It’s easy to get lost in the many moving parts of selling a business. In this cheat sheet, we’re breaking down the various components and players to help you keep track of who’s who and what’s what.
ACRONYMS TO KNOW
Because of the complexity that comes with selling a business, many experts try to shorten their explanations by using acronyms. If you aren’t up to speed, this can create confusion.
APA
Asset purchase agreements include details about the sale, including what specifically the buyer is purchasing from the sale (assets, liabilities, leases, etc) as well as price.
DCF
Discounted cash flow refers to a financial model used to value companies. Without getting into the math, the equation uses a business’s current financials to estimate future cash flow. From there, it uses those projections to estimate the current value of the company. In essence, it’s a valuation designed to take future earning potential into account.
EBITDA
Earnings before interest, taxes, depreciation, and amortization. In other words, this is the revenue generated from your core business. It strips out many outlying factors tied to capital structure, taxes, and operations.
LOI
Before you complete the sale of a business, the buyer will provide a letter of intent to purchase your business and the terms of the deal; it’s seen as a preliminary commitment. This can help facilitate the sale process while lawyers finalize the details.
MIPA
If you execute an interest sale for your business, you’ll do so via a membership interest purchase agreement. This is most common in LLCs and LLPs.
NDA
It’s common for sellers to request prospective buyers and any parties involved in the sale to sign a non-disclosure agreement. This protects private and confidential information that you may need to share throughout the sales process.
NPV
Net present value tends to be used synonymously with discounted cash flow, but the two are not the same. They both use the same calculation, but net present value goes a step further. Once you calculate the valuation, NPV factors in the purchase price (initial investment) to evaluate profitability. Potential buyers do this to determine whether something may or may not be a good investment.
P/E ratio
The price-to-earnings ratio looks at the share price of a company compared to earnings per share.
SDE
Seller’s discretionary earnings. This adds owner compensation and bonuses to EBITDA. It’s a way to factor owner payouts into valuations and payouts.
SPA
If you sell your business via a stock or equity sale, you’ll sign a stock purchase agreement.
UCC filing
UCC refers to the Uniform Commercial Code. When a buyer assumes a seller’s debt, they must file a UCC statement with the state where your business is registered.
TYPES OF BUSINESS SALES
There are three main ways to structure the sale of a business.
ASSET SALE
With an asset sale, you buy the assets (and potentially the liabilities, though this is rare) of a business but don’t purchase the legal entity. This is common in sole proprietorships, where there is no legal entity, as well as LLCs and LLPs when there is a pass-through tax structure. It’s also common for businesses with significant tangible property, like equipment, vehicles, inventory and more. Of course, there are intangible assets to consider as well, such as intellectual property, software, client lists, licenses and leases.
INTEREST SALE
The buyer purchases ownership interest in the company. How much the buyer pays for this ownership stake depends on the value of the company, which is often determined by the underlying asset and liabilities., although there are multiple approaches to valuation. Buying 100% of the interest in a company usually means you own the full legal entity including assets and liabilities.
STOCK OR SHARE SALE
Like an interest sale, but in this instance, the buyer purchases stock or shares of the company instead of ownership interest. For a business sale to be a stock sale, the company must be structured to have shares. This approach is largely reserved for C corporations, and sometimes S corporations.
Which you choose will depend on the structure of your business, the type of business it is, tax considerations for buyer and seller, and more. For instance, C corporations are rarely sold as assets due to potential for double taxation. Buyers tend to prefer asset sales because it allows for a step-up tax basis for tangible property and tends to exclude liabilities; sellers tend to prefer interest or share sales as it’s usually a simpler process from a tax perspective.
TYPES OF BUSINESS VALUATIONS
There are numerous ways to value a business. In general, they are largely based on one of three things: earnings, market, or assets.
EARNINGS-BASED VALUATIONS
At the most basic level, these valuations are multiples of either revenue or profit.
Revenue multiples are common in high-growth industries and with tech-based businesses, such as software companies. These valuations are common when it’s difficult to run a more complex valuation model or when the company is small enough that it doesn’t warrant in-depth projections. The size of the multiple will likely value the consistency of revenue, the effectiveness of operations (margins), and growth potential, as well as market conditions.
Profit multiples are based on net income, usually EBITDA. In some instances, the buyer will also factor the seller’s income into these multiples. Profit multiples tend to make sense for older businesses with a history of profitability, but where deep analysis may not be warranted. Multiples will vary widely based on the size of the business (and the size of the profit) and many other factors.
