Selling a Business Checklist to Ensure a Smooth Sale
Selling a small business is a common exit strategy for business owners, but it's not something most business owners have any experience with. To get the most money for your business and ensure a smooth selling process and a proper ownership transition, you may find the following checklist helpful.
Steps for Selling a Business
This will serve as a plan, and it may last many months or several years. Your steps may include the following:
- Get the business as profitable as possible.
- Find a broker and meet with them.
- Have an accountant prepare your necessary financial documents.
- Collect information regarding insurance, agreements with vendors, clients, rental or leasing entities, etc.
- Assess the value of your business.
- Form an exit strategy that benefits the buyer, employees, partners, and you.
- Have your broker list your business for sale.
Preparing Your Business for Sale
As you go from owning and running a business to selling it, you may need to undergo a shift in mindset: You have to think like the buyer. The value of your business is based on the buyer's perception, so you want to make the business as attractive as possible in their eyes.
Optimize Your Profitability
One of the first things a buyer is going to evaluate is the profitability of your business. It's important to understand how buyers typically assess profitability, often using metrics like Seller's Discretionary Earnings (SDE). Here are some key points to consider:
- Understand Discretionary Earnings: SDE typically includes the owner's salary and benefits, as well as other discretionary expenses. Reducing these doesn't necessarily increase the business's value, as they're often added back in calculations.
- Align Owner's Compensation: Review your compensation structure to ensure it accurately reflects the true cost of your role in the business This could involve adjustments in either direction:
- If you're overcompensated relative to market rates, consider adjusting downward to demonstrate the business's full profit potential.
- If you're undercompensated, be prepared to explain the true cost of replacing your role, as this affects the business's valuation and a buyer's understanding of ongoing expenses.
- Ensure all forms of compensation (salary, benefit, perks) are clearly documented and explainable.
- Focus on Core Operations: Look for ways to improve efficiency and profitability in your core business operations. This might involve streamlining processes, negotiating better terms with suppliers, or focusing on higher-margin products or services.
- Normalize and Organize Financials: Prepare your financial records meticulously for potential buyers. This includes:
- Identifying and documenting any extraordinary or one-time expenses that are typically 'added-back' to understand true earning potential.
- Ensuring all financial records, contracts, and operational documents are up-to-date, well-organized, and easily accessible.
- Being ready to explain any unusual items or trends in your financials.
This approach not only provides a clear picture of your business's earning potential but also facilitates a smoother due diligence process. Well-prepared financial documentation can significantly enhance buyer confidence and potentially speed up the sale process.
Firm Up and Document Your Internal Processes
Many business owners know their business and its market so well that they accomplish many core tasks without even thinking about it. It's important, however, to think like a buyer — particularly a buyer who doesn't know how to run the business. Then, you will want to create or refine processes around those tasks. For example, there should be well defined, repeatable processes supporting the following:
- The acquisition of new business, and sales and marketing plans in general
- Hiring and training new employees
- Evaluation of profit margins concerning individual offerings, as well as the business itself
- Managing inventory
- Sourcing essential components
- Evaluating operating costs
- Core business operations
- Maintaining infrastructure, including office spaces, customer-facing spaces, and IT systems
- Resiliency and continuity, particularly in the event of a disaster
Inventory All of Your Assets — Including Intangible Ones
In addition to inventory, equipment, real estate, furniture, and workers, your business may have some intangible yet valuable assets. Some of these may include contracts you have with existing customers, relationships with long-time clients, a well-established brand, sales systems, well-designed training programs, intellectual property, and more.
With many intangible assets such as patents and trademarks, one could value based on the royalty fees they would receive if they did not own that particular asset. This is called the Relief from Royalty Method (RRM). A similar option known as the With and Without Method (WWM) attempts to estimate the value of the business without a particular intangible asset and then subtract the difference to arrive at a value. There are several other valuation methods for intangibles. Seeking assistance from an accountant, business broker, or valuation expert may be necessary for organizations with more intangible than tangible assets, such as technology companies.
With all intangible assets, there may be some questions about how to quantify them. However, by using sales figures or productivity stats, you can come up with a reasonable valuation.
