Small Business Techniques

Improving Operations: The Low-Risk Path to Growing Profit

by Tom Gray | on Apr 23, 2014 |  Comments

Is your business a “fixer-upper?” Success depends on a solid foundation, whether you are building a house or building a business. You wouldn’t build another level on a crumbling foundation, and you shouldn’t try to grow a business with fundamental weaknesses. The foundation of the business is Operations – the way you use resources to add value to raw materials so that customers want to buy the output.

Thinking about The Business Growth Machine, this means you should work on the Cost Control levers before the Revenue Growth Levers.

Cost Control

Variable Cost

Fixed Cost

  •   Labor hours
  •   Labor wages
  •   Labor benefits
  •   Material amount
  •   Material cost
  •   Subcontractors
  •   Shipping
  •   Sales commission


  •  Rent%
  • nonproductive labor
  • Marketing
  • Office supplies/misc.
  • Your salary/benefits
  • Professional services*
  • IT systems
  • Interest
  • More!

*Professional services includes consultants, lawyer, accountant, other outside services

Cost control, along with quality, is how we measure operational success. Revenue Growth and Cost Control can both improve profits, but you have more control over improving your own operations than growing sales. You know your operations and your people, but growing sales depends the unknown – the decisions of potential customers you have not yet been able to attract.

Starting your growth efforts with improving operations makes sense for two reasons:

  • More control means less risk, so forecasted results are much more likely to actually happen with cost control than with revenue growth initiatives.
  • Revenue growth moves will have a higher payoff if they are based on excellent rather than weak operations.

For example, if 25% of the units produced by ABC Widget Company need “rework” to fix quality problems, adding more sales results in more rework. If ABC can reduce rework to 5%, its sales growth will result in much greater profit growth.

Finding Opportunities: What Needs Improvement?

How do you spot the signals showing opportunities for improvement? Every business has these signals, but owners usually overlook them as they focus on day to day tasks. You need a frame of reference to know what to look for, and an outside perspective to know what level of performance is good. A consultant can offer both, based on broad experience analyzing many types of companies. The next article suggests what to look for.

How to Improve Operations

The goal of operations is high quality production based on efficient use of materials, machinery, and labor. Production is the output. Materials, machinery, and labor are the inputs. Productivity – the end result of cost control – is the value of the outputs divided by the cost of the inputs.

How do you improve operations to achieve better productivity? You use a combination of people management and process improvement.

People Management

Earlier articles explained how to motivate and train your workforce. Employees must want to do the right thing, know how to do it, and know why the right methods work best. See Motivating People and  Employee Performance

A well-managed workforce is the key to efficient and predictable production, and it’s also the key to improving operations. Here’s why. The best managers invite motivated, well-trained employees to participate in finding better production methods. These employees know the details, the opportunities, and the potential pitfalls you’ll encounter in implementation. This opportunity to improve the design of their jobs strengthens their motivation even more, creating a virtuous circle – a spiral of continuous improvement.

Process Improvement Begins with Mapping a Business Process

A business process is the sequence of steps used to produce an output. Every business has several processes. Examples of “high level” processes include ordering supplies, producing widgets, quality control, billing and collection, hiring and training, and cash management. Most of these have sub-processes, such as accepting, stocking and counting inventory, delivering it to work stations, and the various production steps.

Improving a process is the fundamental route to improving operations quality, cost control, and productivity. Process improvement is the best technique for profit improvement because it produces more profit with every sale, and it’s under your control.

Process improvement generates more and more profit as the business grows because it controls variable costs, increasing the contribution or gross margin in both dollars and percentage of revenue. If fixed costs (overhead) stays the same, then this higher gross margin increases profit by the same amount.

To improve a process, you must understand how it works today. The tool is a process map — a special kind of flowchart. It’s a visual method for showing the process in steps, crossing departmental boundaries and linking it to preceding and following processes. The best process maps show more than the physical output. They also show how long each step takes, who does them, and the paper or digital record produced as well as the physical output.

Once you can see the process as it is today, you can also see how it might be changed. Your goal is substantial change, reducing cost or improving quality by as much as 50%. Following articles tell you what signals to look for, what questions to ask, and how to map and improve your processes, the surest way to grow profits.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business, certified as a Turnaround Professional (CTP), Business Development Advisor, and SCORE Mentor. He can be reached at 630-512-0406 or See For Tom’s new book Business Techniques for Growth: More Tools for Small Business Success, and its predecessor Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Successful Cold Calling Techniques

by Tom Gray | on Apr 16, 2014 |  Comments

Growth is the most fundamental challenge to a small business. Will you take the passive approach, relying on marketing, word-of-mouth, and a small customer base to generate incoming transactions? Or will you use marketing as only the base, and build on it with active selling to potential prospects?

Cold calling is part of the active approach, growing the client base and replacing the natural erosion of current customers. It’s a great opportunity to bypass propsects’ current suppliers, pre-empt competitors, and open up huge new possibilities.

The ingredients for a successful cold calling recipe are your attitude, prospect list, script, communications style, and follow-up. Without the right attitude, the rest of the ingredients don’t matter!


As always, start by understanding your goal. Fundamentally, you want to your business to survive and grow by finding new customers. Your goal in cold calling is to open a dialogue so you can find prospects where there is a fit between what they need and how you can help them. For those people, your goal is to continue the dialogue so they can make good decision. This might be an appointment, or just an agreement to keep in touch until they are ready to buy. Rather than focusing on your needs, let them guide you to the outcome that meets their needs best. Don’t try to make the sale in a phone call!

The dispiriting aspect of cold calling is rejection. Handle this by recognizing it in your goals, and reflecting on what works.

  • Set a schedule, such as one hour per day, and set a target, such as two appointments per session. If you reach the goal in less than one hour, stop calling and celebrate success!
  • Set the situation to fit your positive approach. Eliminate distractions and background activities. Stand up when calling. Focus on the needs of the prospect.
  • After each call, think about what you could have done differently to make it a success, or what techniques or words seemed to work best to open dialogue. Then adapt your approach for future calls.

Remember, you are looking for people who want your help, not trying to force your attentions on those who don’t.

Prospect List

Call people like those who are already your customers, e.g., same industry, circumstances, geography. If you already have some connection with them, they are more likely to listen. Do a little research on their industry, company, or circumstances before you call, so you can show your interest in solving their problems. If you decide to rent a list from a list broker, experiment with small segments to find the right kind of list.


