If you’re considering selling a business, let’s discuss some of the myriad issues involved.
From taxes and financing instruments to training the buyer and keeping the transaction confidential, there are dozens of issues that must be considered when it comes time to think about selling a business. We’re going to chat about a few here that are guaranteed to come up during negotiations. If you’re considering selling – or buying, for that matter – spend a few minutes with this post and then some time thinking about the following issues.
Payables and Receivables
Assuming you find a buyer, there will be certain amounts of money in both the receivables and payables columns on the closing date. This will come up in the negotiations and you should give it some thought beforehand.
There are multiple options here in that you can keep both, both can be part of what the buyer buys or portions of both can transfer with the business. Let’s look at the receivables first.
The downsides of keeping the receivables are, 1) that the buyer will likely want a credit in that amount (or some discounted amount) against the purchase price and, 2) you will have the task of collecting after the business is sold. Further to that, if the buyer buys the receivables, valuing them is an art rather than a science because receivables have less value the older they are.
By way of example, if you have $200,000 in receivables less than 30 days old, the buyer is likely to agree to pay something close to 100% of face value (assuming that the customers have a history of paying on time). If you have another $100,000 aged 30-60 days, the buyer may see some risk in collecting 100% and will likely want to discount the value of that amount and reduce the purchase price accordingly. For receivables aged 90 days or more, the buyer will want either you to keep them or to discount the value of the receivables significantly – perhaps as much as 90% – before the buyer will agree to buy them.
The decision on this will depend on the sophistication of the buyer. If it is a large company with accounting and collection functions in place, the buyer will know from experience what is likely to be the percentage of the aged receivables that will be collectable – and offer less. For example, if there is $100,000 aged more than 90 days and the buyer’s history suggests that they will only collect 60%, they may offer 40% for these receivables – essentially an arbitrage move in the hope of profiting on the spread.
Keeping the receivables means that you, the seller, has to collect them. This could turn into a royal pain in the butt. If you want to be finished with the business, having to try to collect money that is yours could be a long and arduous road, especially given that the debtors will likely be aware that the business has been sold, thus reducing their motivation to take care of any debts to you in a timely fashion.
We’ve done deals in which the buyer acquired all the receivables, a portion of the receivables and none of the receivables. Our experience suggests that the seller always wants to be rid of the receivables and arriving at a negotiated discount that is considered “reasonable” by both parties is the way to do this.
Payables are another story. The buyer is unlikely to want the payables but you don’t want to keep them especially given that the products they are meant to pay for will, as of the date of closing, belong to the buyer. A buyer may want you to negotiate new terms with your suppliers that will allow the buyer more time to pay or to take a discount for immediate payment. If you, as the seller, keep the payables, make sure that the purchase price accounts for this. Up front planning that considers payables and receivables will help you set the price/value of the business and is the only way to be ready to address this topic when it inevitably arises
Cash On Hand
Cash on hand should also be considered. Many more-sophisticated buyers may want 30 days of w
orking capital from your cash on hand. The argument against this is that a dollar added to one column (what the buyer is getting for the purchase price) is simply a dollar added to the other column (the purchase price).
For example, let’s assume that a month’s worth of working capital is $50,000 (operating expenses and the purchase of raw materials). Assume further that the business has $150,000 in cash on hand. Our position would be that the cash on hand is not included and if the buyer insisted that some amount be part of the deal, the purchase price is adjusted upward on a dollar-for-dollar basis.
The reason a buyer might do this is if the buyer lacks sufficient cash or does not want to use its own cash. If the purchase is being financed and the lender is willing to raise the financing amount proportionally, this is not a problem. What you, as the seller, want to try to achieve is a dollar increase in the purchase price for each dollar in working capital that the buyer wants you to provide from cash on hand.
Liabilities that exist on the date of closing will also be negotiated. I suggest that you keep an accurate account of all liabilities and update it weekly. Some liabilities may be assumed by the buyer; invoices for inventory or packaging, for example. Other liabilities may not be, such as note or lease payments on equipment, particularly for equipment the buyer is not buying or that the business uses sparingly.
Leases for real estate are a liability. The buyer may want you to renegotiate the lease so that, among other things, the lease term is extended (or shortened if the buyer plans to move the business) and the rental rate and how it is structured when revised. You can find specific, in-depth discussions on this topic here
You may have a credit line or letter of credit (LOC) that you’ve used to finance certain aspects of the business over the years. While it is possible to secure such credit against equipment and/or inventory, it is our experience that the lenders will also look to the owners to personally guarantee the credit instrument and this usually means that your house is securing it. Needless to say, it is crucial to discuss with your lender before negotiations with a buyer get started what their stance will be when the business is sold; Would they like to keep the business as a customer after the sale? Might they allow a qualified buyer to assume the credit instruments? Will they enforce a “due on sale” clause? Know the answers before you get to any serious discussions with a buyer. Favorable financing terms that can be assigned to a buyer give added value to what you’re selling.
There are, of course, many more issues that must be addressed when gearing up to sell your business and I’ll be writing about them periodically in the future. If you have any immediate questions about how to handle a certain issue, let me know in the comments box below.
One final note. We are changing our posting schedule to a more focused format and while I will still be posting every Monday afternoon, each month’s posts will be geared toward a certain group such as sellers, buyers, folks looking for financing, folks that want to become business brokers, etc. Our podcasts will become more focused as well and will be posted at the end of each month recapping the posts from earlier in the month and addressing any comments and questions we may have received about those posts. Hopefully, you will find this new format helpful
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Thanks for reading! See you next week.