Documents Needed for the Sale
Your company's documents are an essential element of a business transfer checklist. Expect that each document will be carefully analyzed by the prospective buyer, their accountants, attorneys, and, in some cases, even friends and family members of the purchaser.
Some of the most important documents include the following items:
- Financial statements dating back three years
- Tax returns for the past 3-5 years
- Lists of all physical assets, including furniture, equipment, and inventory — as well as their respective values
- A detailed inventory list
- Contracts you have with suppliers and distributors
- Your business's organization chart detailing who reports to whom
- Your articles of business formation, including shares and shares outstanding (if applicable)
- Insurance policies
- Loan agreements that are still outstanding
- A manual describing key business procedures
- Detailed descriptions and models of how and why you price products or services the way you do
- Professional certifications of all employees or workers who may be staying on after the sale
- Human resources policies and procedures
For more, see Documents and Information Required for Selling a Business.
Valuing Your Business
Valuing your business is an important step in figuring out the right selling price. However, it's only the first step because the buyer will probably have their own valuation method. It's important to value your business in a way that's as objective and fact-based as possible. You should also be careful not to be over-optimistic or to exaggerate your current or future numbers.
How Do You Calculate the Worth of a Business?
There are as many ways to calculate the worth of a business as there are owners and buyers. However, many people like to use seller's discretionary earnings (SDE) or earnings before interest, taxes, depreciation, and amortization (EBITDA). Both of these give you a snapshot of what the business offers to the buyer.
The primary difference between EBITDA and SDE is that EBITDA accounts for the cost of hiring a manager to replace the owner, while SDE includes the owner's compensation.
SDE takes into account:
- The business's annual income
- Its cost of goods sold (COGS)
- Expenses
The overarching formulas are very simple:
Annual revenue – COGS – expenses + owner salary = SDE.
Annual revenue – COGS – expenses – Salary for operating manager = EBITDA
Business Valuation Example: Brenda's Car Rental
Brenda has a small car rental company, and she's looking to sell it. Her SDE calculation looks like this:
Revenue
- Gross sales: $550,000
Cost of Sales
- COGS: $100,000, from the purchase of an average of two new cars a year at $50,000 each
Expenses
- Salaries: $150,000 ($50,000 for three employees)
- Repairs: $25,000
- Maintenance: $10,000
- Rents: $50,000
- Insurance: $25,000
- Utilities: $10,000
- Landlines and cell phones: $6,000
- Fuel: $4,000 (customers cover their own fuel expenses)
Total expenses: $280,000
Owner Salary: $100,000
SDE:
Revenue – COGS – Expenses + Owner Salary
$550,000 - $100,000 - $280,000 + $100,000 = $270,000
This $270,000 represents the value the buyer will be getting in a single year if they were to purchase Brenda's Car Rental and continue to work for the company in Brenda's role.
To calculate the EBITDA, we subtract the salary they would pay someone to operate the business. Suppose that number is $80,000.
EBITDA calculation:
$270,000 - $80,000 = $190,000
The next question is how to factor this into the selling price.
How Much Should You Ask for When Selling a Business?
Usually, an owner selling their small business can estimate an asking price by multiplying the SDE times a multiple of 2-4. The exact multiple varies based on the relative performance of the business, it's growth potential, and the industry it operates in. The asking price may also vary based on how long the owner thinks a prospective buyer may want to keep the business, which can vary based on the industry.
(To get an idea of how multiples vary across different types of businesses, see BizBuySell's Valuation Multiple Tables).
For Brenda's Car Rental, she may choose to use a multiple of 3, which will be applied to her SDE to arrive at a selling price of $810,000. (SDE of $270,000 x 3)
There is a bit of nuance that goes into pricing your business effectively, and your broker is the best person to help guide your pricing strategy. For a more detailed introduction, see our guide on small business valuation.
What Should Be Included in a Business Purchase Agreement?
The business purchase agreement should include the cost of buying shares of the business, the business' assets, assumed liabilities, restrictive clauses, the business plan, and any necessary agreements.
Some of the agreements you would want to include in the purchase and sales would be:
- A confidentiality agreement. This can help keep business secrets away from competitors.
- Partnership agreement. If partners are remaining with the business, this can delineate their responsibilities and compensation.