A three or four line script makes it easier to call, but sounding like a script means you get treated like a robo-call – a quick disconnect. In the first 30 seconds, you are seeking permission to continue dialogue into a needs analysis.

  • Identify yourself and your firm in the first 5 seconds.
  • Express respect for the prospect’s time in the first 10 seconds.
  • Communicate a compelling and quantifiable customer benefit in the first 20 seconds. Defer details.
  • Ask for permission to continue the call in the first 30 seconds.

The second part of your script is a few questions designed to understand their needs and how they make decisions on meeting them. Listen to the responses! Your replies must position you as an expert advisor, not a seller. Your “close” is an arrangement to be involved and coordinate a solution for their needs.

Practice your script with someone. Anticipate objections, craft your response as part of your script, and practice natural and respectful delivery. The goal is to know your message well enough so you can concentrate on what the prospect is telling you, rather than being focused on your response.

Communications Style

Cold calling works when your communications focus on the customer needs, not your own. The image you want to project is the professional expert advisor. This table sums it up:

How sales people typically see cold calling How customers see cold calling done poorly What successful cold calling should be
fearfulboring,   repetitiveunpleasantpressurizedunimaginative







numbers game


tricky, shifty


reject, repel

shady, evasive

















Source: Cold Calling Techniques – tips, cold calling that works for sales introductions, telephone prospecting and other examples for cold calls in selling

With this approach, you will naturally end the call when the prospect offers three objections. End it with respect, and keep the door open to future contacts when the buyer feels a more imminent need.


When you cannot reach the prospect directly, don’t give up! If you reached their Voice Mail, leave a short message saying who you are and why you called, promise to call back on a certain date, and mention you would appreciate a callback. Then make that follow-up call as promised!

If you reach an assistant, ask if the prospect is in the office. If not, say you’ve been trying to reach him or her, and ask for a good time to call back. Make the gatekeeper your friend: treat them with respect, make a personal connection, and mention briefly why the prospect might want to talk (compelling and quantifiable benefit).

Cold calling is a tool for growth. Treat it positively, and do it regularly. After all, helping customers meet their needs is the reason you’re in business. Cold calling helps you stay that way!

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Finding the Tiebreaker to Close the Sale

by Tom Gray | on Apr 09, 2014 |  Comments

Sometimes your prospect just doesn’t care about your differentiation! How dare they? You’ve done your research and found the competitive edge to attract your target market, but some of those buyers just don’t need that feature. To them, you are just another supplier who can meet their general need, so now they are trying to decide how to choose.

You could cut your price, but then they will just go back and ask the competitors to match it. They may even fear choosing the lowest bidder, to avoid quality issues or later added charges for change orders.

In this B2B sale, the Purchasing Manager is looking for a reason to choose one supplier out of many who would be adequate. What can you do to give him that reason – that justifier for choosing your firm?

A three-year study of 46 companies points the way. See “Tiebreaker Selling: How Nonstrategic Suppliers Can Help Customers Solve Important Problems,” by James Anderson, James A. Narus, and Marc Wouters, Harvard Business Review, March 2014.

The answer lies in understanding the customer’s business well enough to offer something that enables them to do their job better. This creates a “visible win” for the Purchasing Manager – status for finding a way to improve his company’s results.

Real-World Examples

  • Right to cancel without penalty.
  • Changing the timing of payments.
  • Performing a customer function for them, such as pasting their inventory part numbers on the units before shipping.
  • Integrating your product or service with their other suppliers.
  • Performing preventive maintenance on your products while in use by the customer.
  • Creating a team to share some of your company’s expertise, such as packaging.

How to Find the Tiebreaker

To find their tiebreaker, salespeople need to make an extra effort to understand the customer’s business. Too often, this does not happen. The salesperson just sticks to the script of emphasizing product differentiation even when it does not matter to the buyer, and then reverts to cutting price. Instead, you need to take the time to listen, ask, and talk to the users.

Listen when the Purchasing Manager talks about what the company needs. But, most importantly, talk to the people who use the product.

Ask them (better yet, watch) how they use your product, what problems they encounter when using it, what are their objectives and priorities, what their customers need, and how your firm could be a better supplier to them.

Listen for quality problems you can solve, operating costs you can reduce for them, and objectives you can help them meet. Think in terms of “what if” we did this for you, or did that differently. Would that help you meet your goals?

The answer to these questions is your tiebreaker, the justifier for choosing your offer. Your goal is to make the sale with a 3-5% price premium over the lowest-priced competitor. This price will be within the Purchasing Manager’s acceptable range, and your tiebreaker makes him a hero to colleagues. Meanwhile, you avoided a price war!

You’ll want to concentrate on only a few industries, due to the time and effort needed to talk to users to understand the customer’s business. This enables you to re-use your findings and your tiebreaker with several customers in the same industry.

Competitors will eventually match your tiebreaker, so this is a never-ending process. But you’re in a lot better position if they are reacting to your success than if you are simply seen as no better than they are – a commodity continually subject to price pressure.

Your tiebreaker is a new differentiation, a new competitive edge, but it goes beyond the product itself. It’s based on how well your firm, not just your product, solves the customer’s problem.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Negotiating Tactics: Content and Style

by Tom Gray | on Apr 02, 2014 |  Comments

Once you understand the issue, the other party, and your own BATNA and threshold, you can move into Phase 2 of the negotiating process:

  • Phase 1: “Can’t we do better than this? How much better?”
  • Phase 2: “We’re supposed to meet with them next week. How should we play it?”
  • Phase 3: “Good morning! I’m glad we’re finally talking face to face about this issue.”

Think of Phase 2 as Content: what you will negotiate on and for. You’ll decide these before the negotiation starts.

Think of Phase 3 as Style: the way you behave during the discussion itself. Recognize that although you may plan such tactics, your behavior must adapt to conditions “on the fly.” As the boxer Mike Tyson says, “Everybody has a plan ‘til they get punched in the mouth!” That’s when you adapt!

Phase 2: Plan the Content of Your Negotiations

1. Do your best to make sure you are negotiating with the Decision-Maker. If not, after you make a compromise deal with the subordinate, you may end up making further concessions to satisfy their boss. Some bosses need to prove their worth by being “tougher” than their subordinate.

2. Design some win/win solutions, considering the interests (not positions) of both sides. Then you can plan to take positions where the compromises lead to these win/win outcomes. For you to win, the other side does not need to lose. The best outcomes satisfy both sides.

