Deals Closed in 2014 – Statistical Analysis

Approximately 50% deals took between four months to six months to close in 2014. See illustration below. Based on this distribution, on an average, a business will take 8.5 months to sell. The time required to sell a business depends on a number of factors including type of business and asking price for the business and type of buyer. Types of business include Manufacturing, Business services, Consumer goods & services, Health care & biotech, Wholesale & distribution and several others. There are two types of buyer’s strategic buyer and financial buyer. Understanding the buyer type is perhaps the single most important factor when it comes to engaging a buyer and negotiating a deal.

Time to sell Business

There are several reasons a business transaction may fall through. Top three reasons are valuation gap in pricing (29%), insufficient cash flow (22%), and lack of capital to finance (12%). Valuation gap is responsible for almost 30% deals not going through. Both the buyer and seller must complete valuation of the business independently and come up with a valuation range. If there is an overlap then zone of probable agreement (ZOPA) exists and there is a good chance the two parties will find a number during negotiations.

Insufficient cash-flow and lack of capital to finance is another major reason to deals do not go through. It is important to qualify buyers before negotiating a deal.

Reasons For Failing

Of the 30% deals that did not go through because of valuation gap, 65% of the deals had a gap between 10% and 30%. As expected the numbers deals failing for less than 10% gap is very low. When the numbers are so close the buyers and sellers should generally be able to agree on a number and come to a deal.

About 50% are strategic buyers and 50% are financial buyers. Financial buyers will not negotiate much as they have to stick to their financial models. Strategic buyers on the other hand have longer term view and may have synergies with existing assets. On a an average, 21% strategic buyers paid 0-10% more and 29% paid 11-20% more.

Valuation Gap Business Deals

For these reasons it is critical for sellers clearly understand the buyer persona. Financial buyers look for value and evaluate business financial statements in detail. They leave very little room for premium and remain close to the valuation price. They are driven by Return on Investment (ROI) and use large amounts of financing. A financial buyer may not hold the business for long. They may fix the business, improve the financial statements and sell the business.

Strategic buyers on the other hand tend to stay in the business for long periods of time. They may buy the business to enter into a new market, increase market share or foreclose a competitor from acquiring the business. In terms of duration, strategic deals are also done much faster. Strategic deals are preferred because they are done within six months, there are lower chances of valuation gap pricing issues and seller may walk away with a small premium between 10% and 30%.

 

Negotiating a Term Sheet

The term sheet is not a legal document. It is used to negotiate the broad parameters of an investment. The actual agreement is set in several other documents including the stock purchase agreement and investor rights agreement.

Term sheets are non-binding agreement between parties involved except for certain terms that include confidentiality and no-shop provision. Most deals that get negotiated using a term sheet are finalized. Term sheets have an exit date and agreements must be signed before the expiry date.

Term sheets can be for a debt offering or equity offering. Terms common to debt offering and equity offerings include pre-money valuation, amount to be invested, post-money valuation and cap-tables. Debt-offering terms include convertible offering, fixed or indeterminate conversion price, automatic or optional conversion, assets used for security and interest rate. Interest rates are not usually negotiated if it is in a reasonable range. Anything between 3% and 8% is considered reasonable.

Equity offering terms include shares (common or preferred), liquidation preference, conversion price and valuation, automatic conversion, anti-dilution, pre-emptive rights, protective provisions, voting rights and shareholder rights.

Additional common terms in a term sheet include full legal name, type of security (debenture, common shares, and preferred shares), size of round, price per security, number of closings, number of tranches and milestones, targeted closing date, use of proceeds and expiration date.

A term sheet can be for a note deal (debt) or for an equity deal. Usually it is cheaper and quicker to do a convertible note deal because there are a lot fewer terms to negotiate and draft as compared to an equity deal. Additionally, a convertible note term sheet kicks the valuation can down the road to when the note matures. For example, in case of a convertible note deal if the investor invests in 100 thousand when the deal matures (say after 1 year) the investor will get $106 thousand worth equity at the negotiated equity price.