- Agreement for the purchase of real estate. This would outline any real estate included in the deal.
The assumed liabilities include things the buyer will have to continue to pay for after acquiring the business. These are typically short- and long-term debts but can also include leasing contracts or rental agreements.
Finding a Business Broker
You should strongly consider enlisting the help of a broker. But first, determine if using one benefits your situation.
Do I Need a Broker?
Finding a broker begins with asking whether you need one. A broker is often a powerful asset in the sale of a business. Not only can they help you find a buyer, but they can review your valuations and even help you discover assets — tangible or intangible — that can boost the value of your company.
Although not required by law, utilizing a business broker to assist you in selling the business can be very beneficial assuming they have the proper experience, a track record of selling businesses and pool of potential buyers. Some of the benefits of using a business broker are:
- You do not pay the business broker an upfront fee.
- You pay the business broker a commission only if the deal closes.
- A business broker will provide an opinion as to the value of the business based on valuation formulas and comparables.
- The business listing will be strictly confidential (not revealing the identity of the business unless the potential buyer signs a Confidentiality Agreement also referred to as a Non-Disclosure Agreement (NDA).
- Potential buyers will be vetted to avoid the "tire kickers" or potential competition.
- The selling process will be handled from creating the listing, gathering pertinent documentation, vetting buyers, negotiating price, signing the Asset Purchase Agreement, due diligence and closing.
- The seller gains the ability to leverage the database of potential buyers through the business broker.
How Do I Evaluate Brokers?
When evaluating brokers, you should consider their track record, selling resources — including people and advertising methods, and their references. When interviewing references, it's best to use specific questions that may reveal some weaknesses. For instance, you may choose to ask about how they handled setbacks, how they managed time commitments, or even "What was one thing you wish was better about your experience?"
It is recommended to interview at least three different brokers and ask them the questions below. Compare the answers among all the brokers you have interviewed to make an informed decision. If you already identified a buyer and agree to the terms, you could also hire a business broker paying a flat fee to act as a consultant to manage the transaction.
- Are you required to have a license to sell a business in this state?
- How many years have you been in business brokering?
- Over the last 24 months, how many businesses have you sold?
- Approximately how many potential buyers are in your database of contacts?
- How do you vet buyers before providing them sensitive financial information and revealing the business identity?
- How long is your listing agreement?
- What is your commission structure?
- What documentation and information do you need from me to list the business?
- Ask for 1-3 references preferably prior clients who owned a business and sold it with the assistance of the business broker.
(To understand what brokers do, how they work, and how they are paid, see the articles under Working With a Business Broker).
Due Diligence
The buyer isn't the only one who has to do their due diligence. As the seller, you have to ensure you check all the necessary boxes. In addition to preparing the documents described above and evaluating your business's value, you will need to:
Figure Out How You Are Taxed When Selling a Business
In most cases you must pay taxes on the gain of your sale. However, you will have to categorize each asset carefully. Inventory, for example, would trigger the regular taxation rate.
Figure Out Who Will Pay the Closing Costs
In most situations, the seller has to pay the closing fees to the broker. However, you may be able to negotiate some of the fees with the buyer or their agent. For example, because an escrow service benefits both the buyer and seller, the buyer may be willing to split the escrow cost.
Transitioning Ownership
You can transition ownership to the buyer in several ways. In some cases, you, as the current owner, may want to stay on, serving as a consultant to ensure the transition goes as smoothly as possible. This may involve interfacing with current clients and even creditors, explaining how things may be different, and reassuring those who could be nervous about the new ownership.
You may want to stay on in other situations, playing a specific role and earning a salary, for a time period, perhaps six months to a year. In this way, you can guide the business through a safe landing and its next take-off. In any event, the transition process should be discussed by you and the purchasing party.
Where to Find Help and Information
The process of selling your business is long and filled with nuance. As outlined above, there are many steps that require the assistance of an expert. You may find that a business broker will be beneficial to handle all of the details and provide the guidance to complete the sale in a way that is beneficial for all parties. Browse our directory of brokers to find one in your area. Whether you choose to hire a business broker or list your business for sale by owner, be sure to see our Seller Learning Center for a wealth of information to help you sell successfully.