I don't remember exactly when it started, but I am sure the impetus was a period of unhappiness with my job. This turned into an annual tradition of me trying to sell the company I had built as a birthday present to myself. This year, I sold it.
Like running the company, selling the company has been an amazing learning opportunity. I am writing this post to share what you should be thinking about should you try and sell your company.
A few caveats here:
- My company was 100% bootstrapped, and I was the 100% owner
- My company was profitable
- My company was an LLC, as such I did not qualify for a QSBS credit
- Both the seller and purchaser are USA headquartered organizations
- The acquiring company was PE backed
- This isn't an exhaustive list, this is purely based on my one experience selling a company
The better of an understanding you have of your own business, the smoother the whole process will go. It's not enough to know the business, you need supporting evidence, and that evidence should be well organized. Doing so will save you time and money in the process. I would recommend that you start working on this at least 3-6 months before you plan to sell the company.
Financial docs will be pretty easy assuming you have been doing everything legit up till now. It may be worthwhile to run a formal audit on last year's finances to ensure everything is up to spec. Additionally, there are a few core concepts you should internalize early on. Understanding these concepts will help you decide whether now is the right time to sell your business.
You need to understand how buyers value your company. In our case, the company valuation was set using EBITDA. This is one item you want to understand at least one year in advance. From there, you can start to change how you operate and influence the valuation. The buyer is not dumb, if they see you gaming this, they may skip the deal. What you're doing is professionalizing your organization towards a specific metric. This isn't about you making more money on selling the company. This is about the organization operating in a way that aligns with the goals of the buyer.
There is a concept of a 409A valuation which others have told me is valuable to understand. I didn't use one so I have no real input to offer here.
This number is negotiable.
I read a number explanations of working capital. I am sure they make sense to those with an accounting or finance background, but I had a hard time internalizing the idea.
The way I understood working capital is to think of it as the financial ball and chain of why you don't shut down the business and walk away with your cash balance + accounts receivable. It is the part of cashflows where you have money people owe you, and money already paid out, and there is that middle amount that you can never pull out of the business? That's your working capital.
When you get acquired, the acquiring company will likely keep it. Working capital is measured on a monthly basis. If you start preparing long enough in advance, you should be working to reduce working capital going into the sale. Keep in mind that the method of calculating working capital is not fixed. If you're growing, the calculation may be your last month multiplied by some expected growth percentage. While if you're stagnant, it may be a multi month lookback. This is something you should understand and prepared to negotiate. This negotiation happened post letter of intent (LOI) for me, but you may want to do it beforehand depending on how much money is on the table.
This number is negotiable.
Cash free, debt free
This means that the company acquiring you wants to zero out the debts and cash in the company as part of the transaction. Sounds great right? Cash Balance + AR - AP + Acquisition price and you're home free! But no, you actually need to subtract out that working capital mentioned above. And depending on how your business operates, this can be a significant chunk. Make sure you understand your working capital numbers.
Holdback period + amount
As part of the transaction you will set a working capital target. The buyer will track to see how the company does against it for the following 90 days. Should you exceed the working capital target, the buyer doesn't want to add more money to fund the company. To offset this risk, the buyer hold some amount of the seller's money during that 90 day period to act as a buffer. This is the holdback amount and period. If working capital is less than the target, you get the holdback amount plus the amount under the working capital.
If you're going to be getting equity in the buyer, you may need to do an F reorg to reduce your up front tax burden. This is a simple process that your CPA can assist with. We had to do it last minute which was painful, so plan ahead. Your tax professional can tell you about the impact on your taxes.
Purchase Amount Breakdown
Make sure you understand what and how you're being paid, over what period of time, and with what gotchas.
For me, the amount was a mix of cash and equity. For exampe, check if the equity has a vesting period that requires you to stick around, or other provisions that can impact your final compensation. This is something that you should negotiate and analyze with the advice of both your lawyer, financial, and tax advisors.
This part of the process will be death by a million papercuts. You need to prepare yourself for this. My process was less painful because the buyer I picked was super flexible and so were their lawyers. Even with that, it still sucked. It could have sucked much less if someone had provided me with the following advice.
