Using A Proven Formula For Selling a Business

The workforce is graying and within the next 10 years 15% of the population is planning to retire according to StatsCan. For many successful business owners across this country they are somewhat wary of selling their companies because of the unknown. It is very difficult for an owner to see their personal identities separated from their business.

That being said the most important reason sited by owners for wanting to sell their businesses is the prospect of creating financial independence for themselves and their families. While making room for the time to enjoy their lives doing what they truly love without the financial constraints they have experienced while having the vast majority of their net worth tied up in their companies.

According to Rudolph Dorner, President of Corporate Division M&A Inc. in Ontario, which has brokered the successful sale of 74 corporations valued between $2 to $50 million each for over 20 years there are five key indicators that a business owner is a candidate for selling their business:

1) Age, 50 -55 or they have been in the business over 20 years. At this stage the business owners is ready to do something else or wants to enjoy the fruits of their labor.

2) Fatigue, the owner demonstrates a lack of daily enthusiasm for the business. The owner has traveled across North America building their business to many times and has dealt with enough employee problems.

3) Money, - they wants to take some or all of their equity (most of which is in the company) off the table. They want to secure their family’s future.

4) Future, the future of the business is not as bright as it once was for reasons of competition, currency exchange, technology or whatever.

5) Partners, - the long term arrangement has finally hit a major snag. Think of the McCain and the Steinberg Families.

The number one question that many successful business owners ask themselves and their trusted advisors is “when is the right time to sell?” Before considering selling one’s business your client needs to discover what his individual financial independence number is. This “magic number” is the amount of capital that he will need to live on for the rest of his lifetime. The number is “magic”because it can turn a business owner to a business seller. This number can only be understood by working with the client to help him develop a complete financial plan detailing everything your client desires to accomplish in this lifetime and beyond. If it is determined that by your client selling his company today he could net out his magic number, your client is a prime candidate to sell his business. If your client would not reach his magic number today by selling his business your client should consider developing new strategies to grow his business until the day comes that the sale of his business will generate his personal magic number.

The second question asked by business owners of their trust advisors who are contemplating selling their businesses is “who should I sell my business to?”

Generally speaking, there are three primary categories of potential purchasers to consider in any exit/succession planning exercise:

• family members (whether active or passive in the business);
• key managers/senior employees of the business; or
• a third party purchaser (which may be a strategic buyer such as a competitor or key customer/supplier of the business, or a purely financial buyer such as a private equity fund, merchant bank or investor).

Based on my professional experience working with business owners before, during and after their sale of their company, I have found that selling to a third party is the best of the three options. The advantages of selling to a third party over selling to family or key managers is your client has a better probability of selling his business for cash plus the odds are greater they will get a premium for it and surpass their magic number. Plus if the negations fall apart your client will not have to worry about continuing a relationship with the third party again. This can not be said when dealing with family or key managers.

There are a number of key steps in selling a business. First it is essential to choose a reputable business broker. Forget the ads or solicitations in the mail. Ask around for a personal reference from someone who has sold their business. Expect to pay about 5% on the first $10 million and 1% thereafter for the broker. Legal and accounting fees will cost 1.5% of the selling price. The broker will value your client’s business. Over the last 20 years in Ontario, good businesses have sold for an average of 3.54 times Normalized EBITDA. (Earnings before Interest, tax, depreciation and amortization - normalized for the owner’s wages and non - recurring costs).

Rudolph Dorner says “I’ve seen individual companies sell for a multiple of as low as 2.9 ( a foundry) to 6.1 (pharmaceutical raw materials).” The valuation of a business should not cost more than $3,000. The broker should also provide a statement showing the net funds available to the Vendor from the sale after transaction costs and taxes.”

Once your client has decided to sell his business and has selected a business broker to represent him what happens next is the broker writes the Offering Memorandum describing your client’s company in full detail. It usually takes 2 1/2 days of the seller’s time to supply the raw information and this should be assisted by all the client’s trusted advisors.

What is helpful during this process is for the seller to provide a list of every potential buyer that he can remember or think of or imagine, to the broker. The broker will also solicit buyers, sign them to a Non-Disclosure agreement, screen non-serious buyers, and present the company in its best light. The seller will meet with the potential buyers to discuss company history, current and future operations, and any role the seller is willing to play in the business transition. The seller should expect to meet a maximum of 5 potential buyers. If more Buyers are introduced, the broker is not screening carefully enough.