The convertible note puts a stop in the valuation discussion and frees up the business to go and get work done. In effect the valuation discussion is pushed to a later point in time when the business is more established. Convertible notes are only useful if it includes terms that protect the investor from runaway valuation. For example, the investor may invest $100,000 in a business at an early stage, but then if the company gets an investment in millions of dollars the original investor is completely diluted. Suddenly the investor who took the biggest risk has the lowest percentage in the company and correctly compensated for the risk. Convertible debt makes sense only if the term sheet has terms to protect the original investor investing through convertible debt.

The most negotiated terms in a term sheet are valuation, type of security, board of directors, significant financing threshold, IPO threshold, drag along threshold, anti-dilution provisions, pay-to-play and management carve-out.

The term sheet is usually served up by the investor to the entrepreneur. However, in case of a seed round or party round it may fall up to the entrepreneur to create and serve up term sheet and serve it to the investor. Both investors and entrepreneurs should take the opportunity to get legal advice before signing a term sheet.

Ideally, all inside rounds of financing should be shopped around using term sheets. Doing so facilitates a market check that helps determine the correct valuation for the business, which is the correct outcome for everyone involved. That said a term sheet may include a no-shop provision.  During due-diligence investors should be mindful of this provision because can affect the valuation of the company long-term.

Exploding terms sheets are term sheets that must be signed in a very short time. Ideally, investors should avoid exploding term sheets because it does not give them sufficient time to complete due-diligence on the company.

Small and Medium Enterprises (SME) in India

In 2006 there were 26 million micro, small and medium businesses in India. 97% of these businesses do not show up in international statistics because they are unregistered or operate as sole proprietorships and partnerships. Only a very small percentage of businesses in India (> 3%) are incorporated. Over 98% are ‘Micro’ enterprises do not have employees and provide services to local markets with minimal investment. They use traditional techniques and do not have access to bank credit.

In India, businesses are classified as Micro, Small or Medium depending on the amount invested in plants & machinery (MSME). Within Manufacturing sector, micro businesses have  an investment  range of under USD $ 50 thousand. Small businesses have an investment range between USD $ 50 thousand and less than USD $ 1 million. Medium businesses have an investment range between USD $ 1 million and USD $ 2 million. SMEs form 95% of the total manufacturing and manufacture thousands of quality products that are used domestically and exported. As per estimates from SME Chamber of India, 21 Million SMEs in the manufacturing sector contribute 45% of the nation’s industrial output and 40% of the total exports.

Within the service sector, micro businesses have  an investment  range of under USD $ 20 thousand. Small businesses have an investment range between USD $ 20 thousand and less than USD $ 400 thousand. Medium businesses have an investment range between USD 400 thousand and USD $ 1 million. MSME employ ~ 60 million people and contribute ~ 20% to India’s GDP.

Internet Usage in India

India’s Internet base in 2013, was 150 million users representing about 10 percent of the country’s total population. Indians primarily use the internet is for communication including email and social media.  India has 110 million mobile internet users.

India’s eCommerce Market

India’s eCommerce market is USD $16 billion industry and is estimated to grow at a CAGR of 40% $18 billion by 2015 from $4.75 billion in 2011. The eCommerce market grew by 88 percent in 2013. Popular products sold in India include tech and fashion categories like iPads,  digital cameras and jewelry. 78 percent of shoppers prefer to shop on mobile phones for deals. Approximately 75 percent of online shoppers in India are 35 years old or younger.

Venture Capital and IPO in India

On an average less than 100 Indian companies get VC funding each year.  The average VC deal size in India is 20 crore (USD $4 million). The average pre-money valuation at 40 – 60 crore (USD $10 million). Very few businesses receive angel funding and government schemes for startups fund approximately 100 businesses every year.

Approximately 50 companies get listed (IPOs) on Indian stock exchanges. Most companies listed on exchanges (NSE and BSE) are quite illiquid. To stand a chance of an IPO on the NSE or BSE, a company must ideally have revenues of over 100 crore.

