So, you may want to sell your business.
Why not? Valuations are at an all-time high. It appears there will be a near-term tax increase that will reduce the ultimate proceeds you will pocket after the sale if you wait too long. Plus, many pest management professionals (PMPs) currently are challenged with labor and regulatory issues.
If you are young and in a good position to fight the good fight, there is no better industry than the pest control industry to build a business. However, if you are nearing retirement age, don’t have any family members who show an interest in the business, and have your sights set on retirement, it may be a good time to sell.
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What do you do before the sale? Preparation is key.
First, determine what your financial position will be post-sale, and how much money you will need annually to retire in the style in which you are accustomed. What is the amount of money you will need each year in retirement? Take stock. How much do you pay for food, shelter, entertainment, vacations, etc., annually? Let’s assume that amount is $200,000.
Second, determine what the valuation would need to look like in order to invest the proceeds and get the after-tax proceeds needed to achieve that $200,000 annually. If we assume a wealth advisor could make a guaranteed 5 percent per year — a very conservative number — we will need to place $4 million with that advisor (a 5 percent return each year on $4 million would yield $200,000, while leaving the $4 million principal intact).
If we need $4 million after tax, what do we need pretax? Assuming the proceeds will be considered capital gains under current law, the highest marginal capital gain rate is 20 percent (there is no 3.8 percent net investment tax if you actively ran the business). Depending on which state you live in, state taxes may exceed 10 percent — and potentially have you giving one-third of the proceeds away to taxes and fees. If you are lucky enough to live in a state with little or no personal income tax, you will end up paying less tax. But if we assume you will give away one-third to taxes and fees, then the sale price will need to be $6 million to net $4 million.
Third, speak to someone knowledgeable about the current market and the multiples being paid, and see if your firm is realistically worth the $6 million used in our example. In maximizing value, consider that the three most important factors in valuing a pest control business are growth, percentage of cash to ownership, and ratio of recurring to non-recurring revenues. You must know these numbers cold! Other intangibles include geography, reputation, assembled workforce and types of services performed.
WHAT TO EXPECT
So, you are actually going to sell. Let’s see how the process works:
Step 1: Confidentiality agreement/information request. There will be sensitive information a seller will need to provide to a buyer to conduct an assessment of value that leads to an offer. However, because both parties are providing sensitive information to the other, both parties need protection. That protection comes in the form of an executed confidentiality agreement between the seller and any potential buyers. The confidentiality agreement protects both the buyer and seller in the following ways:
- From a buyer’s perspective, it helps to avoid risk of competitors trying to steal the deal or driving up the price if it became known that the seller was selling the business.
- It allows the seller to open the books while ensuring the buyer won’t breach trust or use the information against the seller should a deal not be consummated.
- It ensures trade secrets and customer lists are protected and not stolen by the buyer.
Step 2: Letter of intent. Essentially, this is an offer to the seller from the buyer based on the facts given to the buyer. The offer isn’t just the purchase price, but also the terms of the deal, such as down payment, subsequent payments, legal representations and other important items. It allows the buyer and seller time to perform due diligence and work out the finer points of the deal. Usually, the seller will give the buyer a period of exclusivity where he won’t negotiate with anyone else while the finer points of the deal are worked out. The letter of intent:
- Allows the buyer and seller to agree on major points of the deal, such as price and structure of the proposed deal (stock or asset purchase transaction).
- Lays out certain representations and warranties the buyer and seller would require.
- Describes how certain items would be handled in terms of purchase price adjustments including customer attrition, customer prepaid deposits, un-serviced liabilities, working capital for private equity groups/funds (PEGs), etc.
- Defines the period of exclusivity for getting the deal done.
- Defines the period of due diligence.
Step 3: Due diligence. The period of due diligence starts with an information request from the buyer. This will include financial, operational, legal and insurance requests to determine the actual condition of the seller’s business. The buyer will want to examine information related to:
- Finances – Bank statements, tax returns, payroll, accounts receivable, etc.
- Operations – Routing software reports, customer contracts, production and sales information.
- Legal – Articles of incorporation or formation, licenses, employee non-compete agreements (make sure you have one with each of your employees), etc.
- Insurance – Copies of auto, general liability, workers’ compensation, and employment practices liability insurance policies, as well as loss runs for at least the prior three years.
Due diligence can be grueling without the right team of advisors. Use a team whose members are familiar with one another, or who has all the talent under one roof to avoid confusion.
Step 4: Purchase and sale contract. The buyer usually drafts the first copy of this legal document, which usually includes:
Either an asset purchase agreement or a stock purchase agreement.
- Non-compete agreements for ownership.
- Consulting agreement for any owners staying on board.
- Bill of sale.
- Assignment and assumption agreement.
- Office lease or assignment of lease.
It is important for the buyer to have a skilled mergers and acquisitions (M&A) attorney on their side, preferably one who understands pest control. The contract phase usually is the most contentious, as attorneys hash out unresolved issues and ultimately get to a conclusion. Many times, this is the most stressful aspect of the deal for the buyer, as the issues between the lawyers may be very high-level and sometimes more theoretical than practical. Nevertheless, it’s important to address the issues and resolve them head-on.
Step 5: Closing the deal. Once all issues have been worked out and everyone agrees, a deal is made. The signing of papers and the flow of funds is not very dramatic at all. In fact, all of it will be done remotely without anyone sitting around a table, as in a real estate deal. The lawyers circulate signature pages for the buyer and seller to sign. Once signed, both buyer and seller receive a pack by email with fully executed documents, and then the bank wires the money.
Step 6: Transition day. This is the day the employees are made aware there is a new owner. Usually there will be an all-hands-on meeting first thing in the morning. The seller may address the team and explain why he chose this buyer and how there is a great opportunity for those who continue with the buyer. The buyer then usually has a few team members to introduce the new company to the employees. Usually there is an onboarding process for each employee where pay plans, benefits and core values of the purchasing firm are explained.
Step 7: Mission accomplished. From the seller’s perspective, it’s time to enjoy the next phase of life!
The decision to sell a business that they have spent a career building is one of the biggest decisions most owners will make. It needs to be well thought out and planned; the worst time to decide to sell your business is when you are having a bad day. Consider exactly what you want, and whether you can get a deal that will allow you to enter your next phase in life in a manner that is right for you.
Currently, the market is at an all-time high, and most advisors can get higher-than-normal valuations as a rising tide lifts all ships. However, you should still follow the steps above for maximum value, minimum taxes and ultimately, the successful sale of your company.