Navigating the Sale: An 8-Step Guide for UK Startup Founders
In the thrilling world of startups, pivotal decisions are part of the journey. You may often find yourself evaluating your next big move – should you secure more funding to drive your business towards profitability, continue nurturing your already successful venture, or is it the right time to sell and pivot towards new opportunities?
Each pathway has its own set of challenges, and the best choice varies, heavily influenced by your individual experiences, your startup’s current position, and the unique hurdles you face. However, if your compass is pointing towards selling, it’s vital to be as prepared as possible, ensuring you reap the full rewards of 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?
First up, it’s crucial to pinpoint why you’re choosing to sell. Whether it’s a strategic move for financial gain, a desire to shift gears career-wise, or you believe the business has peaked under your guidance, identifying your rationale will influence every subsequent step from your valuation expectations to your post-sale plans.
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.
- It’s always been the plan. 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 involves selling the company’s assets, such as your technology stack or intellectual property, while you/your investors retain shares in the company itself. This approach is often simpler from a tax perspective, as any profits from the sale go to the existing company owners, who remain shareholders. However, an important consideration is that future share sales won’t benefit from certain tax reliefs that might have been available if your startup had qualified under schemes like EIS or SEIS during its early stages.
A share sale, on the other hand, means you’re selling your business in its entirety, often referred to as “warts and all.” The buyer assumes all outstanding obligations, potentially including tax liabilities, team or investor disputes, etc. While these factors can impact your sale price, one advantage of a share sale is the potential for investor tax reliefs. If your company is eligible under the EIS or SEIS, your investors could access attractive capital gains tax reliefs.
Understanding EIS and SEIS Benefits:
For UK startups, schemes like the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) play a crucial role in helping companies raise finance and grow. Let’s take a look at the two schemes:
- EIS encourages investment in small, higher-risk companies by offering tax reliefs to investors purchasing new shares. These reliefs can significantly reduce the risk profile of investments in eligible startups and growth-focused businesses.
- SEIS targets early-stage companies, offering even more generous tax reliefs to incentivise investment in these higher-risk ventures.
However, it’s important to note that there are specific conditions and criteria that your company must meet. A critical one is the holding period: investors must retain their shares for a minimum of three years under the SEIS rules. Violating this, or other criteria, triggers a ‘claw-back’ of the tax reliefs previously granted. This claw-back can have substantial implications, particularly when contemplating the sale of a business with SEIS or EIS investors on board. Additionally, the tax reliefs provided under EIS and SEIS can affect both the initial investment and the potential sale of the company’s shares, influencing investors’ financial outcomes. Why not take a read of our guide to the SEIS and EIS schemes to find out more?
Therefore, before proceeding with either an asset or share sale, consider how these mechanisms fit into your company’s financial landscape. It’s often wise to seek professional advice to navigate these options effectively and understand the implications for your business sale strategy.
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 Simple Agreement for Future Equity (SAFE) note or Advanced Subscription Agreement (ASA). 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 & 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, it’s crucial they comprehend the potential financial implications for them personally. Ensure they have sufficient time to assess their personal tax situations and seek professional financial advice, if they wish, to optimise their benefits and obligations in light of the sale.
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?
Navigating the various tax implications is crucial when selling a business in the UK. After pouring in effort, time, and resources to grow your startup, it’s essential to understand how you can efficiently manage your tax exposure during a sale. Engaging a tax adviser early in the process is wise, as it allows you to explore all available options and strategies.
When you engage with your tax adviser in preparation for selling your startup, they will guide you through several essential financial aspects. These discussions will be fundamental in shaping your decisions and should happen well before you finalise any sale. Key areas your adviser will likely discuss with you include:
- Business Asset Disposal Relief: Previously known as Entrepreneurs’ Relief, this mechanism might significantly reduce the Capital Gains Tax if you’re eligible, allowing you to keep more of the money you make from the sale.
- EIS/SEIS Status: If your business has benefitted from investments under the EIS or SEIS scheme, it’s crucial to understand how a sale impacts these statuses. The implications for both the business and its investors can be significant, and maintaining compliance is essential to preserve any tax reliefs received.
- Capital Gains Tax (CGT): You’ll need to explore your obligations under CGT, including potential reliefs and exemptions. In the context of a business sale, mechanisms like share exchanges, earn-outs or seller-financing can affect how and when CGT is applied.
- Personal Tax Planning: A sale can significantly impact your personal financial landscape. It’s important to plan how you’ll manage the proceeds, considering your long-term financial security, and understand the tax implications to maximise your net benefit.
Given the complexity of tax legislation and the potential for rules to change, it’s crucial to seek up-to-date, tailored advice from a tax professional who can consider all variables, including your personal circumstances and the evolving business landscape.
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.