IT Services

Indian IT services is USD $52 billion and grew at 17% during the year 2011-2012. About USD $ 40 billion is from exports and the remaining USD $ 12 billion is from the domestic market.

Business Transfer

Business transaction starts with due diligence investigation and negotiation. Usually the prospective buyer makes a written offer (Letter of Intent) that sets the broad parameters of the negotiated deal. The negotiated deal must include consensus regarding price, payment structure, price allocation and all other details that comprise the final deal.

Once all the terms of the offer are accepted by both parties a Purchase-and-Sales agreement is drawn up. The agreement must be drawn up by an attorney who specializes in commercial law possibly with the assistance of an accountant and business broker. The details of the Purchase-and-Sales agreement must be based on the accepted offer. Banks (lenders) also need the agreement signed by both parties to analyze the deal and issue loans.

PURCHASE-AND-SALE AGREEMENT (P&S)

 The Purchase-and-Sale (P&S) agreement is a contract that shows the buyer has decided to acquire the business and the seller has decided to sell the business for a certain price within a certain period of time. This document covers everything negotiated and listed in the letter of intent (term sheet).

The P&S agreement is legal and binding once it is signed by both parties.  It is the conclusion of in-debt investigation and due-diligence by the buyer and seller. At this point the seller has determined the buyer has the financial and business capability to see through the transaction. The Purchase-and-Sale agreement can be several pages with exhibits and attachments that address all the necessary points to be covered. It is important for the buyer and seller to understand the elements covered in the agreement. Listed below are a few items covered in the P&S agreement.

Buyer, Seller and Business Names Names of the business buyer, business seller and the name and location of the business.
Asset Inclusion and Exclusion List of assets included with the sale of the business.  Assets include equipment, machinery, inventory, accounts receivable (AR), brand (business name), goodwill, real estate and so on. The P&S agreement shall also list all items that must be excluded from the agreement cash and real estate.
Price The total purchase price for the business. This section must breakdown the price into its component including down payment.
Closing Date (Time frame) Closing date for the business transaction. It can take 3 to 6 months to get a commercial loan, so the closing date must be a few weeks away.
Liabilities (Accounts Payable) The business seller usually retains responsibility for Accounts Payable (AP). All current business loans must be re-paid by the seller so that the new owner has clear titles on all assets. If the buyer takes on any expenses it should be reflected in the selling price.
Accounts Receivable  Accounts Receivable (AR) that is money owed to the business is also typically retained by the seller. In some cases the AR may be sold with the business by adjusting the selling price higher. If the AR is sold with the business the seller must provide a detailed list containing amounts, counter party details and expected dates.
Payment Terms This section includes the amount of cash that will be paid on the closing day, deferred payment scheme and seller financing details.
Inventory Contains list of all inventory items included in the sale. The inventory should be counted when the agreement is created and once again just before the deal closes.
Seller Agreements This section usually includes non-compete covenant, inspection reports (federal, state and local, environmental) and other actions required by the seller such as repairs and transfer of licenses.
Taxes Taxes due should be paid by the seller before the closing date.
Escrow Agreements Escrow Agreements are created only if there is an outstanding obligation where some work needs to be done by the seller after the closing date. In this case money is held in an escrow account and released when the obligations have been satisfied.
Seller’s Representations and Warranties This one of the important parts of the agreement. It is used to ensure the seller has provided correct business information through the due-diligence process.

Business Transition

The process of buying a business includes several activities. The business buyer must search for an appropriate business, analyze the business and financial data, develop a viable offer, close the sale and transition to the new business. The business transition step is critical because after the sale is finalized the original owner may not be available to answer questions.

The business seller should start grooming the business for sale several years before actually putting up. This period is crucial because it allows the business seller to organize the following documents:

  1. Prepare financial statements for three to five years.
  2. Corporate tax returns for three to five years.
  3. Inventory value and capital expense and equipment.
  4. Customer lists and list of employees.
  5. Documents related to leases and franchise agreements.
  6. Artifacts related to transitioning the business to the new owner.