3. Plan “off-target” responses to expected proposals. Direct, adversarial responses do not move the process forward. They just force the other side to try harder to justify their position, making progress even more difficult. Instead, your response can suggest a changed basis, such as bundling commitments or orders, or revised timing. You veer away from the position the other party has staked out. You change the terms of the discussion, in search of an area of common interest: win/win.

4. Choose your crucial negotiating points, and be prepared to yield on others. When the other party says “no,” research shows they subconsciously feel an obligation to say “yes” later. This means that yielding on some points can help you win acceptance on other points. See “Defend Your Research,” Harvard Business Review, December 2013.

Phase 3: Style — Tips for Behavior in Discussions

1. Don’t bid against yourself! When you propose a price or position, wait until the other side makes a change or concession before changing your offer. If they say, “That’s too high,” do not come back with a lower price. Instead, explain why that price is reasonable, and suggest a change in their specifications that might open the door to a lower price.

2. Be careful about which side mentions their price first. Some say you should try to make the other side be first to mention a price, because that becomes the basis for negotiation, and it may be more favorable than what you would have offered. Others say you should be the first to state a price, because you want to set the basis for price negotiations! If you want to specify the basis for price discussions, then be the first.

3. Keep the tone light. Not only is it more pleasant, but your good-natured style shows you don’t need this deal, that you have other equally-attractive choices. The result could be a more accommodating person across the table.

4. Paraphrase what you heard them say or saw them feel, and invite correction. This avoids wasting time with misunderstandings, and builds goodwill by being a visibly interested listener.

5. Ask open-ended questions. “Why do you say that” is not open-ended, because it forces the other party to defend a statement or position. This makes it harder for them to back away from that position later. Instead, ask questions like “help me understand something better” or “tell me more about…”

6. Non-verbal cues can be a less adversarial way to get your message across.

- Silence creates discomfort. So the other party will often fill the silence by saying more, revealing more about their interest.

- Delay can make the other party anxious about unknown developments or overtures from your alternative suppliers. Their response is to become more flexible in what they’ll agree to.

- Other signals to make the other party doubt the strength of their position: arriving late, taking phone calls during the meeting, closing a portfolio, not taking notes, stepping out to discuss with colleagues, and any number of others.

This planning and behavior can get you where you want to go: an outcome that satisfies your interest. Your behavior need not be bombastic or cruel. Research enough to know the other party’s interest, develop win/win solutions to satisfy their interest as well as your own, and negotiate off-target by changing the basis of discussion without directly opposing the proposals of the other side.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Knowledge Is Power: Five Ways to Win Negotiations before They Start

by Tom Gray | on Mar 27, 2014 |  Comments

For a successful negotiator, the guiding motto is this: “If it’s worth doing, it’s worth planning.”  Winning negotiations is less about how you behave across the table, and more about research and preparation before you sit down.

The negotiation process begins long before the parties meet. It starts when one party decides it needs something from the other, or that it might get a better deal than the current arrangement.

The first two phases are complete even before the two parties sit down to talk:

  • Phase 1: “Can’t we do better than this? How much better?”
  • Phase 2: “We’re supposed to meet with them next week. How should we play it?”
  • Phase 3: “Good morning! I’m glad we’re finally talking face to face about this issue.”

This article is about Phase 1; the next article addresses Phases 2 and 3.

Winning negotiators depend on winning research. To choose their negotiating strategy, they seek answers in five areas.

1. Know the topic and the other negotiator.

Knowing the topic is not as simple as it sounds. You need to know the facts and context from four viewpoints: unbiased outsider; man-on-the-street (how the media would report it); the other party’s interpretation; your own perspective. Each viewpoint has different values and biases, supported by the value (non-neutral) words they choose to describe the situation.

Your knowledge should include assessments of the likelihood and risks of possible outcomes: “Will they really file that lawsuit? Could they win? What if they did?” Leave the rose-colored glasses at home! These assessments will guide the positions you plan to take, a Phase 2 activity.

Knowing the other negotiator is obviously important, but the information might be hard to find. Social media and industry contacts can be good starting points. You want to know their career history, their biases, what they value, positions they took in other negotiations vs. final outcomes, and the importance of this negotiation on their reputation in their company. You would also like to know what kind of negotiating style to expect, and the limits of their decision authority.

2. Know two other suppliers who could meet your needs.

The other negotiator may be more accommodating if they realize you have other options. You will let them know, but first be sure the alternatives can really meet your needs.

3. Decide your BATNA and your threshold: the lowest offer you would accept.

These are your boundaries. BATNA stands for Best Alternative to Negotiated Agreement. It means your course of action if these negotiations do not result in a deal meeting your minimum threshold. What will you do then? Negotiate with the other two potential suppliers? Change the design to avoid using this supplier?

Knowing your BATNA helps you measure the lowest acceptable offer, or “threshold.” The threshold will be a deal worth slightly more than the BATNA.  Having these two boundaries in mind, you can develop several better positions prior to taking your seat at the negotiating table.

4. Understand the other party’s real “interest;” it’s likely to be different than their “position.”

Their position is the set of terms/price they propose. Avoid limiting your thinking to merely modifying their package. Instead, research to understand what they really need: their interest. Do they need the corn, or only the cob? Rather than being stuck dealing with their difficult position, there are probably many ways to satisfy their interest and yours at the same time. Knowing their interest (and yours) lets your creativity find a win/win solution, so your win does not mean their loss.

5. Forecast the other negotiator’s BATNA and threshold.

“What else could they do?” Put aside your arrogance and belief in your own wonderful company, and try to think like the other party. How would they assess their alternatives? Who are their other two potential suppliers or customers? How does the other party think those two companies compare to yours? How much more would they pay to use yours?

Is the answer the same when you replace the value words in your analysis with neutral words? Using value words is how we fool ourselves! For example, change “legacy systems” to “proven systems”, or change “inconsistent” to “flexible.”

These five findings simplify and focus your planning. They set the minimums, and guide you to solutions the other party is likely to accept.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Selling, Then Staying

by Tom Gray | on Mar 19, 2014 |  Comments

Staying with the business – how can that be an exit strategy? Seems like a contradiction, doesn’t it? The answer depends on the terms of the deal.

It’s natural to want a gradual transition. Sellers want to protect the legacy of their life’s work: the brand and the relationships with customers, employees, suppliers, and industry colleagues. Sellers who are planning to retire may prefer to remain engaged part-time, smoothing their own transition to a new lifestyle. Buyers can benefit if the seller helps retain customers, employees, and suppliers.

