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When you decide to sell your company, you enter a process that ranges from assessing its value to preparing for the final transaction. It is a path full of questions: How do I sell my company efficiently? What does the Due Diligence process entail and who carries it out? How is the real value of my business determined?
These questions, along with other considerations such as the possibility of selling a company with debts or losses, are crucial in this process. In addition, it is essential to understand the different business valuation methods and how to choose the most appropriate one for your business.
How to sell my company?
Selling your business is a significant step that requires careful preparation. One of the biggest challenges is determining a fair and competitive price for your business. However, there are several factors you should consider before starting this process:
Documentation
- Legal documentation: You will need to have company bylaws, shareholder agreements, leases, licenses, permits, and any other relevant legal documents.
- Property and Asset Registration: Maintain a detailed inventory of all assets, whether property, equipment or any other property belonging to the company.
- Financial and accounting statement: Prepare and update financial statements, such as balance sheets, income statements, and cash flow statements. In addition, future financial projections are essential to show growth potential.
- Contracts and commercial agreements: Review and organize all business contracts with customers, suppliers, and distributors. Don't forget employment contracts and non-compete agreements with key personnel.
- Employee Information: Provide details about your team, including organizational charts, job descriptions, contracts, and details about benefits or compensation.
- Tax history and tax compliance: Make sure you keep all tax records up to date, including tax returns and correspondence with tax authorities.
- Due Diligence: Be prepared for a potential thorough review by buyers, who may request additional documentation during their legal and financial audit process.
Preparing and organizing all of this documentation in advance will not only facilitate the selling process, but will also convey confidence and transparency to potential buyers, which can be crucial to closing a successful transaction.
Confidentiality Agreement
Before sharing your company's confidential information with potential buyers, it's essential to ensure that they sign a comprehensive confidentiality agreement. This document should clearly define what data is considered confidential, how it should be handled and protected, the period during which confidentiality must be maintained, the procedures for returning or destroying the information upon completion of the process, as well as the potential legal consequences for violating the agreement.
In addition, it is crucial to incorporate a non-compete clause to mitigate any risk that the buyer, should he or she withdraw from the negotiation, will use the acquired information to compete with your company. This precautionary measure not only protects the interests of your business, but also ensures the integrity and confidentiality of strategic information throughout the sales process.
Letter of intent
When the buyer decides to formalize his interest in acquiring the company, he usually issues a letter of intent. In this document, he details his purchase proposal with aspects such as the proposed price, the payment method, the defined deadlines and any other conditions he sees relevant to the transaction. This letter is a significant step in the negotiations, as it establishes the basis for the drafting of the purchase-sale contract.
Due diligence
The Letter of Intent usually sets a period of exclusivity, which generally ranges from 1 to 2 months. During this time, the buyer conducts its Due Diligence process, which includes legal, labor, tax and financial reviews of the company, as well as the valuation of the company and its assets.
During the Due Diligence phase, the buyer typically engages an external team of legal and financial experts to confirm the accuracy and completeness of the information provided to date. Following this review, it is common for the buyer and seller to renegotiate the terms set out in the Letter of Intent to incorporate any necessary changes or adjustments.
Contract of sale
Next, the negotiation of the purchase-sale contract begins. This document covers all the fundamental aspects of the transaction, such as the agreed price, payment methods and terms, withholdings to cover risks or contingencies identified during the Due Diligence and the company valuation, the business transition period, the seller's responsibilities and compensations, and non-competition clauses, among other elements. Given its complexity, this contract requires a detailed review to avoid possible gaps or ambiguities.
It is common that, in addition to the main contract, additional documents are signed, such as guarantee agreements to retain certain sums as protection against possible contingencies, after-sales service contracts with the seller or senior management, among others.
Shareholders' agreement
When the buyer is a private equity fund, it is common for the seller to retain a minority stake in the company for a set period. This tactic ensures the seller's continued involvement for a number of years, thus easing the transition to a new management team.
