First lets understand what Goodwill is. In financial terms, Goodwill is the difference between the company value and the value of its tangible assets net of liabilities. You estimate the total company value and then you deduct the liabilities and the net book value of all tangible assets and the remaining (if any) is the value of Goodwill. In some circumstances the company value is less than its asset book value, so there is no goodwill value remaining.

While technically correct, this definition doesn’t seem very intuitive. How could goodwill have no value or even have a negative value? All this reputation over the years is certainly worth something. The problem is that it is worth something only if somebody is willing to pay something for it. If the seller is lucky enough to find that rare buyer who desperately needs this goodwill for whatever reason, they may get a lot of money for it.

However, when a business broker evaluates a company, they are looking for a fair market value of the business and certainly not a low probability price that sellers might get if they are so lucky that there is a unique buyer desperately in need to buy their business even at above market value. Fair market value is mostly based on the earning ability of the business not the book value of its assets.

In many circumstances, especially for Businesses with valuable tangible assets such as equipment, stock, receivables etc., the earning ability of the business hardly justifies a price higher than the book value of its assets. In these circumstances we can simply say that the buyer is not paying for any goodwill.

How can business owners maximise the value of their goodwill?

If owners increase or maintain their profits while reducing the value of their tangible assets, they can get a much higher value for their goodwill and could end-up with a much higher total proceeds from the sale of their businesses. Below are some concrete suggestions:

1. Modernise stock management and reduce stock to its minimum level while maintaining good customer relationships.
2. Increase machinery utilization and sell any unused/low utilization equipment.
3. Offer customer incentives to reduce payment terms and reduce the need for working capital.
4. Negotiate better terms with suppliers to increase accounts payable.

While I recognize that these suggestions are very difficult to implement in practice, owners can make some bold strategic choices that will make the above suggestions easier to implement. Choices include focusing on the 20% customers that produce 80% of the margins, limiting the number of SKU’s to a smaller more manageable number, standardizing products and/or services offered, increasing marketing and focusing it on the targeted profitable customers etc.

Buyers are concerned that the business is only profitable because of it’s current owner’s skills and attitudes. For example, the business is highly relying on continuous sales efforts and the owner is very talented in selling and deals directly with customers. In his new book “built To Sell“, John suggests a model that would make the sale o f business much easier.

John’s model urges business owners to focus their business exclusively on standardized services and/or services that are easy to teach to employees with no exceptional talents.  Customized project oriented companies are difficult to sell because product manufacturing or service delivery keep changing and need constant judgment that requires talent and hard-to-find skills. Such skills and talents are not necessarily teachable to a new buyer willing to take over the business.

Another suggestion made by John in his book is hiring a team of successful salespeople so that the business owner is exclusively focused on managing the business rather than constantly selling. While there is a large availability of business buyers who have good management skills learned through extended management experience with small businesses and large corporations, and from reputable business schools, sales skills are generally considered a talent and are more difficult to teach.  It’s much easier to find a qualified business buyer with management skills than with salesmanship talent.

Finally, John stresses the importance of finding a good business broker to manage the sale process to sell the business at a desired price and with a smooth transition. John insists that the broker needs to understand all the efforts made by the seller to prepare his/her business for the sale, which efforts should be rewarded by a higher price for the business.

This post provides some general information about the tax repercussions of selling a business but is not intended to replace professional advice from Lawyers, Accountants and Tax Experts. Business sellers should to seek competent professional advice concerning tax and liability matters when contemplating the sale of their companies.

From a tax perspective, a business owner shall first make a decision about the structure of the sale: Share sale vs. Asset sale:

Share Sale: The company is sold as a whole. The new shareholder becomes the Buyer who takes over the company including both its assets and liabilities. Therefore, all company debts are also transferred to the buyer. Other company stakeholders such as employees, customers, suppliers etc. are not affected since the company remains the same. There is only a change in share ownership.