But this natural desire for gradual change becomes turbocharged if the sale deal defers some of the purchase payment into future years. When the seller finances the buyer’s purchase, or agrees to make a portion of the purchase price contingent on the company’s results in future years (“earn-out”), the post-sale success of the business determines whether the seller will eventually receive full value for the business. Facing the risk of not being paid in full, sellers find ways to limit their risk and help the business succeed.

Frequency of Seller Financing and Earn-outs

How often does this happen? Most of the time! “Seller financing is involved in up to 90 percent of small business sales, and more than half of mid-size sales,” according to Options for Financing Your Business Sale | BizFilings Toolkit.

Seller loans amount to 1/3 to 2/3 of the purchase price, with a term of three to seven years (see Key Deal Terms: Seller Financing). Earn-outs are involved in 15% of deals, and generally involve payments over two to three years (see Key Deal Terms: Earn-out).

Pre-Closing Risk Protection

Sellers recognize that seller financing and earn-outs are essentially their investment in the buyer. To avoid unpleasant and costly surprises:

  • Sellers carefully research the buyer’s professional and personal life to decide which buyer they can trust.
  • Like any lender, sellers will require that the buyer provide a business plan prior to closing. They are looking for plans to support the growth and culture of the business: technology, markets, products, marketing, and employee relations. The business plan projections become milestones or loan covenants, triggering payments or remedies such as foreclosure.
  • Collateral for an owner loan is another risk-reducer, but if there is a bank loan as well, usually no collateral remains available to protect the seller.
  • Access to the company’s future accounting information is often part of the deal as well.

Post-Closing Risk Protection: Staying Involved

Not content with these “passive” pre-closing protections, sellers can negotiate an ongoing role in the business after the sale until the loan term or earn-out is completed.

In addition to a few days per week supporting relationships or pursuing new clients, sellers can gain the buyer’s commitment to continue to use the same accountant and authorize the seller’s access to financial inputs and reports. This helps the involved seller spot problem trends and offer solutions.

When the deal terms defer payment via seller financing or earn-out, the seller is motivated to help the business succeed. Staying involved is the best way to leverage a lifetime of knowledge and relationships to gain the full value of a business sold this way.

“It’s really a win-win because the seller can help the buyer retain clients, customers, and vendors,” says Andy Cagnetta, chief executive of Transworld Business Advisors LLC (quoted in Lisa Ward, “Stick Around After the Sale,” Wall Street Journal, February 3, 2014).

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see


Closing Conditions

by Tom Gray | on Mar 12, 2014 |  Comments

Most acquisitions do not close when the parties sign the Purchase Agreement. There is a time interval between signing and closing, often 90 days if regulatory approval does not require longer.

This interval enables the parties to complete some tasks to finalize the transaction, such as assignment of leases and buyer financing.  However, it also adds complexity because the business is operating and changing in the meantime. Changes may include receivables and payables (working capital), customer contracts, employees, and other possibilities such as litigation.

To manage such risks, when they sign the Purchase Agreement the parties also negotiate and agree to a group of commitments, deliverables, and assurances concerning their actions between signing and closing. Together these are called “closing conditions.” If these commitments are not satisfied by the responsible party by the closing date, the other party has the right to refuse to complete the transaction.

Promised Pre-Closing Behaviors (Covenants)

  • Seller will not create a competing company, hire employees from the business into another business, or solicit customers to move to another supplier (“non-compete” and “non-solicit”). This covenant usually lives on for a stated period after closing.
  • Seller will not seek or negotiate with other buyers (”no shop”).
  • Seller will get the buyer’s approval before taking actions that could materially change the value of the business, such as limiting normal capital investment, acquiring or divesting major assets, or signing major contracts with customers, employees, or suppliers. Buyer’s response will be timely and reasonable.
  • Seller may be required to take certain actions that would enable the buyer to take advantage of opportunities more quickly after the sale.
  • Neither party will announce the transaction or its details without the other party’s agreement unless required to do so by law or regulation.

Assurances about Condition of the Business at Closing (Reps and Warranties)

  • All reps and warranties agreed to at signing are true at closing, subject to materiality and knowledge qualifiers negotiated earlier, except as disclosed in updates to disclosure schedules. This “bring-down” condition is the most important closing condition, and will be covered in more detail later in this article.
  • All covenants governing behavior between signing and closing have been complied with.
  • No changes with material adverse effects on the business have occurred since signing.
  • No litigation has started which would restrain or prohibit the transaction.
  • Buyer guarantees to take certain post-closing actions, such as continuing employee benefit plans for a specified period, providing D&O insurance for the seller for a specified period, changing titles on assets, and cooperating on the post-closing working capital adjustment to be completed by a certain date. This latter item is the other highly-important closing condition, addressed later in this article.

Deliverables (Documents)

  • Stockholder and Board of Directors consents to the transaction as agreed.
  • Corporate Secretary’s certificate as to accuracy of company formation and capitalization documents.
  • Regulatory approvals, licenses, permits, etc.
  • Ancillary agreements such as seller financing and employee retention agreements.
  • Third party consents, such as leases and assignment of contracts to the buyer.
  • Release of liens and settlement of litigation.
  • Standard deal documents, such as bill of sale for assets and escrow agreement.

Termination Rights

The transaction can be terminated

  • If both parties agree to do so.
  • If a legal impediment makes the transaction illegal.
  • By one party if the other has not completed its closing conditions by a “drop-dead date.”
  • By one party if the other has materially breached a rep/warranty or failed to perform according to a covenant, after an agreed “cure” period (such as 30 days) to make it right.

“Bring-Down” of Reps and Warranties

The parties and their attorneys will burn plenty of negotiation calories defining which changes in the business since signing allow the buyer to walk away without closing. Materiality issues will include the threshold over which a change in one rep will be considered material, the threshold for the total of all changes before the total can be considered material, and whether the seller can exclude changes from this tabulation by updating disclosure schedules. Sellers want flexibility without enabling the buyer to change the agreed price or walk away, and buyers want the right to do both for the lowest possible materiality threshold.

Post-Closing Working Capital Adjustment

The working capital adjustment is the most common source of post-closing disputes. At signing, the Purchase Agreement uses an estimated figure for working capital, and promises that the actual figure for the closing date will be calculated 60 to 120 days after closing. The difference is paid out of escrow to the seller if actual exceeds estimate, or to the buyer if actual is less than the estimate. This process is called a “true-up.”