In this context, it is vital to safeguard the seller's interests through the negotiation and signing of a Shareholders' Agreement. This document regulates essential points, such as the need to have the seller's favorable vote for significant decisions, considering that it now acts as a minority shareholder.
Therefore, it is crucial to effectively negotiate all clauses and terms of the Shareholders' Agreement to ensure the seller's stability and protection in the company.
Writing of transmission of participants
According to Mexican law, the transfer of shares or interests in a company must be formalized through a public document, with the presence of a Notary during the signing of the purchase-sale contract.
Thus, in certain cases, the contract of sale is signed at the same time as the public deed, while in other cases a private contract is established first. Subsequently, the notarial formalization is carried out after a certain period. This situation may arise when the seller needs to make particular adjustments during that period, such as the sale of high-value assets such as luxury vehicles or real estate.
It is essential that at the time of formalizing the public deed of transfer, the seller's resignation as administrator is also recorded, to prevent potential legal complications in the future.
What is Due Diligence and how is it done?
Due Diligence is a process in which a team of experts conducts a detailed assessment or audit of the target company. Its purpose is to determine the soundness of the company and verify compliance with its obligations. To do so, several aspects are analyzed, such as the sector of activity, business prospects and the status of assets and liabilities.
During the Due Diligence process, two types of analysis are mainly carried out:
- Economic financial analysis: This analysis focuses on reviewing the company's financial statements and valuing its assets. It seeks to understand its economic and financial situation, identifying possible risks or areas for improvement.
- Legal Analysis: The legal aspects of the company are examined, reviewing contracts, commercial agreements and other relevant documents. Its tax and employment situation is also verified to identify possible contingencies or legal risks.
Additionally, the Due Diligence process follows a series of stages:
- Financial and Operational Analysis: Financial and operational processes are reviewed to identify risks, opportunities and areas for improvement.
- Transaction Structuring: The aim is to design a transaction structure that minimises risks and maximises the value of the transaction.
- Advice on Purchase and Sale: Strategic advice is provided for the purchase or sale of the company, evaluating options and associated risks.
- Strategic Solutions and Economic Valuation: Evaluations are carried out to increase the value of the company, considering financial and strategic aspects.
- Real Estate Due Diligence: Real estate transactions related to the company, such as lease agreements and property titles, are reviewed.
- Asset Management and Valuation: The company's assets are managed and valued, considering their useful life and other relevant aspects.
Conducting a thorough and detailed due diligence is essential to provide a complete overview of the company's status, allowing potential investors or buyers to make well-informed decisions.
Who performs a Due Diligence?
The Due Diligence process is carried out by a multidisciplinary team of specialized professionals and consultants. The main roles that are usually involved in a Due Diligence process are described below:
- Financial Consultants: They are responsible for analyzing the company's financial statements, assessing its financial health, and projecting possible future financial scenarios. Their goal is to identify financial risks and opportunities for improvement.
- Lawyers and Legal Advisors: They review the legal aspects of the company, including contracts, business agreements, licenses, and other legal documents. They seek to identify legal contingencies, regulatory compliance, and potential legal risks.
- Business or Strategic Consultants: They analyse the company's business model, its market position, growth prospects and market opportunities. Their aim is to assess the long-term viability and sustainability of the business.
- Human Resources Specialists: They review the organizational structure, employment contracts, human resources policies and organizational culture of the company. They seek to identify possible labor contingencies and aspects related to talent management.
- Internal or External Auditors: They may carry out specific reviews in areas such as accounting, internal control, and risk management. Their objective is to verify the accuracy and reliability of the financial and operational information provided.
- Real Estate Consultants: If the company has significant real estate assets, specialists may be involved to review lease agreements, property titles and other aspects related to real estate.
- Technology and Systems Experts: If the company has a strong dependence on technology, technology specialists may be involved to assess the technological infrastructure, information security and other related aspects.
The Due Diligence team is made up of professionals with different specialties who work together to comprehensively assess all relevant aspects of the target company. This multidisciplinary collaboration allows for a complete and detailed view of the company's status and the potential associated risks and opportunities.