• Tax implications: As a seller, you pay very little tax on the first $750,000 (as of today). This is a one lifetime tax exemption in Ontario, Canada. if other family members are also shareholders, they might also benefit from this exemption. Caution: Qualifications for this exemption are stringent.  Sellers should verify with their tax expert that they qualify.As a buyer, this option is not favorable from a tax perspective because the goodwill portion of the purchase price cannot be depreciated. Most buyers are very reluctant to purchase shares especially when the business is relatively small.
• Risk implications: The seller of shares sells also liabilities including possible employee liabilities and the buyer inherits these liabilities. From a buyer’s perspective, purchasing the shares could be very risky especially if the business has undisclosed liabilities. While most share purchase agreements will have a special clause stating that the seller should still remain liable for any undisclosed liability or any liability that is the result of an event occurring prior to the sale, it will be still the responsibility of the buyer to face the liability with the option to sue the seller if the seller does not pay for such a liability.

Asset Sale: in this structure, the company only sells its assets such as inventory, equipment, leaseholds, goodwill, name, customer contracts and relationships etc. The buyer creates their own legal entity and does not purchase the existing legal entity. The seller dissolves the existing entity after the sale.

• Tax implications: The seller in this case is not the owner directly but the corporation belonging to the owner is. The corporation will sell its assets and will pay a combination of capital gain and income tax. In Ontario, 50% of capital gains (if these gains qualify as capital gains) are not taxable. In this case, the sale structure will matter for seller. The part of the purchase price allocated to equipment, leaseholds and other tangible assets should not exceed their book value on the balance sheet at the time of closing to avoid any recapture, which would increase the portion of taxable income vs. capital gains. From a Buyer’s perspective, this is the most advantageous structure since the goodwill portion of the purchase price can be amortized over a period of time, which should reduce future taxes for the buyer.
• Risk implications: Since the buyer is only buying the assets, all the liabilities remain with the seller. It’s the seller’s responsibility to pay for all debts including any new liabilities related to the period before the sale that only appear after the sale. For example, the Buyer doesn’t have to worry about a tax audit that happens after the sale and that questions the seller’s accounting  practices prior to the sale (with some exceptions).

While most business sellers prefer to sell shares because of the huge tax advantage they receive from a share sale, most business buyers prefer to buy assets. In practical terms, most transactions for small or very small businesses happen as asset sale. As a business broker, I can still see some small transactions structured as share sale and more specifically in these two circumstances 1.When the seller accepts to finance a part of the translation (as a Vendor Take Back Loan), such a loan can guaranty any undisclosed liability that shall be paid for by the seller and 2. When the business has received a large number of offers and one of the buyers is willing to take the risk because they want the business and they trust the sellers.

Unfortunately, during the buyer-seller meeting, most sellers act just like a car salesman. They keep boasting that their business is flawless and is the best investment anyone can ever make. This looks obviously very suspicious to potential buyers. Confidence is lost and the probability of having a transaction as a result of such a meeting is almost nil.

I can understand that most successful business owners are involved in selling in most of their time. They are selling their ideas to employees, selling their products and services to customers, selling their potential to investors etc. As a result, they tend to assume that selling their business will be no much different from selling anything else.

Unfortunately, this approach simply doesn’t work with business buyers. Buyers are investing their hard earned lifetime savings in the business and they are as a result very cautious and extremely suspicious. The natural question they ask is “if your business is so good Mr. seller, then why are you selling it?” and, they expect the seller to be hiding some important unfavorable facts that would make the purchase of that business a very bad investment. When the seller keeps insisting that the business is perfect and that he/she is selling for strictly personal reasons, buyers simply don’t trust.

There are two real problems with this traditional selling approach. First, buyers expect the business to have problems. Nothing is perfect in life and yes if the business were perfect, the seller wouldn’t be selling it. So, the seller’s claim that the business is perfect is clearly a lie or at least an exaggeration. Second, most buyers want to buy a good business they can make great. If the business is already perfect, then the buyer has very little chance of improving it, which contradicts the very reason why the buyer is trying to buy it. Furthermore, by hiding the business’ imperfections, which could also be called opportunities for improvement, the broker end-up selecting the wrong buyer for the business. Even if the buyer trusts the seller and does put an offer, he/she will soon discover some of the imperfections during the due diligence period and will feel having being misled and will walk away. In the meantime a real buyer with some capabilities to correct the problems of that business has not been identified and has been lost. This is a lose-lose situation where the seller loses some real buyers and a lot of his/her credibility in the marketplace, the buyer loses a lot of time and money spent on accountants and lawyers and the broker wastes his time, the only asset in his possession.