When an offer is presented the broker will provide a signed offer in the form of a letter of intent. He will review it with the seller and point out any advantages or deficiencies. He should not advise your client to accept or reject it. He should only advise if the deal is at, above or below market, and that is all.

If the deal is acceptable, the broker will procure a deposit. $100,000 is a standard deposit on deals in this segment. According to Dorner a standard good deal has the following earmarks:

“75% cash up front, maximum 25% Vendor Take Back (VTB). The VTB to be guaranteed by a pledge of shares, guarantee of the purchaser and the purchaser’s principals. The deal should have specific terms to allow excess cash to be stripped out of the company prior to close.”

The seller should have already sat down with his Certified Financial Planner and public accountant and put in place solutions to generate and strip out excess cash.

Working with tax and financial planning specialist will go a long way to minimize the tax liability triggered by the sale. Some of the best ways that your clients can successfully meet their needs requires that their trusted advisors think beyond traditional tax-based solutions. Most business owners’issues, be they related to strategic business planning, estate planning, succession planning, charitable giving, investments or insurance, are as significant as anything tax-related and these must be addressed as well.

Opportunities often exist whereby corporate held monies created from un-drawn net income and/or proceeds from the sale of a business can compound tax free within holding companies and/or be invested in tax-favourable, tailored executive benefit plans.

These opportunities can be achieved through several means, including individual pension plans, retirement compensation arrangements, corporate-owned universal life insurance, employee profit sharing plans, family trusts, holding companies and health and welfare trusts. By implementing any of these strategies the business owner can save hundreds of thousands and even millions of dollars in tax savings. For example by structuring the right life insurance solution your client with your assistance can achieve the following end results:

• Their money would stay in the country, where they can see it, touch it, feel it and smell it.
• Corporate deposits can be structured to be deductible.
• All personal deposits can be structured to be deductible over time.
• Large annual deductions are provided each year against income for the rest of your client’s life.
• Money would be invested on a deductible basis, so the money grows tax-free. The individual retires tax-free, dies tax-free, and all the while having savings protected from creditors.
• The corporate or personal deduction creates a cash-on-cash return every year, year in and year out, in a plan where tax will never be paid as your client uses the funds for either retirement or investing.

The buyer will then do a 90 day due diligence investigation to determine if the facts presented about the business are true. It is important to note that this process will be intrusive and tedious in the extreme. The broker’s job is to minimize the disruption by organizing the information in the manner most useful to the buyers and their lawyers, accountants and certified financial planners.

Next is the Share Purchase Agreement prepared by the Buyer’s lawyers. The terms will be strongly tilted to the buyer’s advantage. The Broker working with the seller’s lawyer or with his own specialist will make sure balance is restored. Expect there to be anywhere from 3 to 10 turns at the merry-go-round before it is fully agreed. The seller stays out of this process, letting the lawyers and his broker apply their craft. The Vendor will formally review the final version.

The Last Steps towards Peace Mind

Just prior to closing the broker will provide a projected balance sheet to the new owners, as well as a payout statement to the Vendor showing all costs, projected taxes and net funds receivable from the sale. The day after closing the broker will usually hand-deliver the cheques and ensure the funds are deposited into the correct entity as per the tax plan. When this happens the broker’s job is not done until the funds due on the Vendor Take Back are collected and in the Vendor’s account.

You now possess a basic primer to map out whether a client is ripe to consider selling his business or not ready to sell. There are trusted advisors who will bring value to your clientele throughout the preparation, the sales process and long afterwards. The best advice I can give is this - find out your clients “magic” number. The more time they will have it firmly in their head the better...as your client’s trusted advisor you need to begin the process today.

For those clients who don’t know their magic number seek out these trusted advisors and communicate with them what you want. Let them help create a pathway towards the next stage in your practice and for your client’s next step in their life’s journey.

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Peter J. Merrick, BA, FMA, CFP, FCSI, is President of MerrickWealth.com a fee-for-services financial planning and executive benefit advisory firm in Toronto, specializing in assisting business owners achieve their very best. He is a professor of financial planning and estate planning, author of “The Essential Individual Pension Plan Handbook”

(Lexisnexis , 2007) and was presenter at the CICA 2007 National Conference on Income Taxes. Peter can be contacted at 416.854.1776 or peter@merrickwealth.com