Selling a Business
If you decide to sell your business, there are several different ways you might transfer ownership of the business to another person. Your decision may also depend on the type of ownership entity utilized for your existing business. There are different tax consequences that will apply depending upon whether your business is a sole proprietorship, partnership, corporation or a limited liability company. Accountants and lawyers can help you decide the best way to transfer ownership of your business, and when might be the best time to sell your business.
Ways to Transfer Ownership
Gradual Sale. A gradual sale involves turning over the day-to-day operations of the business to another person, but you still receive income from the business over a period of time. This is a good option for you if you need or prefer steady income from the business over time, but you can no longer – or prefer not to – run the business anymore.
This might be a good option for the buyer too, because the buyer might not be able to pay a large lump sum payment to you, or may not be able to get a loan to be able to pay you a lump sum. In that case, you are helping finance the purchase for the buyer. A gradual sale might also be a good option if the buyer would like you to be a consultant and help teach the buyer about the business over time. These last two options can also be made available as part of an outright sale of your business.
Lease Agreement. In a Lease Agreement, you continue to own your business, but someone else runs it for you, and makes monthly payments to you. Leasing your business might be a good option if you are not sure that you are ready to sell the business, but circumstances keep you from being able to run the day-to-day operations.
Like the gradual sale option, this option might also be a good option if the buyer would like you to be a consultant and help teach the buyer about the business over time. The Lease Agreement will call for a specific time period or “term.” The lease may be renewed or extended. After the lease expires, your business will be returned to you.
Outright Sale. The fastest, easiest and most frequently used way to transfer ownership of your business might be an outright sale to another person. If you sell the whole business all at once, you can transfer ownership immediately and receive payment right away. This might be the best option if you need quick cash and you want to make a fast exit with no ongoing involvement with your business.
The Sales Process
Valuation of Business. The first step in selling your business is determining the value of the business. This will help you set your asking price. There are several methods that you can use in valuing your businesses. You can set your purchase price based on the value of your business’ assets, plus the value of the customer base and reputation of the business. This is called the “Goodwill” of the business.
Another method is to look at the prices at which similar businesses in your industry and within your location have recently sold for. Your valuation of your business is extremely important, because if you price your business too high, it will scare away potential buyers and if it’s too low, then you will not get the proper financial reward for all of the hard work that you have put into your business.
Getting Your Business in Order. Once you have set your purchase price, it is time to make sure that your business is in order before you start advertising it for sale. When your business is put on the market, you have to understand that your business operations will be looked at very closely by potential buyers.
It is important to take a close look at your business operations. If there are flaws, now is the time to fix them. Some of the areas that you may want to evaluate are:
- your corporate books (you may want to have your accountant review, or possibly even audit, your business for the last three years and you should be sure that any outstanding taxes or judgments are paid);
- the condition of business’ premises (now is the time to fix those repairs that you have been putting off or update your equipment and trade fixtures);
- ongoing claims against the business, or disputes and lawsuits (if you have not already done so, it is important that you address these outstanding claims, disputes and lawsuits), etc.
Attracting Potential Buyers. Now that your business is in good shape, it is time to put up your “For Sale” sign. Depending on the level of success and popularity of your business, you may not need to advertise the sale very much. Simple word-of-mouth of your business being on the market may be enough to get people interested.
Most sellers will have to advertise the sale of their business in newspapers, trade industry publications and on business sales websites. You may also want to hire a business broker to market your business to a larger group of prospective buyers.
Due Diligence. Potential buyers interested in purchasing your business will want to inspect what is “under the hood” of your business operations before they agree to purchase your business. This inspection process is commonly referred to as “Due Diligence.”
