One of the most frequently-asked questions by those looking at the independent business scene is: “How many are for sale?” Right on the heels of that question comes another: “How many actually sell?”

To determine how many of these businesses are for sale at any one time, and what percentage of these get sold, it is necessary first to define terms by business category. The industry groups that account for the majority of small to mid-sized business sales are: manufacturing, wholesale trade, retail trade, business and personal services, and household/miscellaneous services. Using these categories as components, the total number of businesses that apply to our “survey” is approximately 6.3 million.

Of this total, businesses that are for sale at any one time account for roughly 20 percent. There is naturally going to be a higher percentage of businesses for sale that employ four or less workers, but some independent business experts feel that fewer of these businesses–at least percentage-wise–sell than do the larger ones. Of those businesses with four or less employees, one expert’s estimate is that one out of six actually sells; with five to nine employees, about one out of five sells; and the trend continues.

Why is the actual-sale percentage lower for very small businesses? Many factors operate to affect this tendency. For example, the much smaller business may suffer more from unsubstantiated income or inaccurate financial information. Some owners may not be realistic in their pricing or simply aren’t serious about selling (problems that can threaten the sale of a business at any level). Still others may simply pay the bills and close the doors.

However, no matter what the percentages show, a business owner considering putting a company on the market should remember this: most businesses are salable if the seller is realistic in assessing value and is aware that the marketplace is the final arbiter of the selling price.

Family-owned businesses do have some options when it comes time to sell.  Selling the entire business may not be the best choice when there are no other family members involved.  Here are some choices to be considered:

Internal Transactions

• Hire a CEO – This approach is a management exit strategy in which the owner retires, lives off the company’s dividends and possibly sells the company many years later.
• Transition ownership within the family – Keeping the business in the family is a noble endeavor, but the parent seldom liquefies his investment in the short-term, and the son or daughter may run the company into the ground.
• Recapitalization – By recapitalizing the company by increasing the debt to as much as 70 percent of the capitalization, the owner(s) is/are able to liquefy most of their investment now with the intent to pay down the debt and sell the company later on.
• Employee Stock Ownership Plan (ESOP) – Many types of companies such as construction, engineering, and architectural are difficult to sell to a third party, because the employees are the major asset.  ESOPs are a useful vehicle in this regard, but are usually sold in stages over a time period as long as ten years.

External Transactions

• Third party sale – The process could take six months to a year to complete.  This method should produce a high valuation, sometimes all cash at closing and often the ability of the owner to walk away right after the closing.
• Complete sale over time – The owner can sell a minority interest now with the balance sold after maybe five years.  Such an approach allows the owner to liquefy some of his investment now, continue to run the company, and hopefully receive a higher valuation for the company years later.
• Management buy-outs (MBOs) – Selling to the owners’ key employee(s) is an easy transaction and a way to reward them for years of hard work.  Often the owner does not maximize the selling price, and usually the owner participates in the financing.
• Initial public offering (IPO) – In today’s marketplace, a company should have revenues of $100+ million to become a viable candidate.  IPOs receive the highest valuation, but management must remain to run the company.

Source: “Buying & Selling Companies,” a presentation by Russ Robb, Editor, M&A Today

Deals fall apart for many reasons – some reasonable, others unreasonable.

For example:

• The seller doesn’t have all his financials up to date.
• The seller doesn’t have his legal/environmental/administrative affairs up to date.
• The buyer can’t come up with the necessary financing.
• The well known “surprise” surfaces causing the deal to fall apart.

The list could go on and on and this subject has been covered many times. However, there are more hidden reasons that threaten to end a deal usually half to three-quarters of the way to closing. These hidden reasons silently lead to a lack of or loss of momentum.

This essentially means a lack of forward progress. No one notices at first. Even the advisors who are busy doing the necessary due diligence and paperwork don’t notice the waning or missing momentum.  Even though a slow-down in momentum may not be noticeable at first, an experienced business intermediary will catch it.

Let’s say a buyer can’t get through to the seller.  The buyer leaves repeated messages, but the calls are not returned.  (The reverse can also happen, but for our example we’ll assume the seller is unresponsive.) The buyer then calls the intermediary.  The intermediary assures the buyer that he or she will call the seller and have him or her get in touch.  The intermediary calls the seller and receives the same response. Calls are not returned.  Even if calls are returned the seller may fail to provide documents, financial information, etc.