Completing all artifacts for smooth transition significantly increases the chances of a business being sold as it reduces risk of owning a business for the new owner. Some common areas both buyers and sellers must discuss include:

  1. The business seller must be clear why he is putting up the business is for sale and document the reasons. The buyer must ask this question and the business seller must provide a detailed explanation.
  2. The buyer and seller must determine the value of the business and set an asking price range. The asking price breakdown must include asset value, interest expenses, business quality, business value and goodwill. Goodwill amount is the difference between the total value of assets and the selling price.
  3. The business seller must create a marketing plan that contains the type of business, the industry the business belongs to along with trends and projections for the industry. The marketing plan must include market share, growth potential, target market and other elements. The marketing plan must include competitive analysis and rank the competition.
  4. Location of the business and the history of the location. Both parties must be clear if the business can be re-located and / or merged with another business.
  5. The seller must create a customer list. The customer is the most valuable asset in a business, so it critical for the buyer to understand the customer profile and behavior. The Buyer must evaluate any customers who account for more than 10% of the business as losing this business can significantly impact profitability.
  6. Define all products, services and document their history if they have changed over time. The business seller must document how the products or services are priced and create a list of all suppliers.
  7. The seller must also document proprietary processes or trade secrets that must be transferred to the new owner.
  8. All operational tasks related to how products and services are produced from start to finish. Buyers must gain access to payment terms of suppliers, operating manuals and handbooks and any other information that can help them understand the day-to-day operation of the business.
  9. Job descriptions and pay rates of all employees. The new owner usually has the opportunity to re-hire existing employees and review their current and future responsibilities, wages and benefits.
  10. Buyer and seller financing. Buyer financing is the ability of a new buyer to raise sufficient money to buy the business. Seller financing is the seller’s willingness to finance part of the business. The discussion on financing must include liabilities. Usually all debts are paid by the seller unless there is a mutual written agreement stating the amount of debt the new owner will take on.

All the items above are important considerations to reduce the dependency on the current owner and simplify business transition. If the owner of the business agrees to assist with transition after the sale, the decision should be included in the purchase and sale agreement. The agreement must include specific tasks that the owner will perform during the transition period and the length of time for which he will perform the tasks.

 

Determine Reason for Selling a Business

Reasons For SellingIn addition to understanding the business buyer persona, It is also important to understand a business owners motivation to sell a business. Business owners put in a of time, sweat and equity into building a business. Therefore, selling a business is could be an emotional experience for the seller. Businesses are sold for several reasons and similar to understanding the buyer persona, understanding the reason behind the sale can go a long way with negotiations and structuring the business deal. Regardless of determining the business buyer type and reason to sell, business valuation is the most important element for setting the price. Business valuation is pivotal and both the business buyer and business seller must get the business values, preferably using an independent business valuation professional. Additionally, both parties must use multiple valuation techniques to determine the intrinsic value of a business. Now that we have emphasized the importance of business valuation, the following are the most important reasons businesses are sold:

Retirement

Many business owners are in the demographic that will soon be retiring. As per US and Canadian statistics agencies, more than 20% of the population will be over 65 by 2026. For Baby Boomers (people born between 1946 and 1964) business owners, selling their business is the most popular exit strategy to retire. As a business owner, there may be a glut of businesses coming to the market, which is good news for business buyers but may reduce valuation for business sellers.

Owner Fatigue

Business owner fatigue and burnout is the most common reason a business is sold. Additionally, business owners who have owned and operated their business for several years are also bored by the businesses operations. Restaurants, Coffee shops are examples of businesses that may be profitable with potential for growth but the business owner may be selling because of boredom.

Personal and Family Problems

Major changes in a business owner’s personal or family life can be an important reason to sell a business. For example, the business owners spouse or kids may be relocating. Divorce may be another reason to seek a business exit.

Divestment

Majority of a business owners wealth is tied up in one company. A business owner may sell a part or all of his company to diversify. A balanced portfolio is a critical risk mitigation strategy.

