Four Common Mistakes Business Owners Make When Transitioning a Business

September 2017

Man in Warehouse

If you’re a business owner, at some point you are likely to have to make a decision about the future of your business. You may want to retire or simply monetize your hard work and perhaps start a new venture. We have worked with many business owners over the years who are in this position, and we find that many are unprepared for what’s involved in a business sale. While every owner, business, and transition is unique, we have identified four common mistakes that business owners make, whether they are planning to sell their business or pass it on to family or to employees. 

Mistake #1: Not understanding after-tax cash flow needs for retirement

One of the biggest mistakes a business owner can make is to focus on the business’ sale price versus the timing of the sale and how losing the after-tax cash flow their business generated might impact their retirement picture and long-term standard of living. Ignoring after-tax cash flow can be especially problematic if you have historically paid yourself a handsome wage or significant dividends or distributions.

Before you start looking for a buyer for your business, we recommend working with a planner to identify your cash flow sources and how you spend it, your income tax liability, as well as potential risks to income sources both pre- and post-business sale. Such a detailed planning exercise can give you powerful insight as to when (or even whether) you should keep or sell your business. 

Mistake #2: Expecting an all-cash deal

Contrary to what many business owners may think, business transitions are not typically conducted as all-cash transactions. The majority of business transitions involve seller financing, earn-outs, and escrow/holdback arrangements—meaning that while you, as an owner, may receive some cash at closing, you may also receive a significant portion of the purchase price over time.

As a result, future payments may be at risk if the acquiring company faces a financial reversal or downturn. An after-tax cash flow analysis, such as the one discussed above, can help you to better negotiate the timing, amount, and security of contingent consideration in a deal. 

Mistake #3: Speaking with or seeking only one prospective buyer

You may have already been approached by prospective buyers for your company, be they competitors, strategic buyers, or private equity groups. While such offers may seem tempting, especially when you think about the fees involved in bringing in merger and acquisition specialists to help you more broadly market your business, we recommend against considering only one offer. In our experience, a single buyer rarely offers the highest purchase price or most advantageous terms to the seller, simply because the buyer doesn’t have to compete with other buyers for the business.

Instead, consider keeping all your transaction options open. If it’s appropriate for your company, you may want to think about pursuing a sale through a disciplined auction, through which multiple prospective bidders all review the same information at the same time. Such an approach may help increase the probability of finding the right cultural and strategic fit for the company at a purchase price and terms that may best meet your long-term transition (and retirement) planning goals and objectives.

Mistake #4: Lack of preparation

Finally, be prepared. Make sure that you’re not one of those business owners who fails to honestly assess your business’s readiness and attractiveness prior to going to market. Poor preparation lessens the chance that any deal you begin will successfully close, whereas good preparation can often result in improved company performance and potentially more favorable price and terms. It also gives you the gift of time, enabling you to resolve any business or legal issues that might otherwise have arisen during the actual sale process.

We find that a helpful step in this process can be deliberately “thinking like a buyer,” which entails appraising your company’s strategic positioning, weaknesses, and business risks across the competitive landscape, in much the same way that a prospective buyer would when evaluating an acquisition target. You also should consider conducting preliminary operational, financial, and cultural due diligence on your company, perhaps engaging a business consultant or transition advisor to provide an objective evaluation.

Conclusion

If you are considering selling your business, advanced planning and preparation may help you:

  1. Improve performance, leading to a more attractive sales price
  2. Minimize or resolve negative issues that may arise during due diligence
  3. Enhance the probability of a closing

While planning for business transitions can be complex, following a disciplined process can help you confidently plan and execute a successful business transition and maximize outcomes for all stakeholders. To learn more about strategies that could potentially enhance transition success, please consult with a Wells Fargo relationship manager.