Due diligence can be done at any time. Some buyers will want to do their due diligence before beginning serious negotiations. Others buyers will wait until the basic terms of the purchase has been agreed to. While other potential buyers will wait until after the Purchase Agreement has been signed. In doing Due Diligence, potential buyers may ask you for:
- corporate formation documents;
- corporate books and financial information (which might include financial statements and past tax return);
- important agreements (such as real estate and equipment leases);
- intellectual property portfolio;
- employment agreements and arrangements;
- applicable licenses and permits;
- information regarding any past or current environmental issues; and
- information regarding any past or ongoing disputes and litigation.
To make sure the information you are providing to potential buyers is being used for the sole purpose of helping them decide whether or not they wish to purchase your business, before you turn over any documents, you should require them to sign an agreement promising not to disclose any of your business secrets or private information. This is called a “Confidentiality Agreement.”
Negotiating the Sale. After completing their Due Diligence, some potential buyers may decide not to buy the business. But if the buyer is still interested, it is time to negotiate the price, terms and conditions of your sale. Some key points that will need to be addressed during your negotiation discussions include:
- whether you are selling your business entity or you are selling all or a portion of your business assets;
- what assets (if any) you will keep; and
- the manner by which the purchase price will be paid.
You also need to decide whether you will use an attorney to handle the negotiations. Some people feel comfortable negotiating for themselves. Some people consult with an attorney and develop a negotiation strategy, but then handle the negotiations themselves. And, some people prefer to have an attorney represent them throughout the negotiation process. You should pick whichever option feels most comfortable for you.
Often, the next step is to prepare a writing that sets out how the transaction will take place. This is sometimes called a “Deal Memo” and sometimes called a “Letter of Intent.” The Deal Memo or Letter of Intent will spell out the purchase price, the terms of the purchase, other key business points and the conditions for the sale of your business. It will also be basis for the Purchase Agreement. The Letter of Intent is generally not binding on the parties, which means that the parties may change their minds during later negotiations.
Purchase Agreement. The next step is drafting the Purchase Agreement, which sets forth, in a binding contract, the terms and conditions regarding the sale of your business. The Purchase Agreement will include:
- details about what parts of the business you are selling, such as equipment, inventory, customer lists, intellectual property and Goodwill;
- a list of any contracts that the buyer will be taking over; and
- what will happen if the buyer does not fully pay the purchase price.
If you have followed the steps above and not yet hired a lawyer to help you, at this point you may want to hire a lawyer since the Purchase Agreement is typically prepared by the seller’s attorney. A lawyer can help make sure that you have not missed anything in the process listed above, and can also make sure that the details of the deal you negotiated are worded correctly so that what is stated on the paper you sign matches the deal you thought you agreed to when you shook hands with the buyer or signed the Letter of Intent.
Usually, the Purchase Agreement will allow for the buyer to pay a down payment (frequently between 5% and 10% of the purchase price) upon signing, with the cash balance to be paid to you at the closing. Sometimes, the buyer will pay the balance over time. But if you agree to part of the purchase price being “paid out” over time, the buyer should sign a Promissory Note and perhaps a Security Agreement at the closing, as well.
The Closing. The part of the process where you actual turn over the business to the buyer is called a “Closing.” At the Closing, you will appear with your attorney, if you have one, and the buyer will appear with his or her attorney. Sometimes, other persons may need to be at the closing, such as a landlord (to see that your lease, if any, is properly assigned to the buyer). If there are any loans on the property, your bank’s attorney may be present. If the buyer is taking out a loan to buy the business, then the buyer’s bank may send an attorney to the closing.
After all of the documents are exchanged and you shake hands with the buyer and your attorney, you still have some final tasks to do. These final tasks include, closing your business bank accounts, canceling your general liability insurance, winding up your business entity’s business operations, etc. If you have sold your business assets, but not your “entity,” your entity will have to be dissolved and the appropriate documents must be filed with applicable state agencies.
Legal Editor: Richard L. Rosen, November 2014 (updated March 2016)
Changes may occur in this area of law. The information provided is brought to you as a public service with the help and assistance of volunteer legal editors, and is intended to help you better understand the law in general. It is not intended to be legal advice regarding your particular problem or to substitute for the advice of a lawyer.
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