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Selling a business

05 April 2009

As a business coach and mentor in the Midlands and London, helping business owners and directors with their business, one core area of their exit strategy is about selling their business and what is the system of payments they can expect. Payments are invariably split into various ways to reflect the current and future position of the company with reference to its cash flow and profitability. The potential delicate nature of these situations are not always taken into consideration by all parties involved i.e. they want their money now and damn the consequences. This article explains some of the payment possibilities.

After reading this tip sheet, you will:

have a starting point for structuring the receipt of payments for a company sale
have good idea of the many types of payment schemes for which tax advice and planning is always required
realise that it is always important to have as much payment up front as a number of obstacles can suddenly appear when you a re no longer in charge of your company
need to get legal advice to draw up a contract even though you might have already agreed a Heads of Agreement

Selling a Business - Company Sale payment structure

Assumptions
1. Agreement has been reached on the profits in the present P&L and the value of the Fixed and Current Assets and the Liabilities in the Balance Sheet are as current as possible.
2. The board has signed off previous P&L’s and Balance Sheets.
3. There are no outstanding issues involving the above valuations.

Principle Steps
1. Create a Heads of Agreement from the various negotiations that have taken place. It could possibly be as simple as a few sheets of A4 with approximate values and specific dates.

2. These are then sent to the lawyers for them to turn a few pages into potentially hundreds, with the Heads of Agreement as one of the Appendixes. Please note that the more you have agreed between the various parties before going to the lawyers, the less you will pay them and the quicker the legal part will take. The process normally takes up to 2 months.
Note:

One hour of discussion between four directors on £50,000 salary each, costs about £150 per hour .
If both sets of lawyers are present to thrash out details this increases to at least £450 per hour.
If separate meetings are held and letters are exchanged the cost per hour increases to £550 per hour (the increase covers letter writing time) but the time scale increase to roughly two weeks for a simple point to be agreed and eight weeks for a difficult point.
Every time a letter goes back you have roughly another £550 per hour cost.

3. It is also very important to reach an agreement between the parties involved on a limit to the amount that you are willing to pay the lawyers for the legal part of the transaction. The lawyers will not like this at all, but it will save everyone thousands of pounds and speed up the transaction. Lawyers will only spend as much time as they can bill for.

4. Set a cut off date during the discussions with your accountants. This will depend upon the time to prepare a set of audited accounts, the financial year of the company and the tax position of the parties involved.

5. Agree dates and people responsible for when the various stages of the process are to be completed. An example could be as follows: -

Agreement to the FASOR, if required
Agreement to the accounts to date
Agreement to valuation of the assets
Agreement to valuation of the liabilities
Agreement to the price earnings ratio
Agreement to creation of the Future Sales and Profits spreadsheet
Agreement to the “what if” values on the spreadsheet

Payments at the time of signature
1. This is based on when the sale is signed and sealed, normally carried out simultaneously at each parties own solicitors offices, with an exchange of cheques.

2. The value on the cheque should at least match a % of the cash value of the liquid assets at that date i.e. cash in the bank, fixed assets, current assets less liabilities. This is because whoever is selling their shares no longer has control over those assets.

3. The values will be basically those that are in the company accounts, except that the value of the fixed assets may not be those that are used to calculate the “Now Payments, as the true market value may be less.

4. Assuming that a shareholder is selling their 30% shareholding and the agreed value of the Net Assets (Fixed assets + Current Assets – Liabilities) is £20,000, the cheque would have a value of £6,000.

Future payments for Goodwill and future Profits
1. Due to the difficulty in putting a value on “Goodwill” let us assume that to start with everyone has agreed that it means the following: -

Value of previous marketing campaigns – advertising, exhibitions, seminars, presentations, tele-marketing and direct mail
Value of brand name and products
Value of contacts – contacts known by company personnel within the sector prior to joining, contacts made during the course of operations,
Value of referrals

2. It is also agreed that the intrinsic value of the above points will lead directly to Sales and Profits, providing they are managed correctly.

3. Therefore all payments for “Goodwill” will be based on a % of future Profits gained from future Sales.

4. We will assume that it has also been agreed from the Market research carried out on listed companies on the Stock Market involved in software, that the sect oral average has a price to earnings ratio of three.

5. This figure of three years is used on the Spreadsheet calculation, which shows a total amount of Sales amounting to £3,000,000 over the next three years: -

1st year £700,000
2nd year £1,000,000
3rd year £1,300,000.

6. It has also been agreed that based on these figures that the estimated Gross Margin is X % based on the present Gross Margin and the Net Profit before Tax is calculated at Y % (say 4%) which means approximately £120,000.

7. This assumes that all production, marketing and administration costs increase pro-rata and if necessary a check process can be designed and implemented, so that an independently audited set of Sales and Costs are made available to the vendor.

8. It has also been agreed that the vendor shareholder share is therefore £36,000 and that a payment will be paid monthly over the next 12 months. So somehow the company needs to split up the £36,000.

9. The split can be as follows: -

straight amount of £3,000 per month over the 12 months
or as a test of the business, it could be based on the sales in 2003/2004 i.e. if sales were estimated to be £700,000 during this financial year, with a Gross Margin of 40%, that would give a value of £280,000. Therefore in order to reach £36,000, the payment would have to be 10.714% of the Gross Margin to give the estimate of £36,000. Please note that the only reason why the Gross Margin is used as the basis of the calculation is that it is a figure that is quick to obtain at the end of each month.

10. Each month a quick Gross Margin is calculated, multiplied by 10.714 % and a cheque sent to the vendor.

11. If the Sales are more then the vendor still gets 10.714% of the Gross Margin and the vendor gets more. If Sales dip then they still get 10.714% but the amount is less

12. If it the end of the 12 months the total Sales and Gross Margin is better than estimated due to the “Goodwill” (Marketing, etc) is better than anticipated, or the vendor helps get more Sales, or helps Management then they get more “Goodwill and Future Profit” money.

13. If the total is less, due to a variety of reasons then they will get less but overall this system tests the whole business process from Estimating right through to Net Profit.

14. It also allows the company to pay from future Sales and permits financial planning of the Cash Flow.

15. If the company is unable to stand the cash drain over 12 months then increase the time period, but it will mean that the vendor will still be linked to the company for longer, albeit at a distance.

Special Payments – Commission, Referral, Completion, Success
1. Additional commission payments could be considered for special assistance for the procurement of special sales contracts or for providing new products.

2. Similarly payment for referrals or sales leads could attract payments

3. A special one off completion or success payment for “good behaviour” could also be considered.