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The Price Isn’t Always Right: Think Before You Sell Your Business

Posted by BIMA knowledge-sharing Legal & Finance March 18, 2013
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There are plenty of reasons for selling your business. It may be that you want to catch the technological wave before it subsides; or you may need the capital to finance an even bigger and better idea than your current venture. But if the reason is that you just need the money, consider this first.

First, do your (real) sums

Work out what value you will be able to extract either by selling or by retaining the business in some form. You may come up with a surprising result. Say you have been offered £5m for your share of the business. On your initial calculations, this would pay off all your debt and give you a decent income or provide a lump sum to invest in a new venture, even after you had treated yourself to all the things that you were looking forward to buying once you had sold up.

Now think again: the problem is that you may be offered as little as 40% of the total sales proceeds in cash on day one and depending on how the deal is structured (will it involve loan notes?) you may have a tax liability based on the total sum to pay out of that initial sum. The rest of the earn-out will get paid only if you meet certain targets, if you behave properly for the next three or so years under your new owners and if your key team members stay together.

Ask people you know who have sold up already and hear what their experiences have been. These sort of earn-out deals only really work if the transaction creates real synergies that really drive up profits during the earn-out period. Suffice it to say that very few sellers have ever ended up with more than they thought they might take away. And that is particularly true you if find yourself up against your buyer’s lawyers who are really only interested in making sure that you end up with as little as possible.

Pick your team carefully

So have a look at the alternative. Without you realising, your advisers may well have put you on a fast-moving ‘sale travelator’. Get off. Assess your management team and decide whether to promote them or bring in the people whom you need to run the business in your place.

Whatever your strategy this will add immediate value; if you are not key to the business when you do eventually sell, you can skip away without having to work for 3 to 4 years in it as part of the earn-out. Your senior team will be the ones who have to sweat it out during the earn out.

When is a gain not a gain?

One of the key factors that Corporate Finance advisers use to persuade you to sell is that you can extract your share of the value of your business at a capital gains tax rate of 10% rather than paying an effective 50/45% income tax on dividends or salary payments.

But sell out and what will you do with the proceeds? Invest it wisely in the Bank at 3%? If so what rate of tax will you pay on that if it’s not 50/45%? Think about what will have happened to your money. If your stake is worth £5m then you will probably have lost 15% of it through the expense of extracting it (tax and transaction costs).

The balance will then be invested wisely in a bank and/or used to pay off debt which as a result will yield of around 3%. Left in your business it should yield at least 8-15% if only to compensate for the increased risk. The real question therefore is what that level of risk is and how risk averse are you? The facts speak for themselves.

An example in practice

£5m extracted from your business will yield £130k (£5m less sale costs of £150k, taxed at 10% with the balance invested at, say, 3%). However, left in your business it should yield £600k even at 12%.

Both incomes will be taxed at the same rate, so is the additional risk of leaving the capital in your business worth £370k pa? You tell me. And by the way, work out what life will be like without the company credit card, the company car and all the other benefits that owner-managers enjoy. They will all now have to come out of your 3% return.

Try also comparing the two sets of cash flows over a 5 year period that result from selling or not selling at £5m. Taking the above assumptions above what percentage of the earn-out you might end up with let’s look at a 4 year earn out that pays out 70% of what was promised.

Sell and it may look like this:

Year 1

£5,000
Initial 40% down payment 2,000
Transaction costs (100)
4 annual earn-out payments of £525k each, assuming a 70% payout 2,100
Total received 4,000
Net (taxable @ 10%) 3,600

Compare that to the continuing yield of not selling. With an income yield for four years of £600k at 55% net of tax, that makes £1.32m in total. Yes, you are £2.3m down at this point, but you will still have an annual income stream of £600k compared with the £130k we calculated above having sold, so you will be £470k pa better off.

Play the longer game

In less than 5 years’ time you will have caught up and guess what? You will still own the business. And, perish the thought, if you were to die at any point your shares would pass Inheritance-Tax-free to your beneficiaries, whereas all that cash would get hit with a 40% tax charge.

So what is the answer? It is never the case that you should or should not sell; there is not one golden rule. The point is that when confronted by such a significant decision, think about all the options and don’t be tempted solely by the lure of instant cash. The options might even include a management buyout, in whole or in part, but then that is another story…

Ever looked to sell your business and glad you didn’t?  Share your experiences below.

Christopher Jenkins is Senior Partner of Ecovis Wingrave Yeats, Business Advisers and Chartered Accountants. They were voted Best Medium-Sized Firm of the Year and he was voted Best Business Adviser of the Year by the CBI. Contact him at cjenkins@wingrave.co.uk or go to www.wingrave.co.uk

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