“A diligent buyer will want up to five years’ worth of profit and loss statements, bank statements, tax returns, leases, supplier and vendor contracts, and customer data.” (Barbara Findlay Schenck – Author “Selling Your Business for Dummies”)
There are many reasons why a business owner may decide to sell a business built up with great effort over time: perhaps to start another business or pursue a different opportunity; maybe for health reasons, to relocate or retire; or as part of a succession plan or exit strategy.
For whichever reason you might be considering selling your business, ensuring the best outcome for all concerned – including realising the highest possible return for your investment in the business – will require careful planning and preparation to find the right buyer at the right price, as well as a great deal of paperwork, smart management of stakeholders ranging from employees and customers to suppliers and creditors, and exercising a legal duty of due care.
The reasons why a business owner might decide to sell their business are many – perhaps to pursue a new or more exciting business opportunity, relocation, health reasons or retirement. Selling a business to family, to the other partners, to a loyal employee or a group of employees could also be part of a succession plan; or the business owner’s exit strategy may involve selling to an outside buyer, perhaps a competitor, a supplier, or a customer, or even an investor.
Whatever the reason for selling, a smooth transition requires:
- Planning well and in advance,
- Determining a fair value for the business,
- Getting books, accounting records and financial reports in order,
- Collating the required paperwork,
- Managing stakeholder relations, and
- Exercising a legal duty of care.
The outcome of this approach is a business sale to the right buyer at the right price, with little to no disruption to business operations and no negative impact on staff morale or other stakeholder relationships.
Plan well and far ahead, and beware the tax implications
Planning well and ahead provides more control over the process, as well as time and opportunity to strategically enhance the business to ensure its full value is realised when you sell, and also ensures financial and tax implications are well understood.
As just one example, the disposal or deemed disposal of assets, including the sale of a business, will attract capital gains tax (CGT), levied at a stiff 18% for individuals.
Planning to Retire? Do you know about this CGT relief?
There is fortunately some CGT relief – little-known but very advantageous – if you are older than 55 (or in situations where the disposal is “in consequence of ill-health, other infirmity, superannuation or death”) of up to R1.8 million on the disposal of an interest in a small business; or of active business assets of a small business; or the sale of a small business. Of course, many conditions apply, including that the total active business assets of the taxpayer do not exceed R10 million and that the R1.8 million exclusion is cumulative over the taxpayer’s lifetime.
Such a single tax implication can make all the difference between a profitable sale and one that is not. For example, let’s say you bought shares in a company 7 years ago for R2 million, and have since been actively involved in running the business. You decide to sell your share for R4 million, triggering a capital gain of R2 million. At 18%, the CGT liability would be R360,000. If you are over 55 years of age and meet all the other conditions, applying the R1.8-million exclusion would mean only the remaining R200,000 is taxed at 18%, reducing the tax liability to R36,000.
Seek professional advice
Consult with your accountant to ensure that you understand all the potential financial and tax implications of selling your business and ensure that the necessary legal documents are in place, such as non-disclosure agreements for potential buyers and a legal sales agreement. Ask your accountant whether you should consider employing a business broker.
Finding fair value
As the seller, you want to ensure that you get the best possible return for the money, time and effort invested in your business. Similarly, all potential buyers want a business that is financially stable and profitable and that will deliver a good return on their investment.
To set a fair price, you will need to determine the value of the business, and the expertise of an accountant or a professional valuer is highly recommended. This is because there are different ways of valuing a company, as well as many factors – mostly intangible – that affect the valuation beyond simply the financial reports.
This means choosing the right method for valuing your business is important because it will influence the price you can ask for it. The three common methods used to evaluate a business are asset-based valuations (difference between assets and liabilities, also called the book value, net asset value or equity); market-based valuations (considers comparable sale prices for businesses sold in the industry); and income-based valuation (average profit year-on-year for at least the last three years), together with a profit forecast for three or more years ahead.
All of these valuations will be influenced by factors such as location, the condition and age of equipment and fittings, new competitors in the market, branding and goodwill, reputation and customer loyalty.
Get your financials in order
To determine a fair value for your company, you will need a comprehensive picture of the company’s financial situation. Potential buyers, too, will want to see full financial records.
- A minimum of 3 years – but preferably 5 years – of financial statements, audited where necessary
- Monthly management accounts covering the period since the most recent financials
- Profit and loss statements
- Balance sheets
- Tax returns and assessments
- Tax clearance certificate
- A complete detailed list of plant and machinery, furniture and fittings, and equipment
- Complete inventory if the company holds stock
- Three-year financial plan.
In addition to the above, prospective buyers will likely request records to assist them in conducting a due diligence, which is an investigation or review of factors that influence value or market price, some of which are listed below.
- Formal contracts with suppliers and clients
- Organisational charts and employee records
- Material agreements such as property lease agreements, credit agreements, and joint venture agreements
- Details of crucial advisors, such as accountants, attorneys and insurance brokers
- An up-to-date business plan, with growth projections, overheads and working capital
- Marketing and sales strategies, profit margins and sales targets
- SWOT analysis evaluating the business in the current market environment and identifying areas to increase the company’s value
- Statutory documents such as memorandum of incorporation (MOI), shareholder agreements and regulatory authorisations.
Selling a business can take months – if not years – and during this time, business owners should maintain ‘business as usual,’ while also making the business more attractive to potential buyers by establishing a clean and friendly working environment, keeping equipment well-maintained, and improving processes.
It will also be important to manage relationships with stakeholders when it becomes known that the company is up for sale. Employee morale may be impacted if they are fearful of losing their jobs or of a change in working conditions or status. Clients may feel uncertain about receiving the same level of service, while suppliers and creditors may be concerned that the business will continue to honour its commitments. It is advisable to be upfront and honest with everyone concerned before announcing the sale or engaging with prospective buyers.
Duty of care
Among the responsibilities of business owners is the duty of care – a legal duty to take reasonable care not to cause harm when it could be reasonably foreseen.
This duty is certainly relevant when selling a business and creates a legal responsibility or obligation not to omit any information, procedure or activity when it can cause harm to others or the business, including physical harm or financial ruin, and intangible damages such as reputational damage.
In line with this, if you are thinking of selling your business, you are well advised to enlist professional assistance from your accountant to ensure the best possible outcome for all concerned.
Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.