Selling a business? 8 key steps for startup founders
When you’re running a business, especially in the fast-moving startup world, you should regularly think about whether to:
- Raise more funding to reach profitability
- Hold onto a profitable business and keep growing
- Sell your business and pivot into something else
Your answer will depend on many variables unique to you, your situation and your business.
If you decide to go ahead with option 3 and sell your startup, you’ll want to be as prepared as possible to extract the maximum value for your hard work.
Through our CFO work with founders and business owners, I know selling a business can be a very emotional process so it helps to have clear guidelines and choose experienced advisers. Here are 8 key questions to help steer you in the right direction.
1. Why are you selling?
Like all business decisions, it’s good to start with asking yourself “why”. Why are you selling your startup? Here are the main reasons we commonly see.
- You need to sell for financial reasons (known as a ‘distressed sale’).
- You’re emotionally spent. Your business might be profitable, or approaching it, but you don’t have the energy to keep driving it forward. In this case, you might want to sell your business outright or stay involved as part of a bigger company. This is unlikely to be a huge exit for you, but it might be the mix of immediate reward and ongoing involvement you’re looking for.
- You’ve been working towards this since founding your startup. You’ve built a highly profitable business fast, and now you (and your investors if you have them) are ready for a profitable exit.
Understanding why you want to sell your business will help you focus your energy on attracting the right type of buyers.
2. Why would someone buy your business?
You also need to be clear on why someone would want to buy your business. Often, it comes down to one or more of these things.
- They want your team – if this is the case, you need to make sure all your employment contracts are robustly in place.
- They want your tech – this means you need to own it as much as possible (rather than having parts of your product rely on licensed tech). If you need to build out more of your tech to ensure an unbroken chain of ownership, it’s often worth it because buyers tend to look at what they might have to fix/build themselves, and discount their offer accordingly.
- They want your website traffic – if this is the case, potential buyers will look at where your traffic comes from and any costs associated with it, such as advertising or partnership agreements that might need to be renegotiated beyond the business sale.
- They want your intellectual property (IP) – this is quite common with earlier stage startups but it’s not always about patents. Worldwide patents take years to achieve and can be notoriously difficult to defend. Often the IP that buyers want involves whatever patents you do have but more importantly, the shortcut that your dev work gives them to a profitable product.
Buying a business is a big deal (obviously!) so expect potential buyers to go deep in your business, looking behind every door to see what they’re actually buying, what it will cost them to continue and what they can use as leverage to negotiate a cheaper price.
In my experience, considering the due diligence involved at this early stage – before you approach potential buyers – leads to a much smoother sale process and ultimately, a better price for you.
3. Who are your potential buyers?
Now it’s time to consider who your potential buyers are and how to connect with them.
Depending on your answer to question 2 above, you might consider focusing on:
- Larger companies in your sector or industry that could see your business as a strategic purchase
- Private equity firms that could consider your business attractive for their portfolios
It’s also worth speaking to a broker or M&A adviser to connect with potential buyers. At this point though, you need to be ready for ‘go time’. That means having your financials and due diligence documentation in good shape in case they request it, and being ready to dedicate the hours of time it takes to negotiate a successful sale.
4. What type of sale are you aiming for?
Broadly speaking, there are two main types of business sales – assets and shares.
An asset sale means you/your investors retain shares in your company but sell its assets, such as your technology stack or intellectual property. An asset sale is usually simpler from a tax perspective because any sale profits go to existing company owners, who are still shareholders. However, when you/your investors do sell your shares, you won’t be able to access the ESIC capital gains tax concessions that might have otherwise been available (if your company previously qualified as an ESIC).
A share sale means you’re selling your business “warts and all” so the buyer takes on any outstanding tax issues, and team or investor disputes (not that you should aim to sell it with these as it can lower your sale price!). You will need to sign personal indemnities and warranties, which can make you liable for any unforeseen tax liabilities. On the plus side, if your company qualifies as an ESIC, your investors should be able to access attractive capital gains tax concessions.
5. What sort of valuation do you need?
A high one! Jokes aside, there are different business valuation methods and it’s worth having a general understanding of them. They include:
- Strategic value – a value that potential buyers will arrive at, based on the synergies they see between their business and yours in terms of tech, IP, team, website traffic or your customer base
- Net present value – assessing your cashflow (if you have any) over a 5 year period, taking into consideration the cost of capital and your growth rate, viewed against a risk–free asset (e.g. the value of a treasury bond)
- Price-to-earnings (PE) ratio – your current share price relative to earnings per share on a backward or forward-looking basis (you might also hear this called a ‘price multiple’ or ‘earnings multiple’)
Valuations are not set in stone and, startup valuations in particular, are not an exact science. It’s more about having a valuation range to confidently negotiate from. This is definitely an area to seek expert advice on because after all, it’s your future we’re talking about.
6. What if you need to raise funds while selling a business?
This can make things more complicated but it does happen. If you need to do this, it’s important to be transparent about it with potential investors and buyers.
In this situation, you might be best to use a convertible note as the investment instrument. This means if you sell your business at a higher valuation, the note converts to equity for your investors at that higher valuation.
Sometimes the founders are unsure of the valuation and structure of the deal as a safe note. Typically this means that investors get an advantage of a discount of around 20% on the next raise where the valuation must meet a hurdle before the next funding round.
On the other side of the equation, buyers might want to go with a sale price that involves a mix of cash and an ‘earn-out fee’, which you can achieve depending on how your business performs over a period of time, such as the next 12 months.
7. How and when do you tell your team?
It’s usually best to prepare your team early for a potential sale for many reasons, including that the buyer might want your team (and possibly you and any co-founders) to stay on.
If your team has shares or share options in your company, make sure they understand the potential upside for them and have time to set up their own trusts or make other financial decisions, should they want to.
It’s also important to understand that if your team has share options (instead of shares), it means they will automatically vest (convert to shares) when your company is sold. In theory, this means they can cash out and leave in the same way that they could if they’d held shares (instead of share options).
8. What are the main tax considerations?
As you’d expect, there are many tax considerations with a business sale. After all the hard work of developing a product and founding a business, you don’t want to lose too much of your profit in tax – at least no more than what’s absolutely necessary.
When working with your tax adviser on this (well before you sell up), they’ll talk you through:
- The option of setting up a family trust for more flexibility
- The rules around ESIC status, if your company qualifies for it, including the 3-year minimum requirement to access capital gains and other tax deductions
- The possibility of deferring capital gains tax by exchanging shares for scrip (aka new shares in the company you’ve sold)
Help is available
Selling a business is a big decision with the potential to have a big impact on your life. Having experienced advisers in your corner can make all the difference. We’re here to help at every step, from making sure your accounts are in order to prepare financial models and startup valuations, helping you find the right buyers and acting as your CFO in negotiations.
For now, if you simply want to talk through your options, we’re happy to do that too. You can find us here.
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