Working capital is usually defined as current assets (cash, inventory, accounts receivable, and prepaid items) minus current liabilities (accounts payable and accrued expenses). The parties can minimize disputes if they define all these terms clearly in the agreement, if the definitions follow accepted accounting principles, and if the seller has the right to examine pertinent company records after the closing as part of the “true-up” process.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Due Diligence and Deal Terms

by Tom Gray | on Mar 05, 2014 |  Comments

What does the buyer do with all this due diligence information? After due diligence is complete, some buyers may decline to participate further, but most will seek agreement on deal terms that minimize the risks they verified or discovered in the due diligence. They spent time and money to go through the document review process, so they are likely to seek solutions rather than simply walk away.

First, Buyers Assess Their Findings

After due diligence, buyers assess their findings. They list the risks and opportunities, and prioritize them according to financial impact. Together with their advisors, they may create several preliminary forecasts of business results. They’ll use different scenarios for future outcomes of the most important risks and opportunities.

Second, Buyers Discuss Their Concerns with the Seller

Buyers will want to hear the seller’s view of the risks and opportunities. The seller may clarify misunderstandings, point out connections among findings that change the risk assessment, or explain how current initiatives are expected to reduce the risks or take advantage of the opportunities. As a result, buyers change their assessments and preliminary forecasts.

Third, Buyers Seek Deal Terms to Minimize Risk and Optimize Opportunities

This step is the heart of deal negotiations. If buyers can gain protections or guarantees to back up the seller’s assurances, the deal is likely to go forward. Buyers try to shift risk to the seller through deal terms. Methods may include seller guarantees (reps and warranties), exclusion of certain liabilities or assets, closing conditions, installment payment terms contingent on results, or reductions in the price offered.

Closing conditions require the seller to accomplish certain activities between signing the Agreement and actual transfer of ownership (“closing” the transaction). Examples of seller closing conditions include gaining government and lender approvals, release of liens, and gaining commitments from employees to remain with the business. The seller may also be asked to perform certain activities to make buyer synergy opportunities more likely to succeed. The next article is devoted to closing conditions.

Installment payment terms contingent on results include earn-outs, seller financing, and perhaps the seller’s role in the business after sale. See previous articles in this category for more on these.

Reps and Warranties

Buyers usually seek new or modified reps and warranties to make the seller responsible for risks identified in due diligence. These are usually limited to material (sizable) risks/costs discovered within a specified time after closing, such as 6 to 18 months. Four different approaches are:

  • No risks: Seller states there are no risks of this type (e.g. product liability) and agrees to reimburse buyer for the cost of any that appear after closing. This is ideal for the buyer.
  • No known risks other than those disclosed: Seller promises to reimburse buyer for any costs for risks the seller knew about other than those disclosed in an Appendix to the Purchase Agreement. The cost of disclosed risks is reflected in the agreed selling price.
  • No risks seller should have known about other than those disclosed: Same as above, except seller’s liability for disclosure is expanded to cover what a diligent manager should have known.
  • Seller accepts liability to reimburse buyer for losses of a certain type up to a cap. For those costs not disclosed in the Appendix mentioned above, the seller’s duty to reimburse the buyer is limited to a maximum amount, in addition to limitations on materiality and time discovered. Sellers prefer the certainty of a cap on potential future liabilities.

As noted earlier (cite), the parties may agree that part of the purchase price is placed in escrow by the buyer to pay for any such liabilities discovered after closing.

Asset Sales

If the buyer believes liabilities of the business could be worth more than its assets, the offer could change from buying the business to buying only its assets. Buyers usually make this decision on deal structure earlier in the process, such as during preliminary deal term discussions after reviewing the Offering Memorandum. However, there have also been cases where due diligence findings caused buyers to change their deal structure strategy.

Buying only the assets leaves the original business (not the buyer) responsible for its own liabilities. Without its assets, the original business will cease operations and may declare bankruptcy to void the liabilities.

Buyers prefer an asset sale if there is a significant tax advantage due to restarting depreciation from a new basis – the price they paid for the assets. In contrast, when they purchase the business as a whole, they adopt its existing depreciation schedules, and some assets may already be fully depreciated. According to a recent ABA study, 87% of acquisitions were asset sales.

The downside of asset sales is that they do not automatically include the business contracts and intellectual property, requiring separate valuation of these components if they are part of the assets purchased. Valuation of non-physical assets is not well-defined and thus can be an obstacle to reaching agreement.

Shifting the deal structure from sale of the business to sale of its assets changes the basis of valuation and price. In an asset sale, the price is no longer based on the value of future cash flows of the business as a whole. The price basis becomes the value of its assets if sold in the market today, whether sold together or piecemeal. Valuation and selling price are based on appraised value of assets rather than discounted cash flow analysis and multiples of comparable transactions.

In an asset sale, the parties must also agree on how much of the purchase price is allocated to each type of asset, including the premium over market value, called goodwill. Historically goodwill represents about 30% of the purchase price, though recently it has averaged only 19% according to an ABA survey.

Exclusion of Certain Assets or Liabilities

Due diligence findings may show the buyer that certain assets of the business do not contribute to its future value. Examples include facilities with low utilization, inventory more than one year old, and machinery no longer used or duplicated by the buyer’s machinery.

Buyers may also decide that certain liabilities can or must be retired by the seller prior to closing, to reduce the buyer’s risk.

In such cases the buyer’s remedy may be exclusion of such assets or liabilities from the purchase, perhaps with a corresponding change in purchase price. The Purchase Agreement may still apply to the business as a whole, but the unwanted assets or liabilities to be excluded would be listed in an Appendix.

Role of Advisors

Sellers may be shocked and dismayed by these dispassionate assessments of the components of the business. Often the seller has not assessed the business as a buyer would. The seller’s advisors – attorney, investment banker/broker, and accountant – play an important role in these negotiations. They can help the seller see the reasons for the buyer’s proposals, and suggest compromises based on experience in dozens of other transactions. Their counsel can enable the deal to be completed with a fair distribution of value and risk, rather than crumble into acrimony and rejection.

Thanks to Bob Fader for his comments to improve this article! Bob is a Senior Consultant at MidCap Advisors, a nationwide boutique investment banking firm.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Due Diligence Topics and Checklist

by Tom Gray | on Feb 26, 2014 |  Comments

Due Diligence Topics and Checklist

Sellers can use the following categories to organize the documents in their due diligence data room. Note that some of these documents may already have been shared and discussed prior to due diligence, but those documents need to be available in the data room anyway.