Business sellers considering achieving results in their sale process should definitively abandon the traditional car salesman approach and become very upfront with  business buyers by telling them the good, the bad and the ugly about the business as early as possible in the sale process.

However, business prices like prices for any other asset are only a function of supply and demand at a given time. Factors that influence prices must influence supply, demand or both of them at the same time. When most sellers are waiting, prices tend to jump instantly because of a lack of supply. Demand also increases as investor sentiment improves. Spikes in prices tend to happen way before most sellers expect it. When sellers realize that prices have increased, they all tend to jump in the market instantly, driving prices down again. This is exactly what happened to the Canadian real estate market between May 2009 and April 2010. Prices increased dramatically at the very early stages of recovery and started declining as the recovery was confirmed. The business for sale market tends to follow a very similar pattern.

There are so many other reasons why business sellers who are ready to sell their businesses should act now and not wait for the market to improve. These are some of these reasons:

• The massive retirement of baby boomers who own businesses might increase the supply of businesses and decrease prices.
• The expected shortage of labor in the work marketplace might reduce potential buyers looking for job replacement, reducing demand and driving prices down.
• Sellers waiting for prices to increase might lose interest in their business, driving down performance and therefore business value, which could not be compensated by a price increase.
• Sellers with health issues might run short of energy and time to transfer the business to the buyer driving their business value to practically to zero.
• Business is like a perishable good, it could lose a lot of its value if its owner’s drive is not there anymore.
• Another recession might hit before the sellers even realizes it, which could make the sale of the business almost impossible.

There are so many other reasons why owners who are ready should sell and not wait for a wishful and unrealistic increase in prices. Aside from extremely unfavorable market conditions, the sale of a company should be made when the seller is ready not when the market is perceived to have peaked. Trying to time the market to sell for the best possible price is rarely a good idea when selling a business.

When practicing my profession as a business broker in the Greater Toronto Area, the most frequent question I am asked is “how much is the business worth?”. While most are not ready to pay for a formal business valuation, both business buyers and sellers are extremely interested to know the value of the business they are trying to sell and buy. While  business valuation articles I have written before are very general, this one is more specific and describes most commonly used valuation methodologies used in Toronto and surrounding areas in Ontario for the purpose of selling or buying a business. Below are some of  the most commonly used methods:

EBITDA Multiples:

This method is mostly used for valuing middle market companies (values higher than one million dollars). Accountants, Mergers and Acquisitions Intermediaries and Middle Market Business Brokers. it consists of computing EBITDA (Earning Before Tax, Depreciation and Amortization) and applying a multiple to arrive at the Enterprise Value. The enterprise value is then reduced by the amount of interest bearing debt to arrive at the value of equity. This value included equipment, goodwill, inventory, accounts receivable and the necessary cash to arrive at a historical average of working capital. The computed EBITDA has to be normalized before applying the multiple. The normalization process involved the non exhaustive list below :

1. Adjusting the seller’s and his  family members’ salary to market salary. Not working family salaries should be added back to EBITDA,
2. Adding depreciation and amortization
3. Subtracting the  capital investment costs for the following year necessary to maintain the sales at their current level.
4. Adding back to profits any one time, non recurring costs such as a large bad debt resulting from a large client bankruptcy.
5. Adding seller’s personal expenses and perks not necessary for the operation of the business such as meals and entertainment, if not necessary for the business, car allowance, personal insurance etc.
6. Adjusting rent to market price if the owners  owns also the real estate or rents at below market rent that cannot be transferred to the buyer.

The multiple of EBITDA used for valuation is determined  from comparable transactions in similar industries. this is the most challenging step since private company transaction information are generally not available to the public. Some business for sale websites offer incentives to business brokers to collect pricing information for closed transactions and offer large databases of transaction to business valuators for fee based subscriptions. These large databases are not always reliable since business transactions have so many terms other than price that are generally interrelated and influence price, and terminology used by these websites do not always have standard meanings to all business brokers.

