Is Your Retirement Plan to Sell Your Business a House of Cards?

If you’re like the majority of small business owners, your business plays a big part in your retirement plans. Maybe you haven’t had to chance to put aside any funds for retirement outside your business, but you see your small business as your trump card; when the time comes, you’ll just sell it and retire comfortably on the proceeds.

But what if your supposed trump card turns out to be a Joker? Your whole retirement plan could collapse.

Here are the issues you need to deal with now if your plan for selling your business and retiring is going to work.

1) Do you have something worth selling?

Many successful businesses are essentially one person operations in that their success is based on the creations, ideas or even charisma of one individual. And when he or she goes, so does the business.

Others were very profitable businesses in the past but have been superseded by new technologies or behaviors. Video stores, for instance, are now in their sunset years and record stores are obsolete.

Do you actually have a business that someone else is going to want to buy? In other words, will someone else be able to profit from this business in years to come?

2) Be realistic about your small business’s worth.

Maybe not what you think it is.

What someone is willing to pay for your business may be nowhere near what you want to get for it. Small businesses are like houses; they’re both only worth what they’ll fetch on the market at the time that you sell them – not what you hope they’re worth.

And sweat equity is worth nothing unless you can figure out a way to show its value in dollars and cents.

If you don’t know what your small business is worth right now, you need to find out – because we don’t all get to pick our retirement dates. A sudden illness or unexpected event can change everything and force us to retire before we plan.

A professional business valuation is well worth the money. In Canada, you can find Business Valuators through the website of the Canadian Institute of Chartered Business Valuators. Online searching and old-fashioned yellow pages will also work.

3) Start preparing to sell now.

If you had to sell your business immediately would you be able to? Would it be in the kind of shape that would get you top dollar – or any buyers at all?

That’s why so many advisors, tell business owners that they need to get ready to sell their business right now, no matter what their retirement horizon is.

If you are preparing to sell a home, the first thing you do is fix up the landscaping and add a coat of fresh paint to the kitchen and bathroom. Likewise, when you are getting ready to sell a business you’ll want to improve the appearance of your track record in order to maximize the value you receive for all you have invested over the years.

Ideally, you’d like to have at least three years of solid financials and sell when your neighborhood is hot, but you also need to tidy up your balance sheet, which could mean moving around certain assets or removing bad debt.

4) Create a seller’s plan to ease the transition.

Three years of solid financials is a worthy goal, but it’s just one thing that needs to be done to get your small business ready to sell – just like putting a new roof on your house is not enough to make the sale.

As with any project, a list will help. Premises, business records, customer data, inventory; everything needs to be cleaned up and accessible.

And, in consultation with your accountant and/or tax lawyer, you’ll also want to consider what type of sale you want to have; asset sale or share sale.

It may be that a share sale would substantially increase your profits when you sell, but to do that, you’ll need to set up your business as a corporation.

Planning Makes Such a Difference

Who wants to be the person who goes to sell their business and retire and then discovers that all they have to sell is some inventory and fixtures? Drawing up a plan to sell now and following through on doing what you need to do to make your business an attractive proposition will ensure you’re playing with a full deck of cards when the time comes to sell.

4 Things You Need to Know if You Want to Sell Your Business & Retire.

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3 Business Valuation Methods

There are many reasons to have an up-to-date business valuation. For example:

  • You may need to sell the business due to retirement, health, divorce, or for family reasons.
  • You may need debt or equity financing for expansion or due to cash flow problems. Potential financiers or investors will want to see that the business has sufficient worth.
  • You may be adding shareholders (or one or more shareholders may wish a buyout). In this case, share value will need to be determined.

Regardless of the reason, how much your business is worth depends on many factors, from the current state of the economy through your business’s balance sheet. If for example, similar businesses in your area have recently sold, the value of your business will be determined in large part by the selling price of the previous sales.

Get It Done Right

Business owners should not do their own business valuation. This is too much like asking a mother how talented her child is. Neither the business owner nor the mother has the necessary distance to step back and answer the question objectively.

So to ensure that you set and get the best price when you’re selling a business, get a business valuation done by a professional, such as a Chartered Business Valuator (CBV). In the U.S., you can find Business Valuators through the website of the American Society of Appraisers (ASA) while in Canada you can find them through the Canadian Institute of Chartered Business Valuators.