All work will happen via email. Microsoft Word documents and PDFs will be added to a "data room" which is a fancy way of saying Dropbox or one of their competitors. This means that if your data is organized in alignment with this expected method of communication, your life will be much easier. What does this mean in practice? Organize everything in an obvious folder hierarchy. My recommended one is as follows:
- Type of Document - Example: Customer Contract
- Year - Example: 2022
- Entity - Example: ACME Corp
- Number. Document - Example "1. ACME CORP MSA.pdf"
- Entity - Example: ACME Corp
- Year - Example: 2022
I would recommend taking the time to rename files to be super consistent and obvious in naming. When lawyers are asking you questions, you don't want to be trying to find whatever document you need at 2AM on a Sunday. One other tip here is that you will find that documents are missing. Let's say you forgot to sign an NDA with ACME Corp. Create a text document named "ACME Corp NDA - Not Found.txt" and put it in the place where you would otherwise have it. The numbered documents will also make it easier to reference in other places which you will need to do.
Which documents do you care about
All of them. It's unfortunate but it really is all documents. This is part of why I said you want to start doing this 3 to 6 months in advance. This timeline lets you get copies of documents that may be in counterparty hands, or that need to be mailed to you by a slow government agency. To help you, here is a non-exhaustive list of documents you will be asked to provide as part of due diligence and warranties and representations:
Giant List 😢 click to expand ->
- Certificate of Organization
- LLC Agreement
- Operating Agreement
- Equity interests
- IRS S-Election Confirmation
- State registration documents
- Any documents relating to company control
- List of all names the company has ever used and supporting docs
- List of any external consents that may be required for the transaction to proceed and supporting docs
- All documents relating to lines of credit and associated liens
- All permits, certificates, registrations, concessions, exemptions, etc issued by a government
- All documents provided by a government where you have been found in violation of any law or regulation
- All documents related to leases or rentals
- List of all tangible assets owned or leased
- All customer agreements, including NDAs, MSAs, SoWs, etc. If you have a SaaS with ToS and EULA and whatnot, get all the old versions of them as well
- Any agreement with non-compete, non-solicit, exclusivity, or any other kind of limiting factor (everything you ever signed)
- Any agreements or other contracts with any government entity
- Any agreement that includes an indemnification clause
- Any agreement with tax related provisions such as with a local municipality
- Any other agreements that somehow slipped through the above dragnet, and are also material to the success of the business
- All registered and unregistered intellectual property. This means all copyright, trademark, and patents, domain names, etc.
- All license, royalty, or other agreements which support your operations.
- List of all sources for content used in software you produce. Get ready for an SBOM and to justify that all your dependency licenses are compliant.
- List of everyone who has developed the software you have made and what each person worked on
- Copies of contractor and IP assignment agreements for anyone who worked on any of your code
- A list of all software in use by the company
- A list of all sub processors in use by the company
- A list of, and copies of all processes and procedures that you have in place for all business operations including, but not limited to handling of confidential data, trade secrets, data security, disaster recovery, business continuity, etc
- Documents relating to any data breach, and who was impacted and notified
- Documents supporting any kind of credit card processing and how you comply with the relevant regulations
- Copies of current and past privacy policies going back 3 years
- All policies around access, collection, storage, processing, or use of any kind of PII (assume everything is somehow PII), describe known deviations from policies
- List of all standards you comply with, especially around data security
- Documentation which shows what portions of your data are that of EU or California residents
- List all countries except for the US where data is stored, processed, or used
- List of any cyber security incidents you have had and supporting documentation of whatever happened and outcomes
- List of all marketing approaches used, and the channels utilized for them. If you use phone or SMS, prepare for more compliance related questions here
- Document data sources from which you get marketing contact information
- Policies related to data security, data privacy, information security, etc
- Trainings related to data security, data privacy, information security, etc
- All employment, retention, severance, separation agreements, offer letters, compensation plans, contractor agreements, etc going back to company founding
- All NDAs and non-compete agreements
- All vacation, sick, and PTO policies and balances
- Copies of all job descriptions
- All agreements with PEO orgs, staffing agencies, or other providers of contingent labor
- List of all US based team members who are not US citizens and provide their work authorization
- Copies of all policies, handbooks, documents, etc
- List all benefit plans (health, dental, vision, life, 401k etc) and supporting docs
- Any docs related to ERISA plans
- Any docs related to PPP loans, or other similar COVID assistance programs
- Historical background check results
- I9 forms and supporting docs going back 3 years
- Copies of all insurance policies and claims associated with them going back 5 years
- Feel like you have seen duplicates in this list? You will feel that a lot more in the process
You may want to sell the company yourself, or you may want to go through a broker. A broker will handle a lot more of the work for you. They will bring experience and provide an accounting and legal team to support you through the process. Based on my limited experience in this area, this will cost you ~15% of the gross deal price.
