A Founder’s Decision to Sell: Considerations for Obtaining Sustained Value for a Life’s Work
David E. Weiss
Many of the most successful businesses are the product of the investment of its founder’s time, energy and money. Often, this investment may be the most significant source of their retirement income or personal wealth. Yet, at some point, whether due to political or market conditions, or more personal reasons, it may become time to sell the business and unlock the value of this investment.
Here are some important considerations for selling a closely held business, especially for those founders who have never been through a sales process, to achieve a successful exit.
- Know the value of your business — and how a buyer might value it. There is not one standard metric used to value a business, and a valuation may take a variety of factors specific to the business or its industry into consideration. Often, buyers will be willing to pay a multiple of earnings or revenue, though the specific multiple will vary based on industry, size, growth potential, as well as other factors. Sellers, who at times tend to overvalue their company, could benefit by engaging a professional valuation firm for an independent perspective. Also, having multiple years of financial statements that have been audited by a reputable CPA firm will enhance the reliability of any buyer price proposal and reduce the likelihood of the buyer lowering its initial offer once it gets “under the hood.”
- Anticipate likely transaction structures and acceptable forms of consideration. Buyers typically will propose deals on a “cash-free, debt-free” basis and insist on sellers delivering a pre-determined level of working capital. Buyers may offer all cash or some combination of cash, promissory notes and/or equity in buyer. Equity can be a useful mechanism for aligning the parties’ interests and incentivizing the founder post-closing, typically when the founder is asked to remain with the business.
Buyers might propose an “earn-out” arrangement, whereby a portion of the purchase price will get paid only upon the attainment of pre-determined financial or operational milestones. These arrangements are typically more palatable to founders who are staying with the business post-closing and thus have some ability to impact the achievement of those milestones.
- Identify factors that can undermine value, and work to clean them up. Especially if valuation is based on an earnings multiple, eliminating or reducing a several hundred-thousand dollar expense can result in a multi-million dollar increase in purchase price. Similarly, buyers may seek “dollar for dollar” indemnification (i.e., without any deductibles) for certain matters, such as pending or likely litigation. Sellers often try to resolve these issues before a sale to reduce the likelihood of an indemnity claim post-closing. To the extent such issues cannot be resolved, founders should be forthright about them with the prospective buyer.
- Identify third-party approvals — including that of your board. In many deals, a consent or approval from a third party is required before the transaction can close. These can take the form of consents required by contract with a private party, government approvals, or even board approval of the seller. Obtaining these consents or approvals can be time-consuming and expensive, even when founders have enjoyed harmonious relationships with their customers, vendors, lenders and regulators. Often, consent in a sale transaction requires separate legal review by these parties, which could result in delays.
Sometimes other equity holders have a right of first refusal (ROFR) giving them the opportunity for a defined period of time to buy the business on the terms offered by a third party. When a ROFR exists, an eventual sale to a third party could be delayed to allow for the ROFR period to lapse or to obtain a waiver of the ROFR from the holder. Identifying required third party approvals as soon as possible will better enable sellers to realize a timely closing.
- Consider your next move (personally); know that restrictions could be imposed. Many founders envision riding off into the proverbial sunset without looking back. Others are already planning their next venture. Others wish to remain in place to see their life’s work flourish post-closing. Of course, buyers may have something else in mind altogether. Buyers may require founders to stay on with the business for a period of months or years and, in any event, will often insist on non-compete and non-solicitation agreements from founders for a number of years post-closing. Founders may also be able to negotiate exceptions to these restrictions that are acceptable to buyers.
- Tax matters (very much!). Different transaction structures — for example, asset sales vs. stock (or membership interest) sales, or the inclusion of accounts receivable in the deal — may result in vastly different tax effects to the seller. Founders may avoid “seller’s remorse” by understanding the after-tax value of the deal consideration, especially in light of their anticipated post-closing financial needs. Sellers are well-served to seek the advice of tax and accounting specialists as early as possible to identify a tax-advantageous deal structure.
- Take steps to maintain the value of the business. To preserve the value of the business prior to the transaction’s signing and closing, and to facilitate a smooth sales process, sellers may offer retention bonuses to key employees. Variations of these arrangements could entail employees receiving a percentage of the transaction consideration, aligning their interests and those of the founders. Especially where earn-outs are utilized, these arrangements can be tailored to provide for bonuses post-closing, benefiting the business and the founder for years.
- Remember to keep your toys! Exit transactions, regardless of structure, do not automatically involve the transfer to the buyer of every last item on the seller’s premises. Often, certain items are actually owned by the founder outright and not the business. Personal effects such as sports memorabilia, artwork, family heirlooms (such as antique furniture located at the business), and similar items should not be overlooked, and the founder will want the definitive agreement to expressly provide that these items will remain with the founder in the sale of the business.
A founder’s decision to sell will surely be momentous both for the business and for the founder. Hopefully that decision can be easier knowing in advance some key considerations for a successful exit transaction.
This article has been provided for informational purposes only and is not intended and should not be construed to constitute legal advice. The opinions expressed are those of the author, David E. Weiss, and do not necessarily reflect the views of Ostrow Reisin Berk & Abrams, Ltd., Epstein Becker Green or their respective clients, or any of its or their respective affiliates. Please consult your attorneys in connection with any fact-specific situation under federal law and the applicable state or local laws that may impose additional obligations on you and your company.