  • Financial: Financial; Insurance
  • Legal: General Company; Corporate Agreements; Intellectual Property (IP); Litigation; Environmental; Tax
  • Operations: Customers; Marketing; Sales; Support Services; Products and Pricing; Processes and Production; Facilities
  • Information Systems (IT):  Software; Hardware; Data bases; Internal controls
  • Personnel: Employees, pay, benefits, and other HR matters

Extensive checklists for documents can be found at Due Diligence Checklist. Here is a summary description of the ideal documents for each of these topic areas, from the buyer’s perspective.

Financial: Audited financial statements for three years; unaudited results for the current year; budgets vs. actuals for two years; other financial reports for three years; detailed capital expenditures (capex) for three years; receivables aging schedule; correspondence with auditors for three years; projected financial results for the next three years.

Insurance: Summaries of insurance policies including “key man” life insurance, property, general liability, vehicle, worker’s compensation, employee health, and umbrella liability. Include the name of carrier, annual premium, coverage, claims over the last three years, self-insurance amounts reserved, co-payments/deductibles, and type of policy (occurrence vs. claims made).

General: List of subsidiaries; capitalization, number of shares, and owners; certificate of incorporation and bylaws; minutes of stockholder and board meetings including committees for three years; any other agreements among stockholders relating to management, ownership, loans, employment, or indemnity; all financing agreements; stock records; rights and warrants lists and the supporting agreements; address of all land and buildings; all material permits, licenses, government authorizations, and related correspondence; any other agreements with government entities except customer contracts.

Corporate Agreements: Borrowing agreements; credit line correspondence; acquisition and asset disposition agreements; joint venture, consulting, franchise, and other conditional agreements; distributor contracts; non-compete agreements; all other material contracts.

Intellectual Property: List of all trademarks, service marks, trade names, copyrights, and patents; evidence of registration, ownership, and/or first use of these; agreements concerning employee or outsider rights to products; procedures for maintaining trade secrets; end user license agreements; escrow agreements for computer source code; records of claims and disputes for IP;  product literature made public in past two years; product maintenance logs and error reports for past 12 months.

Litigation: List of resolved litigation for past five years; summary of pending or threatened litigation; list of all attorneys acting for the company currently; summary and copies of all court and arbitration orders and settlements currently binding on the company.

Environmental: All permits and notices or demands from environmental authorities; written reports on environmental testing or other such matters; estimates of future remediation costs; records of compliance activities; location of all hazardous waste disposal sites; locations of all underground tanks and lines including those no longer used; any history of leakage or spillage from such facilities.

Tax: All tax returns from the last three years plus any open years; all information on past and pending audits and judgments concerning any open returns; tax waivers or collection agreements; all requests for rulings by taxing bodies; any material tax decisions or elections by management.

Customers and Marketing: List of top 20 customers with revenue billed and collected from them in past three years; total customers by product for past three years; number of monthly website visitors for past two years; description of sales channels per product and their percentage of revenue; target customers and marketing plan per product; description of sales organization and sales/purchase order process; key customer relationships; industry segment description including brand awareness and product introductions/success; competitive analysis including differentiation; customer base vs. that of competitors; strategic alliances.

Sales: Revenue from new customers for past three years; international sales revenue in total and for top ten countries for past three years; planned new product releases; description of significant new business and lost business; growth opportunities; major partnerships and their effect on revenue growth.

Pricing and Support Services: Explanation of the economics behind all fees and prices; level and source of margins per product and support service; significant customer contract terms; process for delivering upgrades to customers; discussion of product customization and effect on margins; description of the customer support function and its availability.

Processes and Production: Process maps for key processes; description of facilities, their role in production, and any significant expected facility upgrade or maintenance costs; list of critical raw materials and key suppliers, and their value and continuity; list of critical production skills and their continuity; utilization rate per asset and monthly utilization rates to show seasonality; percentage of invoices paid in full, percentage or value of warranty returns and key production metrics such as units per hour and percentage of hours devoted to rework; inventory turnover by type, and value and type of any inventory unused for 12 months.

Information Systems and Internal Controls: Describe software, hardware and databases, and how they compare to those used by competitors; identify costs for such assets over the past three years, and any material future expenses expected; describe IT and Internet security, backups, remote records, and disaster recovery plans; describe accounting and financial controls and IT departmental functions.

Employees and HR: Union contracts and any related correspondence; management employment contracts or other agreements such as severance, consulting, and non-compete; organizational chart with names of function heads and number of subordinates; list of all employees earning over $100,000; employee benefit plans and related correspondence, reports, and filings; funding status and non-funded liability of each benefit plan; liability for termination payments to employees; details of other employee plans and arrangements; list of active and inactive employees for last three years with title, function, tenure, unique skills, and compensation; description of any order or decree applying to any senior executive which could affect the company’s conduct of business.

Thanks to Bob Fader for his comments to improve this article! Bob is a Senior Consultant at MidCap Advisors, a nationwide boutique investment banking firm.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Due Diligence: A Process Overview

by Tom Gray | on Feb 19, 2014 |  Comments

Due diligence is the “verify” phase of the deal. In this phase the buyer gets the opportunity to verify the seller’s “representations” about the results, potential, and risks of the business. The buyer will examine financial and other records to make sure there are no material (that is, having a major effect on value) issues or impairments that could limit the company’s ability to operate at the level described by the seller.

If the buyer finds such issues, the seller should expect one or more of these responses: buyer offers a lower price; buyer seeks stronger guarantees and risk-sharing from the seller; or buyer walks away.

Due Diligence is where the seller’s assurances are scrutinized. The seller provides the buyer with access to documents, and perhaps interviews and site visits as well. This information is highly confidential, so sellers allow buyers access only when a sale seems likely.

Prior to due diligence, the seller and buyer have reached this point in the overall sales process:

  • The buyer has signed a Non-Disclosure (Confidentiality) Agreement.
  • Deal terms and buyer concerns have been discussed in general, the seller has described the business and made representations about the company and its prospects, and the seller believes an agreement can be reached.
  • The buyer has submitted a signed Letter of Intent (LOI) containing price and terms. The LOI usually qualifies the offer by making it subject to findings in due diligence.
  • Often the buyer has submitted a list of the documents they wish to review in due diligence.

The Data Room

The seller enables due diligence by placing documents in binders for major topics, such as Financial, Legal, Operations, IT, and Personnel. The binders are shelved in a secure room, often located in the office of the seller’s attorney. The attorney controls access to this “data room.”

Buyers or their advisors will be allowed to review the documents at certain hours on certain days. If there are multiple potential buyers, each is scheduled for different days/times. A representative of the seller or their attorney will be present within or just outside the data room at these times.