New Challenges

The business owner may have found other businesses to pursue that have higher growth rates or profitability.

Buyer Interest

The old adage “Everything is for sale at the right price” applies to businesses as well. A strategic buyer may be willing to pay a premium for a business to gain from synergies, eliminating competition, gaining market share or several other reasons. For the business owner it is an opportunity to capitalize their hard work for a premium.

Competitive Threats

The business may be struggling because of competitive threats. In many cases a business has been around for several years and has not innovated. In many cases business owners may exit the business, which creates a good opportunity for business buyers if they can turn the business around.

Market Timing

Business valuation is the most important criteria to determine the transaction price. Assuming costs are constant, valuation is directly proportional to revenue, earnings and cash flow – depending on the valuation technique used. When the economy is strong, businesses have the highest valuation and it is a good time to exit. The best time to sell a business is when a business has been up for three years and the best time buy a business is in the third year of an economic downturn.

Lack of vision

Perhaps the worst reason to sell a business if lack or vision. In many cases business owners go instant gratification and losing out on long-term growth from the business.

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Determine Business Buyer Persona

Business for SaleDo develop a negotiating strategy the business seller needs to understand the buyer of the business (Seller Due-Diligence). There are several types of business buyer personas where the buyer can be an individual or a business.

Financial Buyers – Financial buyers look for value, spruce up the business and then sell it. Financial buyers are looking for profitability or signs of profitability and stability that are right around the corner. Sometimes they are looking to merge a business with another to benefit from synergies (Synergistic Buyer) with another similar operation in the industry. Financial buyers analyze the businesses numbers in great detail and calculate the price using valuation metrics and comparable deals. They are most driven by proven return on investment (ROI) and tend to get large amounts of financing to purchase a company. In summary the objective of a financial buyer is to negotiate a deal where the deal can be paid of through operating profits, growth over time or immediate profits from some arbitrage.

PE groups raise capital raised through high net worth individuals, family trusts, pensions and others and are the most common type of financial buyers. Their objective is to maximize value for their investor pool.

Strategic buyers – Strategic Buyers look for buy and hold opportunities where they can enter new markets, increase the market share or foreclose some element of competition. Typically these buyers come from the industry (Industry Buyer) and understand the business and its marketplace. A strategic buyer may be a big company already operating in the industry and wants to acquire a business as a platform to enter a new market or to add new products and services to the marketing mix. Sometimes the purchase can be about getting people or management. Strategic buyers may pay more because they understand the value of the acquisition is more than the financial value of the business. The acquired business provides a new leverage. Strategic deals get done quicker and are usually preferred. Strategic business deals tend to be of larger sizes.

Special-Purpose buyers – There are many types of special-purpose buyers. They may be business buyers are private citizens doing private deals. The buyer may be a public company attempting to defend decreasing market share or defend market share from a competitor. In some cases these deals are emotional and the buyer just cannot stand by and watch a business being sold to someone else. For an emotional buyer, price is not the most critical factor in the sale.

In addition to the above classification, an individual buyer can be classified as:

Lifestyle Business – An individual buys a business that revolves around his / her hobbies, personal interest or social life. Sea sports, nigh-clubs, fashion shops, dancing schools are examples of life style businesses.

Owner / Manager – The business buyer wants to make a living and a profit from the business by operating the business.

Owner / Manager as required – The buyer is capable of running the business but does not want to manage the business personally on a day to day basis. Typically absentee owner businesses are non-cash businesses. Cash businesses like cafeterias and bars are very difficult to control without the owner.

Passive Investor – High net worth investors invest in businesses in the same way as they would have listed in shares, bonds and property. They usually hire professional management to run the business.

The business seller must identify the persona (or archetype) of the potential business buyer. Business buyers for main street businesses ($0 – $ 2MM) tend to be individuals who have experience in the sector or companies acquiring businesses for growth. Small main-street businesses with valuation of less than 500K are almost always individuals. First time buyers tend to buy smaller businesses that typically have a valuation of less than 500K.

