A potential buyer has just given you a letter of intent to buy your business – time to celebrate! This is what you’ve been working and sacrificing for all these years. If it’s unsolicited, it’s even more exciting because you won’t have to go through the time-consuming process of preparing your business for sale, finding a buyer and negotiating a price. It all sounds great, but is it really that simple? Rarely. Regardless of whether the offer is unsolicited or one that you’ve received after marketing your business to potential buyers, you need to take a step back and make sure the offer is really as good as it “feels.” Generally, a letter of intent will require exclusivity with that buyer. Before you limit your options with one buyer, consider all the reasons you should reject the offer. Below are some of the reasons you might consider rejecting a letter of intent to sell your business.
Reason #1 – The price in the letter of intent doesn’t meet your financial needs post-exit
Before even considering a letter of intent to sell your business, you should have prepared yourself financially for your exit. How much money will you want and need to live the life you envision after you sell your business? What debts will need to be paid off and what other costs will need to be paid when you exit? If you believe you need $5 million to retire, then an offer of $5 million will not be sufficient. After you repay your debt obligations and pay transaction costs and taxes, you may end up with only a fraction of that amount. If you decide to accept an offer that doesn’t meet your financial plans post-exit, then be prepared to find another way to earn money after you sell your business.
Reason #2 – You haven’t figured out “what’s next” for you
If you haven’t figured out who you’ll be when you’re no longer “the owner of your business,” you may want to delay selling your business. As Lee Iacocca said, “You plan everything in life, and then the roof caves in on you because you haven’t done enough thinking about who you are and what you should do with the rest of your life.” When you sell your business, you are in for some big changes. If you haven’t planned for those changes and feel confident moving to the next phase of your life, you may have difficulty actually going through with sale. In fact, this is one of the most common reasons that business owners fail to sell their business. A failed exit is not what anyone wants. Don’t risk selling your business until you’re prepared emotionally for what you’ll do next.
Reason #3 – You haven’t “prepared your business” to maximize your business valuation
The likelihood of you receiving the perfect, unsolicited offer for your business is not high. You’ll likely need to go through the process of soliciting offers from potential buyers. Unfortunately, you can’t just wake up one day and decide to sell your business in the next six months. You’ve run your business for years and know every aspect of it. You know how valuable it is…to you. It may not be as valuable to a potential buyer who doesn’t have the years of history with your employees, customers and suppliers. You’ll need to look at your business through the “eyes of the buyer” to determine areas that need to be improved or changed in order to position your business as a viable opportunity for a potential buyer. We call this “preparing your business” for sale. Depending on the areas of improvement you identify and the action plan you implement, preparing your business could take anywhere from 18 months to five years. Taking the time to prepare your business should help maximize the value of your business to a potential buyer and improve the odds of successfully closing the transaction. Don’t accept a letter of intent before determining the cost/benefit of spending more time to potentially improve the value and future sale price of your business.
Reason #4 – The proposed transaction structure results in higher taxes for you
There are plenty of horror stories of business owners selling their business only to end up with overwhelming tax bills because of how the transaction was structured. No one had explained the tax consequences of the different structures to the business owner while negotiating the purchase agreement. The type of legal structure of your business (C-corporation, S-corporation, etc.) and the type of transaction structure (asset sale versus stock sale) can significantly impact the taxes you pay at closing and your net proceeds from the sale. Not surprisingly, the best structure for you is generally not the best for your buyer. Sellers generally want stock sales and buyers generally prefer asset sales. With asset sales, the seller still owns the corporate entity, including all of its liabilities, making it difficult to fully exit that business at closing. Work with your legal and tax advisors to understand the tax impact of any transaction structures you’re considering. You don’t want any surprises that put you in a financial bind after selling your business.
Reason #5 – You’re worried the buyer might reduce the price after due diligence
Signing a letter of intent is only the beginning of the process for the buyer who will now perform due diligence on your business. The buyer will be looking to validate the information you’ve provided and look for potential items that could be used to adjust the price downward. These items could include errors in your financials, liabilities that haven’t been recorded, and significant infrastructure costs that are required in the future. The adjustments could also be due to intangible items such as customer concentration, poor quality of management or lack of internal controls. The buyer’s goal will be to decrease the offer before the deal closes. It’s like selling a house where you enter into a contract subject to inspection. If you haven’t done your own inspection, you may be worried the buyer might reduce the price because the inspector finds issues with the electrical or plumbing that you don’t know about. If you believe the buyer may “find” adjustments during due diligence on your business, you have two options. You can reject the offer and spend time addressing the issues before selling your business. The other option is to accept the risk of the buyer finding adjustments understanding that your sale proceeds may be less than you originally anticipated.
Remember, selling your business is a financial and emotional decision. If you’ve prepared your business, you should have a good idea of what your business is really worth and what issues a buyer might discover during due diligence. That knowledge, combined with a clear plan of “what’s next” for you, will help you decide whether the letter of intent is right for you and your business. Then you can celebrate knowing you’ve made the right decision.