A Business Valuator (or anyone valuating your business such as an accountant) will use a variety of business valuation methods to determine a fair price for your business, such as:

Three Business Valuation Methods

1. Asset-Based Approaches

Basically, these business valuation methods total up all the investments in the business.

Asset-based business valuations can be done on a going concern or on a liquidation basis.

  • going concern asset-based approach lists the business’s net balance sheet value of its assets and subtracts the value of its liabilities.
  • liquidation asset-based approach determines the net cash that would be received if all assets were sold and liabilities paid off.

Using the asset-based approach to value a sole proprietorship is more difficult. In a corporation,  all assets are owned by the company and would normally be included in a sale of the business. Assets in a sole proprietorship exist in the name of the owner and separating assets from business and personal use can be difficult.

For instance, a sole proprietor in a lawn care business may use various pieces of lawn care equipment for both business and personal use. A potential purchaser of the business would need to sort out which assets the owner intends to sell as part of the business.

2. Earning Value Approaches

These business valuation methods are predicated on the idea that a business’s true value lies in its ability to produce wealth in the future. The most common earning value approach is Capitalizing Past Earning.

With this approach, a valuator determines an expected level of cash flow for the company using a company’s record of past earnings, normalizes them for unusual revenue or expenses, and multiplies the expected normalized cash flows by a capitalization factor.

The capitalization factor is a reflection of what rate of return a reasonable purchaser would expect on the investment, as well as a measure of the risk that the expected earnings will not be achieved.

Discounted Future Earnings is another earning value approach to business valuation where instead of an average of past earnings, an average of the trend of predicted future earnings is used and divided by the capitalization factor.

What might such capitalization rates be? In a Management Issues paper discussing “How Much Is Your Business Worth?”, law firm Grant Thornton LLP suggests:

“Well established businesses with a history of strong earnings and good market share might often trade with a capitalization rate of, say 12% to 20%. Unproven businesses in a fluctuating and volatile market tend to trade at much higher capitalization rates, say 25% to 50%.”

Valuation of a sole proprietorship in terms of past earnings can be tricky, as customer loyalty is directly tied to the identity of the business owner. Whether the business involves plumbing or management consulting, will existing customers automatically expect that a new owner delivers the same degree of service and professionalism?

Any valuation of a service oriented sole proprietorship needs to involve an estimate of the percentage of business that might be lost under a change of ownership. Note that this can be mitigated in many cases, such as when a trusted family member (who may already be familiar with the client list) takes over the business.

3. Market Value Approaches

Market value approaches to business valuation attempt to establish the value of your business by comparing your business to similar businesses that have recently sold. Obviously, this method is only going to work well if there are a sufficient number of similar businesses to compare.

Assigning a value to a sole proprietorship based on market value is particularly difficult. By definition,​ sole proprietorships are individually owned so attempting to find public information on prior sales of like businesses is not an easy task.

Although the Earning Value Approach is the most popular business valuation method, for most businesses, some combination of business valuation methods will be the fairest way to set a selling price.

Non-Competition Clauses Can Affect Valuation

Non-competition clauses are frequently included in agreements for the sale of a business, particularly in cases where goodwill forms a significant part of the valuation. No one wants to purchase a business on the assumption that current customers will continue to patronize the business only to have the previous owner immediately join a competitor or open a similar business in the same area.

Non-competition clauses typically contain restrictions such as:

  • Forbidding the seller from opening up a competing business in the same geographical area
  • Attaching a time limit to competing activity – for example the buyer may request that the seller not engage in direct competition for a period of five years

Non-competition agreements can be a thorny legal issue and are often the subject of court cases between buyers and sellers after a business is sold. From a legal standpoint, to be enforceable the restrictions placed in a non-competition clause must be clearly defined and ‘reasonable’. Non-competition covenants can be nullified by the courts if it is determined that enforcement places overly broad and/or unreasonable restrictions on the seller’s ability to continue his/her trade and earn a living. Non-competition clauses should be reviewed by the legal representatives of the buyer and seller prior to the sale of the business.

What About Franchise Businesses?

Franchise agreements generally define how a franchise can be sold, and these vary by franchise vendor — check your franchise contract. Some contracts stipulate that the franchisors will buy back your franchise directly for a fixed price. Others provide assistance with valuation and locating a buyer, as it is in their best interest to make sure that the business continues uninterrupted.