Complex earnings-based valuations may also be used. There are numerous formulas that may be employed. Sometimes a seller will use one formula to set a price, and a buyer will use another to evaluate it. Common calculations include discounted cash flow (DCF), capitalization of earnings, and residual income (if you’re not doing a full sale).
MARKET-BASED VALUATIONS
As with most assets (like homes or stocks), supply and demand can influence the valuation of a business. Looking at how similar businesses have sold can help you assess the value of your business. Many of these metrics don’t consider fundamentals specific to your company, such as any debt or book value.
Industry multiples. Over time, trends emerge around the size of the revenue or profit multiples being used in a given sector or industry.
Public sector comparisons. Even if your company is private, you may be able to use publicly listed peers as a reference point for share price based on earnings.
Transaction comparison. Business brokers often have access to a list of recent business transactions, allowing you to see the price of businesses like yours.
ASSET-BASED VALUATIONS
You can use an asset-based valuation even if you are doing a stock or interest sale. This can be a good option for business with a lot of real (tangible) assets like inventory or equipment.
Book value. This takes total assets and uses standard accounting methods to calculate depreciation over time. From there, you subtract liabilities to get book value. This is the most conservative approach to valuing assets; oftentimes an asset maintains resale value even after it has depreciated to zero from an accounting perspective.
Net asset value. Starts with book value but adjusts asset prices to reflect market value before subtracting liabilities. Net asset value may also factor in intangible assets, such as client lists or intellectual property.
Liquidation value. For distressed businesses or dire financial situations, you may need to price your company based on a fire sale of assets less any outstanding debt. In planned sales, this may be used as a reference point.
SPECIALIZED VALUATIONS
Certain industries use specific valuations that don’t fit neatly into the previous three categories. For instance, venture capitalists often use potential exits to reverse engineer a present value. Private equity tends to favor the first Chicago method, as it factors in multiple outcomes when determining a price. Businesses that work in R&D or have a long product pipeline might use a real options approach, where the buyer might purchase the right to abandon the deal or the right to defer or expand if certain conditions are met, all of which would impact the total sale price.
WHO’S WHO DURING THE PROCESS
You’ll likely need to bring in a full team of specialized professionals to protect your interests throughout the sale process.
CPA
You’ll want to retain a certified public account to help prepare your books in advance of a sale. Make sure you start working with a CPA as soon as possible. You’ll need at least 2-3 years of clear and accurate records, and more data is often better in terms of valuing your business.
BUSINESS ATTORNEY
You’ll need a lawyer to handle the finer points of negotiation in the sale. If the business you’re selling is a partnership, you may want to hire a personal lawyer in addition to a lawyer for the business. However, in straightforward or single owner sales, a single attorney often represents both business and owner. For a large sale, you may want to look for an M&A attorney, which is a slightly more specific specialization.
BUSINESS BROKER
Like a mortgage or real estate broker, a business broker can help facilitate the sale process. They can help with determining a valuation (including which valuation message to use), provide comps on how previous businesses have sold, help you find a buyer, help you list the business if needed, and more. If you expect your business to be valued at more than $5 million, you may need to upgrade to an M&A advisor. For larger deals (often more than $100M) you may want to go one level higher and work with an investment banker.
COACHES OR CONSULTANTS
If you’re not ready to sell and want to prepare or better understand the market, you might be better served hiring a business coach or consultant, as many of the other professionals listed here will focus on the deal itself, not the prep work.
FINANCIAL ADVISOR
Financial advisors (also called wealth advisors and investment advisors) can help you handle the personal financial implications of a big money event. A good financial advisor can also coordinate between the various other professionals handling the sale, including your CPA and/or tax accountant, as well as a tax attorney. They can also work with brokers and bankers on coordinating the logistics. If you need to set up trusts or other financial instruments to help manage the tax implications, they may be able to coordinate trustee services and/or help manage assets within the trusts you create. Additionally, some of the professionals involved in the sale of your business may represent the company, or you and the company, or you and your partners. Financial advisors, depending on their certifications and registrations, are required to put your best interests first. In other words, you’ll have someone on your team looking out for you, specifically.
TAX ACCOUNTANT and/or TAX ATTORNEY
While the CPA might be focused on the business financials, a tax accountant can focus on the implication to your personal finances. If the tax implications are significant, you may also want to consult an estate or tax attorney who can help you minimize the tax implications of a sale using a trust, transfer, or similar.
Questions on how these terms and professionals might come into play in the sale of your business? Read the Quorun guide to selling your business next, or skip right to a consultation with a member of our team.