If you don't go with a broker, you will need to put the team together yourself. At the very least, this means one lawyer, and one CPA. Don't try and do the process with less than this. Not all lawyers are equal. If your buddy is a criminal defense attorney or a real estate lawyer, they're not the right person for the job. Find someone with M&A experience. Get specific information on how many transactions they have done in the last year, what the per transaction gross sale amount was, and what category of business was the company being sold in. If a lawyer knows medical M&A and you're a software startup, this won't be a good fit. I found that legal representation will cost in the ballpark of $10k-$100k depending on what they offer. It will also depend on how much prep work you're willing to do up front.
I would also recommend you get a therapist to talk to throughout this process. The best thing to find is other founders who have sold a company at roughly the same size and price. Their experience, emotional support, and references to representatives is very valuable.
If you have a broker, they will handle this part for you. You need to figure out who is going to buy your company. This is standard sales. You can reach out to others, or others can reach out to you. The more they are reaching out to you, the more your company will be worth. If you're large enough, you can get investment bankers involved. Get at least 3 potential buyers interested if you want to feel like you're getting a fair price.
Make a deck
Did you do the prep work I mentioned above? Great. Now you have an understanding of what your company looks like from a financial and legal perspective. Take that and create a pitch deck for selling the company. You may also want to make a more in depth prospectus.
Get an NDA and provide the appropriate data to the potential buyers. What is appropriate data? That's tough to answer and you will get differing opinions. You'll have to tell the buyer everything during due diligence, so don't cover anything up. My personal preference is to be open, and that seemed to buy me trust and good will from our buyers.
Letter of Intent
You're going to collect letters of intent (LOI) from your potential buyers. Once you accept one, you have to stop talking to everyone else until you either succeed in selling the company, or the no-shop period expires. You should aim to get them at the same time. It's like selling a house, buyers don't want you to hold an offer while you shop around. When I mentioned the three buyers earlier, that's the minimum, in practice you want more to ensure you can get many well timed offers.
Once you get an LOI, make sure it covers the following points:
- price: the amount and the structure (cash vs stock; merger or asset purchase)
- executive compensation post acquisition: especially equity revesting
- net-working capital: is the sale price cash-free/debt-free?
- no-shop period: once you accept the LOI, how long does the buyer have to complete due diligence and buy the company before you can go back on the market
Hell (Due Diligence + Representations and Warranties)
This could also be an easy process. It will depend on how much prep work you have done, how much you're paying others to do this work for you, and how strict or flexible your buyers want to be. I had done a poor job on prep work, and was doing most of the work myself. My process could have been much worse had our buyers not been gracious and understanding of my inexperience and the mistakes that came along. This is one of those moments in the process when I got additional confidence that I had picked the right buyer.
The buyer will ask you to sign a non-compete as part of the transaction. The main thing I want to call out here is that this non-compete will exist outside of an employment contract. This is an important distinction. Moving to a state like California which doesn't honor non-competes in employment contracts won't save you. Have a clear understanding of the duration of the non-compete, and exactly what activities it does and does not cover. I negotiated improved language in mine which allowed me to operate in a similar area of business that isn't directly competitive. I will most likely never need this, but it means my back isn't against the wall anymore if something were to go wrong.