Built a successful startup business that has just started to scale? Running an SME that has real growth potential? Thinking of starting a new project?
Is it time to sell…?
We previously wrote about what investors want to know about in the accounts and finances of a business before investing.
In this article, however, we look at four key questions that business owners should ask themselves when considering a sale of their business. Of course, every situation will be different – owners can have many reasons for selling. However, there are common considerations that will arise for owners in almost every sale!
First off – why might an owner even consider selling their business?
Reasons for selling a business
The circumstances around a business sale will be different for every owner, for every business, in every industry and for every sale transaction.
An owner may have spent time building a business from the ground up, has now brought it to the point where he or she is happy to move away, reap the financial rewards and maybe start something new. A desirable position to be in!
In contrast, a business may be in financial difficulty and the only way to secure its future and avoid the various financial risks is by selling to an interested party with available funds to keep the business alive.
In other cases, an owner may wish to sell just a part of the business (i.e. retain an element of ownership and control) and take on a new partner with strategic value and additional capabilities. Check out our recent article explaining how venture capital firms often act as strategic partners for startups and SMEs.
Whatever the reasons (and there will usually be more than one), the following 4 questions must be considered!
1. How much ownership and control will the owner give away?
Before selling their business, an owner must consider how much ownership and control they want to give away!
Ownership generally relates to the number or % of stocks (or shares) a person owns in a company. This is also commonly referred to as equity in a company.
Control will usually relate to the level of decision-making power a person holds within the business. Ownership and control are linked – the higher the % of stock owned, generally the higher number of stockholder voting rights and the greater level of representation on the board of directors (of course – every company structure can differ!).
If an owner is happy to sell all of the business, decisions around ownership and control can be straightforward – the owner will part with all level of ownership and control.
An owner may, however, wish to sell just part of their business and continue with a new partner. This will generally mean that ownership will be shared. The question that arise will then be: what proportion of ownership will be shared with the new investor? This, in turn, also asks the question: what degree of decision-making power they will have over the company?
Decisions around ownership and control can be straightforward or complex. This will usually depend on a combination of the existing owner’s preferences, requirements, desires and financial capabilities as well as the current status of the company, industry and other economic forces.
2. What is the valuation of the business?
When selling a business, a fundamental question, from the outset, will always be around the valuation of the business, or in other words – what is the business worth?
So what is “company valuation”? Valuation is the financial and analytical process of examining and determining the worth (present and future) of a business (or an asset) by reviewing a variety of internal and external factors concerning the business.
Much of the time, a key part of the valuation will depend on the financial status or prospects of the company. Check out our recent article on what investors really want to know about a company’s accounts and finances!
There are a number of valuation methods used by buyers and sellers within the market to decide on the value of a business. Below are just some of the common methods:
- Multiples Method
The Price-to-Earning Multiple is just one commonly used approach under the multiples method. It computes the company’s share price by reference to its earnings-per-share. The EBITDA Multiple is a different ratio which uses the “Enterprise Value” of a business in conjunction with its annual EBITDA (earnings before interest, taxes, depreciation, and amortization) as the basis of the computation. Effectively, the company’s cashflow is used as the key indicator to determine company value.
- Comparable Transactions Method
This method requires the parties to review comparable transactions involving similar business models in the same industry as the target company and then compare the financial ratios and multiples that are most relevant. The parties will compare the financial data of similar companies involved in similar deals and try to agree on a multiple that aligns with a potential valuation.
In practice, there are various business valuation methods available. In many sales transactions, a combination of business valuation methods will be used by both buyers and sellers to arrive at an agreed sale price.
As valuation is one of the most fundamental items of negotiation in almost every deal, it will be very difficult to get a deal agreed and completed if there is no agreement on the value of the business!
3. Is the company ready for a due diligence process?
Before investing in a new business, an investor will first want to examine the company to understand exactly what they are buying. This is the “Due Diligence” process and is akin to “looking under the hood” of the business.
Below is a list of some of the most common items that will be examined by a potential investor during the Due Diligence process:
- Finances – Usually, an investor will want to review all financial data of a company, sometimes as far back as 3 to 5 years of historic finances. They will also want to review bank statements, cashflow statements, historic and existing sales margins and much more!
- Legal Issues – This might include a review of all business licenses, contracts and agreements, company by-laws, regulations and compliance, corporate governance, SEC and BIR compliance, etc.
- Assets – Verifying intellectual property ownership, equipment and materials agreements, stock qualities, goodwill valuations, etc. For example, investors will want to know what exactly is in the existing loan book of a Financing or Lending Company.
- Property – Review the full terms and conditions of property usage, obtain and review property leases, inspection of all land and property boundaries, etc.
- Suppliers/Manufacturing Terms – Review current and historic contracts with suppliers, determine the storage sites of raw materials, investigate import / export activities and compliance.
- Liabilities – Review tax returns, explore bad debts or potential customer write-offs, examine existing and potential litigation against the company, identify areas where litigation may arise.
- Human Resources – Explore employee handbooks and policies, review compliance with DOLE and deductions and government contributions, review past employee disputes and identify future problems.
4. Share Sale or Asset Sale? What’s the difference?
When considering a sale of a business, there are a number of selling options available. For example, an owner can sell the entire business by selling all of the shares or sell part of the ownership by selling just some of the shares. An owner might also, however, sell just some of its business assets but hold onto the actual company itself and all the shares in that company and the remaining assets.
Here are just four key points for an owner to consider when exploring if an Asset Sale or a Share Sale is the right path for the business. Again, financial or external economic forces may have an impact on the decision!
|Key Consideration||Share Sale||Asset Sale|
|Assets/Liabilities||All assets and liabilities of the business remain with the company. A buyer will be purchasing shares in the company which includes the assets and liabilities relating to the company.||This enables a buyer to engage in a type of “cherrypicking” where they can select the assets (or liabilities) they wish to buy and leave behind the ones they don’t want.|
|Employees||When an investor buys shares (or all shares) in a company, the employees remain part of that company. From a legal perspective, nothing should really change for existing employees.||Depending on the employment laws in a particular country, employees may or may not have a legal right to transfer with a purchased asset. Employee transfers are a critical consideration in any asset sale.|
|Ownership||A buyer purchases the company and all of the assets, liabilities and anything else that is owned or owed by the company. Think of buying a house and also receiving all of the fixtures and fittings inside too!||The buyer will have no ownership or control in the company. The asset is bought and transferred to the buyer – nothing else. Think of buying a table and chairs from a household – the house remains entirely with the original household owners.|
|Taxation||Depending on the country, the sale of shares may be subject to capital gains tax. It will be a point of negotiation to agree which party shoulders the tax. Other taxes such as DST are also likely to apply!||Depending on the type of asset being sold and purchased, different taxes may apply. For example, property taxes may be applicable for property sales. Income tax may also apply on the sale of an asset. Other taxes such as DST are also likely to apply!|
CloudCfo – Online Accounting, Bookkeeping and Compliance Services in Metro Manila and the Philippines
Need support with a due diligence process for your business? Need your historic accounts examined and reconstructed to show a potential investor? Need financial advisory support such as debt restructuring, M&A assistance, forecasting or financial modelling?
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Contact our team directly at firstname.lastname@example.org or visit us at www.cloudcfo.ph for more information about our online accounting, bookkeeping and finance services in the Philippines!