Transactions in the Greater Toronto Area are not necessarily comparable to transactions in other US cities mostly because of the difference between Canada and the US in currency, risk, tax rates etc. EBITDA multiples in Toronto vary between 3 and 5 with 4 been an average especially in challenging economic times. These multiples can reach 7 in good times for established companies. High growth companies especially in the technology sector can reach much higher multiples, especially for a strategic buyer.

Seller Discretionary Earnings (SDE)

This method is mostly used for small businesses with less than one million dollars in value. This method is very similar to EBITDA with two main differences:

• The salary of the owner is added to SDE and the same normalization process is applied
• Inventory, Accounts receivable and cash are not included in the valuation.

Multiples of SDE are much lower than those of EBITDA. Generally between 1 and 3 in Toronto. Larger companies tend to sell for larger multiples. Multiples are lower for companies with problems, high risk or who require a large amount of inventory and accounts receivable.

Asset Based Valuation:

This method is generally used when the EBITDA or SDE methods cannot be used, especially when companies are unprofitable or when profits are very low compared to the value of assets. This method is generally the calculation of the net book value of the company. Most buyers acquiring a company based on the method are turnaround buyers with clear plans to make dramatic changes to the acquired companies to improve the bottom line.

While valuation is an important step before listing a business for sale, sellers should understand the the sale price will be the price a buyer is willing to pay irrespective of what a formal valuation is. A strategic seller for example can pay much more than the company valuation.

1. The price is right. Business buyers are looking for profitable businesses that are priced reasonably. A highly priced business will take a lot more time to sell and will sell generally for a lower price (not higher) than if it was priced right from the first time.
2. The general state of the economy: in prosperous times, buyers’ sentiment is positive and risk taking appetite is big. Businesses generally sell is much shorter times. An average time of 6 months is generally sufficient.
3. The seller’s emotional readiness: Sellers’ Remorse is one of the biggest deal killers in Canada. An unready seller that puts his/her business for sale in the market has a very hard time making a decision about an offer. They generally end-up frustrating the buyer, loosing the offer and even losing credibility in the marketplace. The seller would need the help of a very experienced business broker to get serious buyers back on the negotiating table and close a new deal in a reasonable time. This might take years.
4. Luck: sometimes the first potential buyer ends up being the right one. The business can sell in only a few weeks. The seller needs however to be alert and recognize that a reasonable offer from a first buyer could be a great opportunity that should not be missed. A large number of sellers interpret a quick offer from a first buyer as an indication that the business is low priced. This cannot be further from the truth, especially if the business has been professionally priced.
5. The business is “sexy”: some industries are simply more attractive to buyers.  This does not mean that they represent better opportunities. It simply means that they are trendy. For example, Import and distribution businesses are in big demand at this time and generally sell for higher multiples and in shorter time periods.
6. The seller is very honest with the broker and/or buyers about the good the bad and the ugly of his/her business. Brokers collect information from sellers and present them to potential buyers. When information is unclear or misleading, brokers loose faith in the seller and the business. Brokers will then take more time to understand the intricacies of the business and find the right buyer for it. On the other side, buyers ask many questions about the business. Most buyers will back off if information is conflicting.
7. Betting on the wrong buyer. Some sellers are so desperate to sell their businesses that they accept offers from non qualified buyers knowing in advance that these buyers will fail if they buy the business. This is a big mistake as these buyers at one time or another will discover that the business is not for them. All the time spent with these buyers is scarified, The business has been out of the market during that time. Worse, new buyers start wondering if there is anything wrong with the business. Why didn’t that buyer buy it?

These are some of the reasons that will influence the time it will take to sell a business. In the current state of the economy, it generally takes the average business seller between 6 months and 2 years to find the right buyer. Good Luck!