Usually the seller allows the buyer to use computers to take notes about the documents, but does not permit buyers to make copies without special permission.

Seller’s Preparation: “Think Like a Buyer”

The seller and their attorney must decide which documents to provide, so they can prepare the binders before due diligence begins. After preliminary negotiations, they will adapt the binder contents to address concerns expressed by the buyer. In choosing documents, their first thought will be to minimize disclosure of any information that might diminish the value of the business in the eyes of the buyer.

The danger in this attitude is that its pursuit of the highest price can prevent any deal at all! Buyers are getting expert advice, and they know what they’re looking for. If they cannot find it, or it is incomplete, their confidence in the seller and the company may suffer enough that they walk away.

Buyers are looking for a trustworthy seller, a company with solid results, and opportunities to grow profits. They expect to pay a price reflecting those solid results and a portion of the growth opportunity, but hope to grow the business so its value significantly exceeds the price they paid. Thus company weaknesses that can be corrected by the buyer after the sale become opportunities for greater profits to the buyer.

A seller who tries to hide or downplay such weaknesses makes the company less attractive to buyers intent on growing profits! Even worse, when a buyer finds those weaknesses anyway, their trust in the seller tumbles, and they begin to doubt everything else they’ve been told. If this happens, the deal may fall apart.

The best way to prepare for due diligence is to think like a buyer. Provide the basic documents supporting the assertions in the Offering Memorandum, or the list of requested documents provided by the buyer, but go further to anticipate the key issues buyers will want to learn more about. Such issues should not be difficult to anticipate:

  • The seller already knows the company’s main challenges.
  • Consideration of fifteen areas of due diligence listed in the next article can reveal other risks that may concern buyers.

Assemble and be ready to provide documents to address these likely major concerns, if requested. Be prepared to discuss how the buyer can solve these issues, thereby adding value to his newly-acquired company. This is what “think like a buyer” means. Anticipate the buyer’s concerns and offer solutions that will add value. Moreover, if the seller can implement some of those solutions before closing, a higher sales price may result.

The Buyer’s Due Diligence Process

The buyer may review some documents in person, and may also delegate review of certain areas to an accountant or attorney. The buyer may create a “notes document” about each item reviewed, summarizing its content, any issues raised, and the potential risk or opportunity.

After the data room review is completed, the buyer may take some steps for follow-up due diligence:

  • Submit a list of questions for clarification or discussion by the seller.
  • Request site visits.
  • Request permission to contact certain customers or suppliers, or even unions. Note that asking for permission is polite, but may not be needed if the buyer already knew of these customers or suppliers from sources other than the seller’s confidential information.

When data-gathering is complete, the buyer will evaluate the findings for risks and opportunities, and will consider potential changes in deal terms to reduce risks. See Article 14.3 for more on this.

Seller’s Due Diligence on the Buyer

The seller may request access to buyer information as seller’s due diligence, to understand buyer qualifications in more depth than was possible when the buyer first expressed interest. The goal is the same as the buyer’s goal: to reduce risk in the transaction. This is less common than buyer due diligence, so it is not the focus of this article.

Thanks to Bob Fader for his comments to improve this article! Bob is a Senior Consultant at MidCap Advisors, a nationwide boutique investment banking firm.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Key Deal Terms: Where Your Advisors Add Value

by Tom Gray | on Feb 11, 2014 |  Comments

Buyers and sellers depend on three types of advisors:

  • Business Broker or Investment Banker helps with valuation, the Offering Memorandum, finding and qualifying potential buyers, and advising on deal terms to satisfy both parties.
  • Accountant prepares the business financial statements and advises on the formulation of deal terms which depend on financial metrics, such as earn-outs and post-purchase price adjustments.
  • Business lawyer anticipates risks, drafts/negotiates the wording of deal terms to reduce risk, and ensures proper deal documentation.
  • Both broker and attorney advise the seller concerning the sales process itself.

Representations and Warranties and “Disclosures”

The previous article defined reps and warranties as statements about the business that the seller warrants or guarantees are true. The seller agrees to pay the buyer (indemnifies the buyer) for the financial impact of any reps that turn out to be untrue.

Many of the most important reps are disclosure statements. They communicate that there are no liabilities in a particular subject area except those disclosed to the buyer, usually in an attachment to the deal documents.

The seller’s promise of cash compensation guarantees the accuracy of the business description. The guarantee means money could change hands, so these deal terms are heavily-negotiated by the attorneys for both sides.

Not just any attorney will suffice. The seller’s attorney should be experienced in buy/sell transactions for the seller’s business size. This experience enables the attorney to minimize the seller’s risk by quickly suggesting subtle wording changes, or by responding to the wording proposed by the buyer’s experienced deal lawyer.

Disclosure Wording Issues

The seller’s attorney tries to narrow the definitions in the disclosures. Examples:

  • They are true, but only to the knowledge of the seller at the time they made the statement. The buyer wants them to be true according to what the seller should have known with reasonable investigation, and wants them to be true at closing as well as when first stated.
  • Inaccuracies that are not significant should not matter. This threshold is called a “material adverse effect,” and can be defined several ways. One issue is whether the inaccuracy materially affects the business now, or should its effect on the prospects of the business also be considered?
  • The buyer wants the seller to have the duty to inform the buyer when the seller becomes aware that something in the disclosure statement is no longer true. The seller may accept this responsibility, but may want to limit it to things they are aware of, and only if those issues are material.
  • Regarding the litigation disclosure, the buyer may want it to cover both pending and threatened litigation, while the seller wants to address only actual litigation already filed since they may not know of all pending or threatened suits.

Indemnity Wording Issues

The seller’s attorney tries to limit the amount of the indemnity, the duration of the discovery period, and the complexity of the claims process. Examples:

  • Seller wants to cap the total amount of the indemnity. Buyer does not.
  • Seller wants a threshold of materiality before an indemnity claim is permitted. Buyer does not.
  • Seller wants to pay only for damages beyond the threshold. Buyer wants payment from the first dollar.
  • Buyer may want to introduce punitive damage claims as well as actual impact.
  • Buyer will want some “carve-outs:” seller liabilities that survive beyond the indemnity end date, or which carry different levels of potential liability. Seller does not. Sometimes the solution is indemnity “baskets” of different liability types or payment types.

