax returns, and so forth—to make sure everything is in order. Taking this step early will leave you time to address any issues before speaking with potential acquirers.
Also consider obtaining a quality of earnings review from an accounting firm early in the process, to reveal your company’s true level of profitability. A prospective buyer normally commissions this review once it has exclusivity—about three to four months after the sale process begins. But when you are deep into the sale process, a sudden realization that your company’s true profitability does not reconcile with the buyer’s understanding could lead to a purchase price reduction. You are better off going through this step now, to stave off buyer disappointment and avoid imperiling the deal. Knowing your true profitability from the start will minimize the chance of a later price reduction.
Don’t Risk Damaging Your Business! Do Execute Confidentiality Agreements
The next step in your sale process is getting a confidentiality agreement signed by any potential buyers. This basic but critical step will deliver the necessary protections for maintaining confidentiality, which is crucial in your efforts to maintain your business’s reputation, morale, and customer base. Only share information with potential acquirers who have signed your confidentiality agreement, and don’t share sensitive information until a buyer has demonstrated serious interest in the transaction. Working with your attorney and investment banker will ensure you have a well-drafted agreement in place that provides you with the appropriate protections.
Don’t Risk Selling to the Wrong Buyer! Do Meet Potential Acquirers in Advance
After you have received bids for your company, you will want to meet with the potential acquirers. This part of the process affords value to both parties in the transaction as you explore whether you are a good fit and examine how you would work together after the transaction closes. Be sure to interview each buyer’s references before signing a letter of intent (LOI). Good-faith purchasers should be willing to introduce you to companies they have previously acquired that will give you an honest assessment of the buyer’s dealings during and after the transaction.
Did the buyer stick to the terms in the LOI? If there was an issue after the transaction, how did the buyer react? The answers to these questions—in combination with your own impressions and feedback from the buyer’s references—are essential in making your decision. You’ll only sell your company once, so you want to make sure to choose the right partner.
Don’t Risk Misunderstandings! Do Negotiate a Detailed Letter of Intent
When the time comes to draw up a letter of intent, stand firm on the most crucial aspects of your purchase agreement. You don’t need to negotiate every term in the LOI, but addressing key terms upfront—such as purchase price, indemnification levels, escrows or rep and warranty insurance, working capital, and any contingencies—will set the right expectations and make the process run more smoothly.
Rep and warranty insurance is a particularly useful tool that limits your risk after a sale by reducing your exposure to any claims by the buyer once the transaction has closed. The buyer receives a higher level of coverage, and the seller’s exposure is typically limited to 50% of the retention. (You can find a more thorough description of this product here.)
Remember, you have more leverage prior to signing the LOI—and you’ll want to use it to the best of your ability. Consider asking bidders to provide comments in response to a purchase agreement when submitting their LOI. If an issue surfaces in the comments, this is the best time to resolve it.
Don’t Risk Making Costly Mistakes! Do Engage Experienced M&A Professionals
Finally, and most important, engage a team of professional mergers and acquisitions (M&A) advisors from the start, to guide you through the sale process. A good investment banker will help you avoid problems and identify any risks built into the deal while also helping you seek out potential buyers, negotiate sale terms, and manage the transaction process. An experienced M&A attorney will help you review legal documents, draft the purchase agreement, and comply with relevant laws and regulations. And a skilled accountant can help you review financial statements, analyze the tax implications of the sale, and structure the transaction in the most tax-efficient way possible.
Carefully planning and executing the sale of your company is essential to success for both you and the buyer. Taking the six critical steps described here—engaging professional advisors, getting a proper valuation, signing a confidentiality agreement, conducting thorough due diligence, vetting potential buyers, and negotiating a letter of intent—will limit your risk during the sale process. You will undoubtedly encounter additional issues along the way, but addressing these six main points will help you walk away from the sale of your business with no regrets.
If you have any questions about how to limit your risk when selling your business, please contact us. We’re happy to provide additional suggestions to ensure the successful sale of your company.