How is the value of a company calculated?
Book Value:
- This method is based on a company's accounting records and calculates its value by subtracting its total liabilities from its total assets.
- Assets include things like cash, inventory, property, and equipment.
- Liabilities can be debts, accounts payable, or other financial obligations.
- However, book value does not always reflect the true market value of a company, as it does not consider intangible assets such as brand or reputation.
Adjusted Book Value:
- Similar to book value, but adjusted to reflect the market value of certain assets or liabilities.
- Adjustments may include revaluation of undervalued assets or overvalued liabilities to reflect their true value.
Liquidation Value:
- This method calculates the value of a company based on what would be obtained if all its assets were sold and all its liabilities were paid.
- It is a conservative value since it does not take into account business continuity or brand value.
Free Cash Flow to Firm (FCFF):
- FCFF is a measure of the amount of cash a company generates after covering all its operating and capital expenses, but before paying interest and taxes.
- It is an important measure of a company's ability to generate cash and finance operations, investments and debt.
Free Cash Flow to Equity (FCFE):
- FCFE is the cash left after the company has covered all its expenses, including capital expenditures and debt service.
- Represents the cash available to shareholders after all financial obligations.
Multiples:
- This method compares certain financial metrics of a company with those of comparable companies in the same industry or sector.
- Common multiples include price to sales, price to earnings, and book value.
Determining the value of a company involves using different Business Valuation Methods, chosen according to the specific case and purpose. A Professional Valuation Expert certified in Business Valuation is the one who decides which method is the most appropriate.
- Admission Rating: This method values a business by calculating the expenditure required to start a similar enterprise from scratch. For an accurate valuation, it is crucial to identify all initial costs, such as purchasing physical assets, hiring and training employees, establishing a clientele, and developing products or services.
- Discounted flows: The Discounted Cash Flows method values an asset based on the cash flows it is expected to generate in the future. This approach is based on two key factors: the estimation of future cash flows and the selection of an appropriate discount rate to bring those cash flows to their present value.
The discount rate helps us determine the present value of future cash flows, allowing us to understand how much the money that will be obtained later is worth today.
In this method, the company's revenues, expenses and other costs are projected over an anticipated period, usually five years, to calculate the annual Free Cash Flow (FCF). When reaching the last year of the projection, the FCF is considered perpetual, that is, as continuous cash flows indefinitely.
Free Cash Flow is calculated by subtracting capital expenditures from total cash flow. This indicator shows the financial performance of the company. Cash flows, on the other hand, show the difference between income and expenses in a given period, which indicates the company's liquidity or cash availability.
Example of valuation using discounted cash flows:
Laura is the head of a startup focused on producing healthy foods and is looking for funding to scale her business. She needs to raise $150,000 to open a new production facility and expand her product line. Laura expects to be able to pay back investors within 4 years with an expected return. Considering that the food sector is competitive and her company is relatively new, Laura decides to apply a discount rate of 18% to reflect the risk of the business.
When calculating the discounted cash flows over the next four years, the resulting value is $280,000. After subtracting the initial investment of $150,000, the net present value is $130,000. This indicates that Laura will not only be able to return the investment in the expected time frame but will also generate an additional return for investors. This solid analysis strengthens Laura's proposal to potential investors, demonstrating the financial health of her project and increasing the chances of obtaining the necessary financing to boost its growth.
- According to the income statement: This document provides details of a company's profits and losses, making it easier to estimate its theoretical value. Various methods are used for this assessment, including:
- PER (Price-Earnings Ratio): The P/E ratio is a key financial indicator that examines whether or not a company's stock is valued appropriately in relation to its earnings. It helps determine whether the stock price has changed significantly relative to the company's earnings.
- BAIT (Earnings Before Taxes and Fees):Also known as operating profit, the BAIT is a valuable tool to contrast the value of different companies. By excluding taxes and interest, it becomes an indicator of efficient capital management.
- Sales: This approach uses sales ratios to assess the value of a company.
- EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): The EBITDA ratio stands out for its ability to simplify business valuation, which is often complex. Experts such as Aswath Damodaran, a renowned valuation expert, advocate simplicity in business valuation. Following this idea, the EBITDA ratio, which is calculated by multiplying the annual EBITDA by an agreed factor, offers a clear solution to this challenge. Although it is considered a basic method, many use it as a reference because of its robustness and reliability.
This ratio reflects the value of a company based on its revenues, without taking into account its financial structure. By excluding interest, taxes and depreciation, it provides a clear view of the company's actual operating performance.
- Net Book Value (NBV): It is calculated by subtracting trade liabilities, which include outstanding debts and receivables, from the combined value of a company's tangible and intangible assets. For an accurate valuation of these assets, it is essential to update records regularly, taking into account factors such as inflation, depreciation and appreciation.
It is crucial to recognize that this valuation approach often results in a lower estimate for a company because it does not consider “goodwill.” This accounting concept refers to the discrepancy between a company’s market value (the amount buyers are willing to pay) and the value of its net assets (the difference between assets and liabilities).
Asset-based valuation may not be suitable for companies with a significant amount of intangible assets, as it may not adequately reflect the growth potential and future prospects of the business.
Valuation example using the Net Book Value method:
Carlos owns a small local bakery and wants to assess the financial position of his business to plan for growth and possible expansion. The bakery specializes in the production of artisan breads and custom pastries. He chooses to use the asset-based valuation method to get an accurate estimate.
Inside his bakery, Carlos has an industrial oven and a dough mixer as his main assets. The oven has an original value of $1200 and the dough mixer $800. The estimated useful life of both pieces of equipment is 5 years. Carlos estimates that the oven has been in use for 3 years and the dough mixer for 2 years.
Thus, the annual depreciation of the oven is $240 ($1200 / 5 = $240) and the annual depreciation of the mixer is $160 ($800 / 5 = $160). The adjusted value of the oven is $720 ($1200 – [$240 x 3] = $720) and that of the mixer is $480 ($800 – [$160 x 2] = $480).
In addition to this equipment, Carlos has an inventory of ingredients and materials valued at $600 and a cash fund of $400 intended exclusively for daily operations, adding up to total assets of $2200 ($720 + $480 + $600 + $400 = $2200).
Carlos's obligations include the annual cost of a management software license, which amounts to $200.
The net book value of Carlos’s bakery is $2000 ($2200 – $200 = $2000). This valuation provides Carlos with a clear perspective on the financial health of his business, facilitating strategic decision making for its future growth and success.
- Market value: It is obtained by multiplying the price of a share by the total number of shares available on the market. Typically, this value is greater than the company's net book value.
- Mixed Methods / Goodwill: Combined methods, often referred to as Goodwill, calculate “goodwill,” which represents a brand’s intangible assets in addition to its physical assets. These assets can include customer loyalty, the company’s reputation, public trust, and its competitive position. However, these approaches tend to be less popular due to the inherent subjectivity in their application.
- Market Capitalization (Market Cap): It is a measure that determines the value of a company based on the price of its shares and the total number of shares available on the market. The formula for its calculation varies according to the specific information of each company:
- Capitalization of profits: This method is an effective and quick way to estimate the value of a business and is used in DCF analysis to calculate perpetual earnings, which are the profits generated after the terminal period of the DCF analysis. Also called the Gordon Growth Model, this method assumes that the business will maintain constant growth and a stable cost of capital. In this method, the numerator, usually the free cash flow, is divided by the difference between the discount rate and the growth rate, expressed in terms of fractions, to obtain an estimate of the value:
It is essential to remember that not all assets and their value can be quantified using formulas, making it especially challenging to determine the value of intangible assets such as your company's reputation.
A company's valuation is the result of detailed analysis and should be central to your decision-making process when considering an investment.
