When it is time to exit, is it better to liquidate the business or sell it as an ongoing business enterprise?
In our 35+ years of advising the owners of thousands of different businesses, we have encountered situations where it is better for the entrepreneur to liquidate and situations where we have advised the business owner that it is better to try to sell the business as an ongoing entity. Below is a discussion of the pros and cons of each option.
Pros – A liquidation is straight forward, it can be executed rather quickly, and the owner can usually move on without any ongoing encumbrances. We may recommend a liquidation if the business is losing money, as it may be the quickest way to stop the bleeding. We may also recommend a liquidation if the business assets have appreciated to the point that the business income may not be able to support an appropriate rate of return on investment at the fair market value of the assets. A classic example is real estate that could be repurposed to generate higher income. For example, my father worked for a 100+ year old company in downtown Chicago. Originally located in an industrial neighborhood, over the years, the area developed into high rise office buildings. The family that owned the business and real estate decided to sell the real estate, but were at that stage in life where they did not want to go through the hassle of relocating the business, so they elected to liquidate the assets.
Cons – Usually, liquidation results in the lowest net value for the business owner, because there is no goodwill attributed to the business in liquidation. As a result, liquidation value is generally used as the floor when estimating a range of value for the business. There also may be costs associated with liquidation. Another consequence of a liquidation is the displacement of employees, as the business will cease to exist when the assets are sold. There may also be expenses related to an ongoing lease or unoccupied real estate if the property is owned by the business or a related entity.
Sale as an ongoing entity:
Pros – Assuming the business is profitable and has attractive characteristics, such as market share or a diversified customer base, buyers will generally pay a premium over the value of the assets. An ongoing operation usually means the employees will continue to be employed after the business is sold and that the customers can still obtain goods and services from the business.
Cons – The transaction may take longer than a liquidation in order to find the right buyer, negotiate a transaction, and obtain financing. Additionally, in the sale of an ongoing business, the former owner is usually expected to assist the buyer in a transition period of 30 to 180 days. (The typical transition period is 30 to 90 days, depending on the complexity of the business and the experience of the buyer.) Even though we are enjoying an attractive lending environment with an abundance of acquisition capital available at attractive rates, it is customary to have either a Seller note or an escrow of a portion of the purchase price to ensure that the business was sold as represented. Buyer and lender concerns include potential warranty work for transactions previously completed by the seller and unpaid taxes. The typical escrow amount is about 10% and lasts for 12 to 24 months, while a Seller note may be for 10% -15% of the sale price, and may run from three to seven years. In some cases, a Seller note can provide additional income (current interest rates on seller notes are about 6 – 6.5%) and may provide tax benefits to the Seller by deferring a portion of the sale proceeds.
The bottom line is that there are a number of factors for business owners to consider in order to 1) avoid leaving money on the table, and 2) achieve goals and objectives in the best way possible. The FBB team is available to assist you in providing options that will enable you not only to know the facts, but to make the decision that is best for you.