The Best Choice May Be a Combination

Although the Earning Value Approach is the most popular business valuation method, for most businesses, some combination of business valuation methods will be the fairest way to set a selling price. The first step is to hire a professional Business Valuator; he or she will be able to advise you on the best method or methods to use to set your price so you can successfully sell your business.

How to Determine What Your Business Is Worth.

How to Sell a Business – Asset Sale vs Share Sale

Is selling the business your succession plan? It is for many small business owners. Whether you sell plan to sell your business to a partner, internal management group, or an outside third party, there are actually only two types of business sales, an asset sale and a share sale.

This article explains each type of sale and compares the two types.

The Asset Sale

In an asset sale, you are selling the different assets that the business owns.

Assets may be:

  • tangible, such as land, buildings, equipment, cash, investments, and inventory,
  • intangible, such as the goodwill your business has built up during the years of its operation, customer lists, patents, copyrights, and trademarks.

If your business is not incorporated (i.e. a sole proprietorship or partnership), an asset sale is the only selling option since there are no share certificates of ownership to transfer in a sale.

To come up with a selling price for the business, the different assets of the business are individually appraised.

Here’s a simple example of how a sale price could be set for an asset sale. Let’s suppose that you want to sell your dog treat business. The list of your assets might look like this:

Asset Value
Equipment $10,000
Inventory $2,000
Accounts Receivable $4,000
Delivery truck $12,000
Trademark $10,000
Goodwill $20,000
Total: $58,000

Looking at the example, you can easily see how quickly something that sounds so simple (list all your assets and what they’re worth and total them up to arrive at a selling price for your business) can become very complicated.

How do you know, for instance, that your business’s goodwill is worth $20,000?

And even if you think so, how will you prove that it is to a potential buyer who sees such a value on an intangible asset a good chance to knock down your selling price?

This is one of the reasons that it’s wise to seek professional assistance to help you assess and sell your business.

Sole Proprietorship Asset Sales

From an asset perspective sole proprietorship business sales can be particularly difficult:

  • Since there is no distinction between personal and business assets in a sole proprietorship, problems may arise when it comes to transferring tangible assets. For example, if the business has been operated from home or from a building on the owner’s property, relinquishing the asset in a sale of the business is problematic. Similarly, the owner may wish to retain other assets such as vehicles or equipment for personal use.
  • By definition a sole proprietorship is typically a one-person business and as such the owner’s skills and experience often constitute most or all of the value of the business. In this case it can become an almost purely intangible asset sale which is very difficult to value. As an example, a financial consultant wishing to sell his or her business may place a high value on having an extensive client list, but clients may not value the skills and experience of a new owner as highly and decide to take their business elsewhere.

The Share Sale (Incorporated Businesses Only)

The other type of business sale, the share sale (also known as a stock sale), simplifies matters because you are selling the shares of the business, rather than its assets.

This can be an advantage because all of the business’s liabilities are included in the sale so as a seller, you can get completely clear of the business.

And a share sale can be extremely beneficial tax-wise as you may be able to pay no tax on the sale if you are a Canadian resident and can use your $750,000 lifetime capital gains exemption to cover the sale.

The obvious catch to the share sale, however, is that your business has to be incorporated to be sold this way. So if you currently have a sole proprietorship or partnership that you want to sell, you may wish to restructure the business as a corporation first.

 

Asset Sale vs. Share Sale

In summary then:

  • An asset sale can be used to sell any type of business; a share sale can only be used to sell an incorporated business.
  • In an asset sale, you can choose what you’re selling to a degree. For instance, you may want to keep the name of the business, or another particular asset. In a share sale, the entire business passes to the new owners, including things such as the business name.
  • In a share sale, the liabilities are sold along with the rest of the business; in an asset sale, only assets are sold, meaning that the original owner may still be responsible for the business’s liabilities.
  • Tax-wise, in a share sale, there is a possibility that the entire price you are paid for your business may be tax free if you are able to write it off using your lifetime capital gains exemption. In an asset sale, this is not the case because business assets will be affected by the rules of Capital Cost Allowance.

Seek Advice Before You Sell Your Business

Both types of business sales will have tax implications; you should seek the advice of accounting and/or legal professionals to determine the best type of business sale for your situation.

Which Type of Business Sale is Best for Your Small Business?