Business buyers in the lower middle market ($2MM – $5MM) are dominated by strategic corporate buyers and private-equity groups. Private equity groups buy twice as many businesses as compared to strategic corporate buyers, so lower middle market businesses must target private equity groups. In the same vein, the best time to sell a lower middle market business is when private groups have raised a lot of money. As such, it helps to keep a watch on business cycles for private equity groups.

Why list a Business for Sale Online

Business OnlineBusiness for Sale listings used to be posted by business brokers and business owners in print media.  However, listing businesses for sale in print is rapidly declining for several reasons.

To start with space is limited and only a brief summary of business can be listed. If the user wants more information there is no mechanism for him to get it besides calling the business buyer. The print format is just not well suited for business for sale listings, which tends to be more complex and has several attributes attached to it. On BuySellBusinesses.com business sellers can list up 20 images, several videos and any number of documents. Additionally, business sellers can use deal-rooms, which allows business sellers to securely share documents with selected users only.

Print media tends to be expensive, slow with limited reach, so business brokers and business owners have to advertise in a publication for several months to get any attention. In that duration, changing the advertisement can be onerous and time consuming and because there is a physical media involved – expensive.

Online listings are confidential. Business for Sale listing on BuySellBusinesses.com can be set-up with varying levels of disclosure depending on the sellers requirement. The business seller cab decide what to include or exclude from the listing.

Finally, the most important reason print media does not work for business listings is because print readership is declining rapidly and readership not targeted. In the US, only 6% of time is spent on print media. Radio and TV, as an advertising medium, is just not suitable for business for sale listings.

MediaTime

Time Spent on Media

On the flip side, Internet and mobile account for 36% of time spent on Media. The Internet is the first place business buyer’s start the buying process and potential business buyers spend time researching and looking for businesses to buy on multiple sites. On an average, buyers can take between one to two years to complete the buying process and a large portion of the search is conducted online.

Internet traffic on http://www.buysellbusinesses.com/ is highly targeted because Google and Bing match keywords to Websites so that only relevant users are directed to the site. Dynamic nature of the Web allows business sellers to login to a site and de-list their business listing or change the content of their business listing at any time. Additionally, online sites allow business sellers to track and manage leads generated. When a potential business buyer asks for MORE information, the business seller receives the request and the lead instantly.

The ability to syndicate deals online and share business listings on social media is adding fire to the fuel for online business deals. Business deals can be syndicated through a trusted network, through email or through other business-for-sale sites.

Finally, the best part of listing online is the price. Online listings are cheaper than print media and http://www.buysellbusinesses.com/ and makes business listings even more inexpensive. Being mindful of these facts one can safely assume almost 100% business for sale listings will move online in the next few years.

Typical businesses listed online

Almost any business can be listed online, but given the semi-confidential nature of online listings it is best suited for main-street businesses (Businesses valued between $0 and $2 Million). Businesses commonly listed online include E-Commerce businesses, Health and fitness clubs, Websites, Convenience stores, Restaurants, Auto repair, Bars, Fast food franchises, Bakeries, Gas stations, Delis, Printing businesses, Pizza Delivery Businesses and several others.

Business for Sale Checklist

Gather Information for Business Valuation

Business brokers and sophisticated business buyers may use intrinsic valuation techniques for business valuation. They will project the free cash flow (FCF) from the business for the next few years and discount the cash flow projections to determine the intrinsic value. Additionally, business buyers will also try and estimate the value of a business by looking at values of similar businesses sold locally.

Selling a business is complex and the seller must take the time to plan and organize the exit. To assist with valuation and eventual sale, businesses need the following information.

  • Balance sheet, income statement and cash flow statement for 3 to 5 years
  • Corporate tax returns for 3 to 5 years
  • Value of inventory
  • List of capital expenses on fixtures and equipment
  • Customer and contact lists (Customer of Contact Management System)
  • List of employees
  • Copies of all leases, franchise agreements (if applicable)