To the experienced intermediary the “red flag” goes up. Something is wrong. If not resolved immediately, the deal will lose its momentum and things can fall apart quite rapidly. What is this hidden element that causes a loss of momentum? It is generally not price or anything concrete.

It often boils down to an emotional issue. The buyer or seller gets what we call “cold feet.” Often it is the seller who has decided that he really doesn’t want to sell and doesn’t know what to do.  It may also be that the buyer has discovered something that is quite concerning and doesn’t know how to handle it. Maybe the chemistry between buyer and seller is just not there for one or the other of them. Whatever the reason, the reluctant party just tries to ignore the proceedings and lack of momentum occurs.

The sooner this loss of momentum is addressed, the better the chance for the deal to continue to closing. Because the root of the problem is often an emotional issue, it has to be faced directly. An advisor, the intermediary or someone close to the person should immediately make a personal visit. Another suggestion is to get the buyer and seller together for lunch or dinner, preferably the latter. Regardless of how it happens, the loss of momentum should be addressed if the sale has any chance of closing.

Personal Goodwill has always been a fascinating subject, impacting the sale of many small to medium-sized businesses – and possibly even larger companies. How is personal goodwill developed? An individual starts a business and, during the process, builds one or more of the following:

• A positive personal reputation
• A personal relationship with many of the largest customers and/or suppliers
• Company products, publications, etc., as the sole author, designer, or inventor

The creation of personal goodwill occurs far beyond just customers and suppliers. Over the years, personal goodwill has been established through relationships with tax advisors, doctors, dentists, attorneys, and other personal service providers.  While these relationships are wonderful benefits, they are, unfortunately, non-transferable. There is an old saying:  In businesses built around personal goodwill, the goodwill goes home at night.

It can be difficult to sell a business, regardless of size, where personal goodwill plays an integral role in the business’ success. The larger the business, the less likely that one person holds the key to its profitability. In small to medium-sized businesses, personal goodwill can be a crucial ingredient.  A buyer certainly has to consider it when considering whether to buy such a business.

In the case of the sale of a medical, accounting, or legal practice, existing clients/patients may visit a new owner of the same practice; they are used to coming to that location, they have an immediate problem, or they have some other practical reason for staying with the same practice. However, if existing clients or patients don’t like the new owner, or they don’t feel that their needs were handled the way the old owner cared for them, they may look for a new provider. The new owner might be as competent as, or more competent than, his predecessor, but chemistry, or the lack of it, can supersede competency in the eyes of a customer.

Businesses centered on the goodwill of the owner can certainly be sold, but usually the buyer will want some protection in case business is lost with the departure of the seller. One simple method requires the seller to stay for a sufficient period after the sale to allow him or her to work with the new owner and slowly transfer the goodwill. No doubt, some goodwill will be lost, but that expectation should be built into the price.

Another approach uses some form of “earnout.” At the end of the year, the lost business that can be attributed to the goodwill of the seller is tallied.  A percentage is then subtracted from monies owed to the seller, or funds from the down payment are placed in escrow, and adjustments are made from that source.

In some cases, the sale of goodwill may offer some favorable tax benefits for the seller. If the seller of the business is also the owner of the personal goodwill, the sale can essentially be two taxable events. The tax courts have ruled that the business doesn’t own the goodwill, the owner of the business does. The seller thus sells the business and then also sells his or her personal goodwill. The seller’s tax professional will be able to give further advice on this matter.

New accounting rules may require that acquirers and acquiring companies report earnout agreements as liabilities.

Joel Johnson, president of Orchard Partners Inc., in his article, “Earnouts,” published by Valuation Strategies, states: “In a given year, 2% – 3% of announced mergers and acquisition agreements involve earnouts.  These figures probably understate their prevalence.  Earnouts tend to be a characteristic of smaller deals; and in many small deals, terms are not announced.  Earnouts are rare when public companies are acquired and more common when ownership is concentrated among a few shareholders.”

This would mean, if implemented, that earnout agreements must have a value placed on them for accounting purposes. As Joel Johnson points out, “The higher the earnout, the greater the liability.”

Why the Earnout?

Johnson further states that earnouts are used for various reasons:

1. to bridge the pricing gap between the seller who places a heavy emphasis on the company’s projections, and the buyer who places most of the company’s value on its present and past performance.
2. to tie the acquisition payout to future performance.
3. to create a form of seller financing in that some of the buyer’s purchase price is delayed into the future. 4. to establish a form of escrow account in that the money is paid on condition of meeting certain thresholds.
5. to act as a type of employment agreement in that the CEO has to stick around in order to collect.