Starting and building a business is a rewarding endeavor for many entrepreneurs, but it's hard work. All businesses require capital and some require a significant amount. Sole ownership may not be the optimal structure when it comes to transitioning leadership. So, many business owners sell ownership in their company.
Reasons to Sell
There are many valid reasons to sell all or part of a business. Selling shares in a business can generate significant cash, which can pay down debts, or be used for investments or charitable donations. That cash can also go back into the business, where it can fund expansion. Likewise, selling part of a business can reduce the owner's risk and allow them to diversify their personal assets.
Business owners may have several other reasons to sell shares. Selling shares over time can be a means of preparing for eventual succession and transferring ownership in a way that minimizes the tax shock to the eventual new owners. Finally, selling shares in a business can be the end result of burnout or an unwillingness to grow the business further.
Complete Versus Partial Sale
First, you need to determine whether you are looking for a complete or partial sale. A complete sale is fairly straightforward. It more or less ends your involvement with the enterprise, unless there's an employment or consulting contract that continues the relationship. Business sales can be structured in a way that essentially offers annuity payments, so a complete sale makes sense if the owner is looking to completely move on financially.
Partial sales are different. They can raise capital, incentivize employees or start ownership transitions. Before contemplating a partial sale, consider the ramifications of how much you wish to sell. If you sell too much and become a minority investor, you may no longer have the ability to control, or even influence, decisions.
Different Options for Selling
Go Public. For the large majority of business owners, going public is not an option. Pursuing a public listing for your business is the most expensive option, and the most demanding in terms of legal, auditing, and disclosure requirements. Still, it is generally the best option for raising large amounts of capital and/or maximizing the value of a business.
Sell to Large Private Investors. Companies do not have to go public to attract investment dollars from institutions. It is considerably easier, faster, and cheaper to sell shares privately. While there are limits on the extent to which a company may solicit investors without filing with the SEC, private sales offer the same advantage of raising capital publicly without some of the downfalls.
Private sales usually include venture capital financing. In venture funding, a business or business owner sells shares to venture capital investors in exchange for capital that the business needs to grow or expand. In many cases, significant share sales to large private investors also require that the company give the investors a spot on the board of directors.
Selling to Smaller Investors. In some respects, selling shares in your private business to small private investors is both more difficult and easier than selling to large, sophisticated investors. On the plus side, it's easier to hand pick the investors and there are often pre-existing relationships. These investors are also less likely to force some of the bigger compromises that bigger investors may demand, like board representation or a CEO replacement. On the other hand, smaller investors typically have less money, and the legal process can be more complicated.
Selling to Employees. Selling shares of your business to your employees is another option to consider. Establishing an employee stock ownership program (ESOP) increases loyalty and retention and reduces a business's cash compensation needs like awards or bonuses that would otherwise be paid in cash. These contributions are usually tax-deductible. However, selling shares to employees is not a practical option for raising capital.
Important Steps in Selling a Business
If you're pondering an exit, here are some steps to get started.
Begin by answering one question: How do you want to spend your time, money, and energy after you sell? Many people find this kind of soul searching difficult and avoid it. Unfortunately, owners who enter negotiations with a potential buyer without a vision for the future rarely conclude the deal. Put your future life vision in a document, so you can refer to it when needed, and update as necessary.
The next question to ask is: What do your stakeholders want from your company? Stakeholders include people whose actions affect the health of the business – employees, other owners, investors, and family members. The goals of these pivotal people will shape the future of the business, and a smart buyer will want to know and agree with their objectives before concluding a deal.
Next, you need to establish a value for the business. This process may require the services of an accountant, independent analyst and/or consultant. The entrepreneur has grown his or her business from an idea into an organization with employees, assets, intellectual property and a reputation. It's priceless – to the entrepreneur. Potential buyers will assign a price to the business and walk away if they consider the owner's price outlandish.
If you're considering a sale to a third party, seek the assistance of a business broker, who will typically be experienced in finding a buyer, managing paperwork, navigating tax and other laws, and closing the deal more quickly than an entrepreneur selling a business for the first time. A broker will concentrate on the sale, allowing the entrepreneur to continue to focus on running – and maintaining the value – of his or her business.
Once you have an idea of the fair value for the business, solicit multiple bids (at least three if possible). If the bids differ significantly from the owner's idea of fair value, it may well be necessary to rethink the assumptions.
It's also worth mentioning that private businesses almost always sell at discounts to public companies, but a controlling stake is often worth a substantial premium to a non-controlling minority investment.
It is also important to properly market a business that is to be sold. There are internet sites built around helping owners sell their businesses, but owners need to be prepared to create their own sales materials. At a minimum, a well-formatted, one-page summary is critical, as is a more detailed package for serious bidders. These materials need to include details like the sales, profits and cash flows of the business, as well as a detailed description of the business and other pertinent details, like the assets.
Finally, get the business in order before attempting to sell it. Just like a house needs a refresh before a sale, so does a business. Look for issues that will scare off potential buyers and fix them before opening the books for inspection. Make sure that cosmetic details and repairs are attended to, prepare a detailed inventory and equipment list, and have multiple years of financial data and tax returns on hand.
Other Details to Remember
There are several other key details to keep in mind when considering selling part or all of your business. Remember that it takes time. An IPO or venture round of financing takes months to organize, and getting a good price for a private business can take a year or more. Patience is vital; the more you rush to sell, the worse the prices you'll see.
Chris Snider, CEO of Exit Planning Institute, a national organization that trains financial advisers on the fundamentals of selling a business, says that selling should be treated like retirement and started early. "Exit planning is a process, not an event," Snider says. "It’s a way of running your business that maximizes its value and provides a means to achieving an owner’s personal and financial goals.”
As good as Snider’s advice sounds, many entrepreneurs fail to follow it. Instead, they treat selling their business like an event approached when they are ready to retire, burned out or facing an unexpected life change.
It's also important to contemplate and plan for the tax and cash flow consequences of a sale. Investors are likely to insist on more rigorous auditing or reporting. What's more, if you sell shares with the promise of regular dividends, you need to prove the cash flow to support them. Consult with accountants and/or lawyers regarding the potential tax consequences of a sale – both to you and the business.
Finally, don't forget to consider the psychological implications. Are you ready to walk away? Are you prepared to have new partners questioning your decisions? Having investors in your business makes you legally accountable to others and requires more transparency than a sole proprietor may be accustomed to.
The Bottom Line
Selling even a small part of your business is a serious undertaking. At a minimum, make sure you are thoroughly prepared and have clear expectations for the process. Selling shares in a private business can be a great way to raise capital, incentivize employees or bring new talent and ideas into a business. But it requires patience, preparedness and a willingness to negotiate.
The best way to get the maximum value from selling your company is to plan well in advance. Take a hard look at what your business is worth, and solve any problems that could make it sell for less than it should. Then, take the proceeds and start on your next adventure.