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Attracting Investment for the Amateur Entrepreneur Part III: Selling the Business or Buying Back Stock

Yogi Patel - Friday, June 26, 2015

Intro


Once an entrepreneur has used their investments to grow the business and sustain substantial profits over the course of a few years, the time may be ripe for her to make another important decision: sell the company or buy back shares of stock from investors.

           There are many reasons why an entrepreneur may wish to sell her business—she may be looking to retire, needs a break, or may be simply looking for a new venture—but regardless, there are many factors and obligations she must consider once she has decided to sell. This article will address many of the most important steps in the process, including developing an exit strategy, obtaining a valuation, and deciding whether to make an asset or stock sale of the business.           

Alternatively, the entrepreneur may decide to keep growing the business but only after buying back the shares of equity that were sold to investors. Buying back equity may be an obligation, a right, or a negotiation, depending on what was previously agreed to by the parties involved, but the entrepreneur’s goal should be to increase future profits through an increased share in equity or to secure financing at a lower interest rate elsewhere. Of course, there are additional options that a successful entrepreneur may pursue at this point, but the scope of this article will be limited to these two possibilities as they are among the most common decision amateur entrepreneurs make.


For What It’s Worth

Before doing just about anything, the entrepreneur would be well advised to obtain a valuation of her business from an appraiser. Even if she has an accurate idea of what the business is worth, being able to demonstrate an independent, objective analysis is essential to establishing a credible asking price. You will receive a detailed, written assessment that you can share with potential investors as well as use for making your own determinations about the future of the business.


Prepare and Document

As with running a business, the more organized and prepared you are when it comes to selling your company, the better off you will be. In addition to obtaining an official valuation, you should also organize the past several years of tax returns, create a list of inventory, equipment, and other items that will be sold with the business, and obtain copies of any contracts, leases, or other documents that create an obligation or right for your business.

The especially ambitious entrepreneur should not only organize all these materials, but she should also prepare a summary or explanation that also includes the history of the business and its operations. You want to present a business that is organized, operational, and profitable.


So Who is Ready, Willing, and Able?

A business owner may have a clear, organized presentation of a highly desirable business, but without a viable purchaser, no sale will ever happen. Finding the right buyer can prove to be a challenge, and it may be something for which you should enlist professional help.

Brokers are professionals whose job is to research and vet prospective buyers and bring them to the table. Working with a broker allows the business owner to stay focused on the business and generally keeps news of the sale much less public. The down side, of course, is that a broker’s service is not free.

For many amateur entrepreneurs, the ideal scenario is one in which a current employee, manager, or other trusted person with knowledge of the business’s operations is interested in buying, in which case there is no need for a broker. However, if you are inexperienced and attempting to sell to the general public, working with a broker might prove to be invaluable.

No matter whether you use a broker or not, you should always do your own due diligence with prospective buyers and require that they sign a confidentiality/nondisclosure meeting before you discussing your business with them.


How Should You Sell? Stock Sale or Asset Sale?

One of the most important decisions an entrepreneur looking to sell her business must make is whether she is going to insist on a stock sale or if she is open to an asset sale. This is a difficult decision to make because an asset sale is typically more attractive to a buyer, but a stock sale is usually in the seller’s best interest, so the parties interested in the transaction have even more to negotiate.

A stock sale is where a buyer purchases the owner’s share of a corporation. The buyer obtains ownership of the corporation and thereby title to all the company’s assets, but the buyer also is exposed to additional liabilities, such as latent environmental concerns and employment issues.

An asset sale is where a buyer purchases each asset of the company, such as equipment, licenses, goodwill, trade secrets, and inventory, but the seller retains ownership of the legal entity, the entity’s cash, inventory, and certain debts and receivables. Buyers prefer this not only because it is easier for them to avoid taking on additional liabilities held by the company, but there are additional tax benefits offered by the IRS.

More often than not business are sold through asset sales.  However, this is not always the case.  Sellers may wish to mitigate some of the concerns of buyers with regards to a stock sale rather than give into the demand for an asset sale. For example, a seller could make specific representations that the business does not have particular liabilities and indemnify the buyer from certain liabilities as well in order to make a stock sale more attractive to a buyer.

In the end, negotiations will also depend on the desirability of the business, how urgently the seller needs to find a buyer, and what additional terms and conditions can be agreed to in order to sway one party. Having a detailed plan, well-prepared records and documentations, and the advice of experts can prove to be invaluable to a seller hoping to make a stock sale.


Share the Wealth, but Pay Your Taxes (and other Debts)

When a business is finally sold, this is considered a liquidation event that triggers rights of both preferred and common shareholders as defined by the corporation’s various agreements. As discussed in the previous articles, preferred shareholders receive their payments before common shareholders at whatever the agreed upon calculation of preferred stock price upon liquidation is, including the factoring in of any multiplier. If preferred shareholders have conversion rights, they may opt to exercise those as well.

After preferred shareholders have been paid or their shares have been converted, common shareholders receive their percentage of profits. Keep in mind, however, that there may be additional debts or expenses to pay, such as loans, taxes, and employee-related expenses, so before distributing any profits, business owners should consult with an accountant to fully understand their obligations upon liquidation.


Holding on to Your Business

If instead, an entrepreneur wishes to continue operating a business, she should be sure to understand the rights of all preferred shareholder investors and what her options are with regard to buying back preferred shares. For one, after a certain amount of time or when the company reaches a particular valuation, preferred shareholders could have the right to sell their shares, or, alternatively, the owner may have the right to buy back the shares. Particularly if a company would be required to pay a fixed, preferred dividend, it may be financially prudent to buy out preferred shareholders.

            While purchasing back preferred shares will reduce the company’s immediate liquid capital, it does increase the share in equity for the purchaser of the preferred shares, and if additional funding can be secured at a lower interest rate, (which should be possible now that the business is worth more than when it started) then the economic conditions may be ripe for such action.


In Conclusion

Selling a business typically can take anywhere from six months to a few years. Any entrepreneur who is starting a business with the intention of selling it eventually should seriously begin planning the sale as part of the company’s formation. This means not only setting financial objectives, but also negotiating for the right terms with investors that gives the entrepreneur the greatest flexibility to grow the business and sell it for the maximum profit.

Every business has its particularities and constraints, and entrepreneurs should consult with expert attorneys and accountants along the way to ensure that their documents are valid and reflect the goals of the company, and that their financial planning and tax obligations are being executed properly. Fortunately, access to capital and other forms of assistance are at an all time high, and it is an exciting time in which the amateur entrepreneur with the next great idea can realistically make it into reality without relinquishing ownership and control.


This article was intended to provide an overview and is not to be construed as legal advice.



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