6 Common Pitfalls Small Business Owners Must Avoid When Selling Their Business Entrepreneurs looking to sell their business face a myriad of pitfalls. This informal guide helps navigate these challenges and examines the double-edged sword of post-transition employment and non-compete agreements.
By Chad D. Cummings Edited by Kara McIntyre
Opinions expressed by Entrepreneur contributors are their own.
Selling a business is a monumental decision for any entrepreneur. After years of toiling to build your venture, it's essential to ensure that you receive the best possible return on your investment.
However, in the rush to close a deal, many entrepreneurs fall into traps that can jeopardize the sale or significantly reduce the value of their business. I've compiled a list of several common pitfalls that entrepreneurs must sidestep to ensure a successful sale.
Related: Selling Your Business? Do These 6 Things Right Now.
1. Inadequate preparation
One of the gravest financial faux pas an entrepreneur can commit is failing to prepare their business for sale. Preparation should begin at least 12 months before listing the business or entertaining solicited offers. This lengthy involves cleaning up the company's financial records, ensuring compliance with laws and regulations and optimizing operations to improve profitability. Engage an expert early to begin valuing your business appropriately and consult a legal advisor to understand the technical aspects of the sale.
Moreover, inadequate preparation can also mean missing out on identifying potential value drivers in your business. Value drivers are elements that could enhance the worth of your company in the eyes of potential buyers.
2. Neglecting due diligence
Due diligence is a critical aspect of any business sale, and neglecting this process can lead to severe consequences. Due diligence involves a comprehensive appraisal of your business by the prospective buyer. This typically includes the evaluation of financial statements, contracts, intellectual property, liabilities (including possible and existing litigation and other legal risks) and assets. Failing to disclose material information or attempting to hide liabilities can create legal issues and can cause the buyer to back out of the deal — or worse.
Due diligence is a two-way street: While the buyer is prospecting the seller, the reverse should also occur. It is essential to assess the potential buyer's financial capacity, background and intentions. Ask for references early if the prospective buyer is not already known to you. This will help in understanding whether the buyer is serious and capable of completing the transaction. Knowing who you're dealing with will save time and resources and ensure that you're handing over your business to someone who values its legacy and your earlier contributions.
Related: When Selecting a Buyer for Your Business, Don't Just Consider Price
3. Not engaging experienced advisors at the outset
Selling a business is a complex process and having experienced advisors on your side is integral to your success. I have worked with clients in the past who mistakenly conceived of the sale of their business as something as simple as buying a can of soda out of a vending machine. It is not.
Engaging experienced attorneys will help you navigate the legal complexities, while a certified public accountant (CPA) can ensure your financials and taxes are in order. Additionally, a business broker can sometimes help in finding the right buyer and exploring initial terms — although they are no substitute for experienced legal and financial advisors.
4. Over or under-valuing the business
Setting the right price for your business is crucial. Overvaluing the business can deter potential buyers while undervaluing it means leaving money on the table. To avoid this, obtain a business valuation from a professional. This will not only provide you with a realistic figure but also give you a stronger position during negotiations. This includes broaching the equity/cash split early in the game.
Sellers generally favor pure cash deals; however, buyers want to tilt the table in favor of equity, not only to minimize their initial cash outlay but also to link the sellers' compensation with the future success of the business post-closing.
5. Lack of a post-sale plan
Many entrepreneurs are so fixated on the sale that they neglect to consider what they will do after the transaction is complete. Will you retire, start another business or take up employment? How will the proceeds from the sale be invested to ensure financial security? Having a defined, articulated post-sale roadmap is essential for a smooth transition and to ensure that your financial future is secure.
Additionally, entrepreneurs must consider the emotional aspect of selling their business. For many, the business has been a significant part of their lives. There may be a sense of loss or identity crisis after the sale. Having a post-sale plan is not only about financial security but also about preparing mentally for the transition.
Related: How to Value a Business: 9 Ways to Calculate a Business's Worth
6. Understanding post-transition employment and non-compete agreements
An essential component often negotiated during the sale of a business is the role of post-transition employment and non-compete agreements. Smart sellers consider these topics in the first or second inning. I have seen more than one sale derailed by sellers' reluctance or inability to address these often contentious points early in the negotiations.
Post-transition employment agreements
Pros:
- Smooth transition: Staying on board as an employee, contractor or consultant can facilitate a smoother transition as you can help the new owner understand the intricacies of the business.
- Financial security: You can continue earning a steady income and possibly share in the profits or growth of the business after the sale.
Cons:
- Loss of control: As an employee of contractor, you will no longer have the final say in the decisions regarding the business.
- Potential conflict: There might be conflicts of interest between you and the new owner regarding the direction and management of the business.
Post-transition non-compete agreements
Pros:
- More attractive to buyers: Buyers are often more willing to proceed with the acquisition if they know that the seller will not become a direct or indirect competitor.
- Possible higher selling price: You might be able to negotiate a higher selling price in exchange for agreeing to a non-compete clause.
Cons:
- Limitation on future endeavors: A non-compete agreement can severely limit your ability to pursue similar business opportunities within a certain geographic area, business segment and time frame.
- Enforceability issues: Non-compete agreements are subject to state laws and, in some cases, are considered unenforceable if they are too restrictive.
The controversy surrounding non-compete agreements
There is an ongoing debate ensnaring the enforceability of non-compete agreements. Some states have taken steps to limit or ban these agreements, deeming them as restrictive to free trade and entrepreneurship.
Additionally, the federal Department of Labor generally and National Labor Relations General Counsel Jennifer Abruzzo specifically have been scrutinizing non-compete agreements more closely, and there is a growing push to implement federal legislation or regulation that would limit or even extinguish their scope and enforceability.
Related: 6 Proven Ways to Sell Your Business for 10x or More
Conclusion
As an entrepreneur, divesting your business is likely one of the most significant financial transactions you will ever undertake. Avoiding common pitfalls is essential to ensuring that the process goes smoothly and that you realize the full value of your enterprise. Engage experienced advisors, prepare your business for sale, conduct thorough due diligence, set the right price, have a post-sale plan and understand the implications of post-transition employment and non-compete agreements.
By undertaking these steps, you can help to avoid the myriad minefields that ensnare unwary entrepreneurs and ensure a successful and lucrative sale of your business. Remember, this isn't just about closing a deal — it's about closing a chapter in your life and starting a new one. Make sure it's a chapter you can be proud of.
Disclaimer: My thoughts expressed in this article are general in nature. They should not be construed as legal or tax advice, are not relevant or applicable to anyone's particular circumstance or fact pattern and should not be relied upon in the absence of formal advice from a qualified professional.