There are quite a few implications for business owners who have a good reason to sell their companies and need an exit in a reasonable time. The business owner needs to prepare his/her business quite in advance for an exit. These are some of the preparations that would dramatically increase the chances of selling the business at a reasonable price without having to spend years waiting for the perfect buyer:

• Seek professional advice from experienced business brokers, accountants and lawyers a few years before listing the business in order to prepare the business for the sale.
• Make your business more efficient buy reducing redundant costs.
• Sell unproductive equipment. This will not affect the value of the business but will certainly increase the total proceeds from the sale.
• Optimize your stock and sell any surplus before listing the business. Excess stock requires that the buyer invests more money for the same business without increasing profitability. It’s much easier to find a buyer for a business that has a smaller stock.
• Create documented processes and procedures for your business so that the less skilled employees can still be hired and manage the business. This will not only reduce the operating costs of the business but will make it easier to find a buyer with the right qualifications for the business. Buyers don’t like to depend on highly skilled employees and offer lower prices for employee dependent businesses.
• Hire an Internet capable business broker at the time of selling your business. The Internet became the first medium to reach business buyers. Furthermore, the Internet will bring buyers form large cities as well as new immigrant from other countries who don’t mind settling in a remote area if they can make a good living from the business.
• Finally, be patient. Selling a business located in a remote area will take time, so patience is a virtue.

While challenging, selling a business outside large cities in Ontario is not impossible  but needs discipline,  preparation and patience. The few guidelines we have provided will produce great results if followed diligently.

• Because of the larger amounts of money involved in the purchase of a middle market business, the number of potential buyers is generally much smaller. Middle market transactions generally require various types of financing and are as a result very dependent on lenders. The credit crunch that characterizes the current economic climate has dramatically reduced the sources of financing for middle market transactions and therefore reduced the number of transactions.
• Private equity groups investing in middle market businesses have now a serious advantage over individual purchasers because they have large amounts of equity to invest and generally do not need financing.
• Middle Market companies have a larger number of employees than smaller businesses and are consequently less dependent on their owners. This reduces the transition risks for potential buyers and as a result increases the business valuation. Middle market companies sell generally for larger multiples than smaller businesses.
• Middle market business buyers are very analytical and require detailed and accurate financial information before making a decision to purchase.
• Middle market transactions are also more complicated and require help from professionals such as business brokers, accountants, experienced business lawyers, tax experts etc.

Middle market business owners looking for an exit strategy should definitively seek professional help to assist them in their transactions. Potential buyers have to be screened for financial capacity, business experience and management capabilities. Sellers should hire professional appraisers to value their businesses before putting  them in the market. Sellers have to prepare their businesses for sale by improving their accounting practices and restructuring their businesses to make their businesses less dependent on them and more transferable to potential buyers.

When interviewing potential business sellers before listing their businesses for sale, I spend a lot of time and attention understanding their real motivation for selling their companies. A seller with fuzzy reasons will rarely have the patience to go through the whole process and complete a deal. Having a good reason for selling ,while necessary, is certainly not enough. The other key ingredient is the persistence. I occasionally run into sellers who get discouraged after the first unsuccessful attempt and abandon the whole idea of selling.

The rapid swings in sellers’ emotional state is one of the reasons reducing their persistence when trying to sell. Sellers generally identify with their businesses and tend to confuse buyers’ objections about the business with personal attacks against them that they have hard time handling. Sellers feel such a pain and unfairness that the whole idea of selling becomes insurmountable. A good business broker understands the emotional states of business sellers and warns them in advance about their emotions before listing the business. A prepared seller recognizes his/her emotional swings when they happen and deals with them accordingly.

I generally advise sellers not to rely too much on potential buyers’ preliminary excitement about the business. While the initial buyers’ excitement can be a real engine to push toward a deal it also could be an unrealistic dream that will never happen. In order to increase the likelihood of having a deal, the broker and/or seller should deal with as many buyers as possible and not rely on promises.

After a serious buyer makes an acceptable offer, the seller and broker need to make a tough decision. Is this buyer worth focusing on? Should we work with him/her on an exclusive basis? There is generally no sure answer to these questions. A decision needs to be made quickly. If the decision is yes, then the seller should put all his/her efforts to help the buyer with the due diligence.

It is frequent that the chosen buyer ends-up not being the right one. In this case the seller and broker must move-on and start the process again with no hard feelings!