PICTURE THIS SCENARIO:
An investor approaches a business owner with an attractive offer to buy the business. There is an initial meeting and general deal points are discussed. A rough outline of the terms is sketched out on the proverbial napkin and the parties shake hands leaving the owner thinking they have a deal subject only to a few details to be worked out.
Then the investor starts with due diligence. It begins with a few questions trickling in. Then the first round of answers leads to new questions, and the trickle turns into a stream, and then a torrent. Spending so much time responding to questions diverts the company management away from its primary responsibilities. The investor becomes frustrated with the delayed responses and with the incomplete or contradictory information. The owner is frustrated by the amount of time and effort that is being used and may perceive the questions as signaling lack of trust or commitment from the buyer.
If the buyer is serious and likes the responses to the initial questions, then a team of advisors, including lawyers, CPAs and auditors, may come in for an even more comprehensive set of demands for information. The company undergoes even greater stress, and tensions increase. Under these circumstances, it is not unusual for negotiations to break down, and what could have been a good deal turns into no deal at all.
AFTER THE PROVISIONAL OFFER
Most due diligence is done after a potential buyer makes a provisional offer. The due diligence process then begins, often with a very short timeframe for the seller to respond.
A COMPLEX TRANSACTION
Selling a business involves a potentially complex transaction or series of related transactions. Unlike the sale of say, commercial real estate, selling a business involves significantly greater advance planning and hard work ahead of time for the seller. In the next series of posts, we’ll discuss some steps that sellers can take beforehand to make the due diligence process a little easier to navigate.
Last month we discussed six common mistakes that business owners make and their potentially devastating consequences for those companies. This month we’ll go a step further and let readers examine their own risk level for each of these mistakes. The first mistake involves not knowing what your business is worth.
Answer the following questions to see if your company is vulnerable:
• Has the business value been appraised by an outside expert?
• If so, has the appraisal been reviewed within the past three years?
• Is there a written buy-sell agreement?
• Is the buy-sell agreement funded through insurance or adequate cash reserves?
• Does the buy-sell agreement protect the business owner’s family and co-owners?
• Has the buy-sell agreement been reviewed within the past three years?
• Is the signed buy-sell agreement readily locatable?
The more “no” answers, the greater the risk. How does your company look?
If you don’t have a buy-sell agreement, you’re not prepared to deal with an owner who wants (or needs) to sell his or her stake in the business. A buy-sell agreement sets the ground rules for how that ownership stake can be sold or transferred and specifies how it will be valued.
Most companies with buy-sell agreements choose life insurance as a cost-effective funding mechanism to deal with the unexpected death of an owner, but insurance won’t help when an owner retires or simply wants to sell and move on. Although companies rarely fund 100 percent of future obligations in advance, it may be wise to consider setting aside money each year to help offset the financial burden of cashing out an owner at retirement. Either way, it’s critical to know the true market value of the company to ensure that enough funds are available to buy out an owner’s share of the company, especially if the buyout comes at an unexpected or inconvenient time.
Business Killers is an innovative educational program for executives and business owners put on by my friends Mark Baker and Lisa Brumm of AXA Advisors. For more information, contact Mark at firstname.lastname@example.org or Lisa at email@example.com