Factors to consider when choosing a valuation method
When choosing a business valuation method, it is crucial to consider several factors to ensure that the selected approach is appropriate and provides an accurate and relevant valuation. Some of the most important factors to consider are:
- Type of business and sector: Not all valuation methods are suitable for all companies or sectors. For example, an income-based method might be more suitable for early-stage or fast-growing companies, while an asset-based approach might be more relevant for companies with a large amount of physical assets.
- Purpose of the assessment: Depending on the purpose of the valuation (sale of the company, investment, merger, etc.), certain methods may be more appropriate than others. For example, for a pre-sale valuation, the market multiples valuation method may be more relevant.
- Data availability: Some methods require specific data that may not be available or may be difficult to obtain. It is important to choose a method for which the necessary information is available.
- Complexity and time: Some methods, such as discounted cash flow (DCF), can be more complex and require more time and resources to calculate and analyse. It is important to consider the complexity and the time available to carry out the valuation.
- Business volatility: For companies with volatile revenues or earnings, a method that averages results over time, such as adjusted EBITDA or average market multiples, might provide a more realistic valuation.
- Long-term perspective: If the valuation is carried out with a long-term perspective, it is important to consider future growth potential and expected profitability, which could make methods such as DCF more appropriate.
- Market acceptance: It is important to consider what methods are commonly accepted and used in the financial market, especially if the valuation will be presented to investors, banks or other stakeholders.
- Associated risks: It is essential to consider the risks associated with the business and industry, as well as the appropriate discount rate to reflect these risks in the selected valuation method.
- Flexibility and adaptability: In some cases, it may be useful to use a mixed approach that combines several valuation methods to obtain a more complete and balanced view of the company's value.
Can I sell a company that has debts and/or losses?
The answer is yes, it is possible to sell a company that has debts or is recording losses, but there are several important aspects to consider:
- Company Value: The value of the company will be affected by debts and recorded losses. Potential buyers will likely discount these liabilities and risks when evaluating how much they are willing to pay for the company.
- Buyer Type: Depending on the type of buyer, debt and losses may be less of a problem. For example, a strategic investor who sees growth opportunities or synergies with your existing business might be willing to take on the debt and losses in exchange for other long-term benefits.
- Debt Negotiation: Before the sale, negotiations may be held with creditors to restructure the debt or establish more favorable terms. This can make the company more attractive to buyers and increase its sale value.
- Due Diligence: Buyers will conduct a thorough due diligence process to assess the company's financial situation, including its debts and losses. It is important to have all financial information in order and to be transparent during this process.
- Transaction Structure: The structure of the transaction can also influence the buyer's willingness to assume debt or losses. For example, an asset sale may allow the selling company to retain certain obligations or liabilities, while a stock sale transfers full ownership, including all debts and liabilities.
- Warranties and Protections: Purchase and sale agreements often include warranties and protections for the buyer regarding liabilities and losses. These warranties may include indemnification clauses, payment retentions, or earn-out agreements that link the purchase price to future financial results.
- Professional advice: It is advisable to seek the advice of professionals, such as lawyers and financial advisors, who specialize in mergers and acquisitions to navigate the process of selling a company with debts or losses.
While selling a debt-ridden or loss-making business presents additional challenges, it is possible to do so successfully if the situation is handled appropriately, the business is presented transparently to potential buyers, and the terms of the transaction are negotiated effectively.
How does ANEPSA help you sell your company?
By opting for the services of ANEPSA For the sale of your company, we offer comprehensive advice that goes beyond simply finding a buyer. We have a team of experts in mergers and acquisitions, supported by certified appraisers, who join a multidisciplinary group of professionals with extensive experience in the market.
With more than three decades of experience in the financial and business world, ANEPSA has the knowledge and skills to carry out a detailed analysis of your company, assessing its market potential, competitive position and growth prospects. We identify both the tangible and intangible assets that add value to your business and the areas that could benefit from optimization.
Our personalized approach focuses on understanding your needs and objectives, working closely with you to develop an effective sales strategy that maximizes the value of your company. We are committed to offering you a transparent, ethical and reliable service, ensuring that you are informed and satisfied at every stage of the sales process.