Other Wording Issues

The seller’s attorney will try to limit post-purchase price adjustments, such as by excluding unknown tax liabilities on pre-sale operations. The deal will also include “covenants:” agreements by the buyer and seller that both will take (or not take) certain actions, usually between signing and closing. The most common examples are that neither will announce the deal without the other’s permission, and that the seller will not “shop” the deal to other buyers to get a better price. The attorneys will seek agreement on wording that provides for certain exceptions to these covenants.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Key Deal Terms: Representations, Warranties, and Escrow

by Tom Gray | on Feb 04, 2014 |  Comments

Ronald Reagan is famous for saying “Trust, but verify.” Representations, warranties, and escrow are the fundamental tools for describing the business and guaranteeing that the descriptions are true. They are used to make sure the seller tells the whole truth, because he loses a portion of the purchase price if his descriptions turn out to be untrue.

Buyers try to reduce the risk of unforeseen value destroyers when agreeing to purchase a business. Their goal is to get a clear and honest picture of the business from the seller. Prior articles showed how seller financing and earn-outs make payment of the purchase price depend on the post-sale success of the business. This motivates the seller to avoid painting an overly-optimistic picture to get a higher price, by reducing payments if the reality turns out to be less attractive.

Seller financing and earn-outs take years to play out, and deals may use one or the other but rarely both methods. Representations and warranties are a third method to achieve the same goal: an honest and complete understanding of the business liabilities before signing the Purchase Agreement. Reps and Warranties claims are usually resolved in 12 to 18 months. Every transaction will use representations and warranties.

Representations and Warranties

In the Purchase Agreement, Sellers make several statements to describe the business situation. These are called “representations” or “reps” for short. Textbooks list 32 possible reps! Some examples are absence of environmental liabilities, absence of tax liabilities, and clear rights to all your intellectual property.  Some rep topics apply to all businesses, and others apply depending on the nature of the business being sold.

Buyers also offer reps and warranties about their own business and their personal net worth, but since the seller’s reps are typically much more important to the deal, this article focuses only on seller reps.

Reps and warranties are contractual commitments from seller to buyer. The seller “warrants” (guarantees) they are true. This guarantee or warranty means a financial penalty to the seller if the statement is not true. Without that warranty, the buyer has no assurance that they can rely on those statements. So the two terms are almost always used together: “reps and warranties.”


The indemnity section of the Purchase Agreement is where the parties agree to indemnify each other for inaccurate representations. Indemnify means one party pays the other to make up for the financial effect of such inaccuracies.


Escrow is the method often used to implement the seller’s indemnity, i.e., the warranty or guarantee.

Escrow uses a third party to receive money from the buyer, and to release it to the seller only when certain agreed conditions have been met. This tool gives the seller the comfort of knowing the buyer has committed the money. Meanwhile, it protects the buyer from the difficult task of recovering funds from the seller if it turns out the seller has not done everything he agreed to, or has made untrue representations about the business.

Escrow is used for several purposes, not just for indemnification. Escrow is used for earnest money, i.e. a deposit that might be made with the Letter of Intent. It is also used between signing the agreement and actually closing the transaction. The buyer’s money can be paid to the escrow agent shortly after signing, and then released to the seller after closing conditions have been met to everyone’s satisfaction.

Escrow can also be used to hold a portion of the purchase price until some number of months after the closing date, so the amount eventually paid to the seller can be reduced by the amount of indemnification due to the buyer.

Another use of the escrow account is to compensate either buyer or seller for a difference from the agreed net working capital (current assets minus current liabilities) of the business when the deal closes. Such differences are usually discovered shortly after the closing of the transaction. The same escrow account used for indemnification is also used to balance such Post-Purchase Adjustments (PPAs).

Importance of Reps, Warranties ,and Indemnity Claims

Some statistics from SRS ( for sales of privately-held companies in 2012 show that sellers are wise to pay careful attention to reps, warranties, and indemnification:

  • The amount of the escrow account was more than 10% of the purchase price in over half these deals. The average range was 10 to 15%. For 3% of the deals, the escrow amount was 100% of the purchase price!
  • The escrow holding period averaged 12 to 18 months.
  • 98% of the deals contained “carve-outs,” meaning that indemnity liability for certain matters lasts longer than the escrow holding period. Typical carve-outs involve sellers’ ownership of shares, taxes, and fraud.
  • 58% of the deals had escrow claims, usually reducing the funds eventually provided to the seller.
  • Release of escrow funds was delayed due to claims in 30% of the deals, with the average delay being 7 months.
  • Deals with delays had an average of 3.6 escrow claims.
  • The most common sources of claims were tax and intellectual property issues.
  • 72% of the deals with PPA mechanisms had a post-closing adjustment.

What Sellers Should Do

Reps and warranties, disclosures, and covenants are where your deal lawyer adds value. Wording choices and negotiations can have substantial effects on the amount eventually paid to the seller. The next article addresses some typical issues in these deal terms.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Key Deal Terms: Earn-out

by Tom Gray | on Jan 29, 2014 |  Comments

The term “Earn-out” means that part of the purchase price of the business is paid to the seller only if the acquired company achieves specified financial or non-financial milestones during a specified period after the deal’s closing date. Typical parameters are 30% of the stated purchase price and a two year period, according to Shareholder Representative Services LLC ( In their study, 15% of transactions included Earn-out provisions, and it was uncommon for the Earn-out period to extend beyond three years.

The metric for milestone achievement is normally percent change in gross sales or some earnings measurement. Most sellers prefer to base the Earn-out on highest possible line of the income statement, ideally percent change in gross sales. Sellers prefer to avoid using earnings-based metrics because earnings depend on expense control, which is subject to management discretion (manipulation) for both amounts and timing. For example, the new owner could pay a large bonus to employees to reduce earnings, causing an Earn-out milestone to be missed, resulting in no payment to the seller.

In contrast, buyers prefer to base the Earn-out on earnings. In the SRS study, 89% of the milestones were financial, the most common financial measurement was EBITDA, and only 50% of Earn-out metrics or milestones were actually achieved. EBITDA stands for Earnings Before Interest, Tax, Depreciation, and Amortization. It is basically Operating Margin plus Depreciation.

The earn-out agreement is often the compromise solution when the buyer and the seller have different views of the future value of the business. The buyer pays a minimum at the time of closing, and events determine the amount of the remainder paid later. For example, when the asking price is $2 million, the buyer may be willing to pay $1 million at closing plus 5% of gross sales over the next three years. Some earn-outs, such as this example, may offer some “upside potential” to the seller, i.e., the potential to be paid more than the asking price.

The most fundamental issue in negotiating an Earn-out is identifying who will be managing the business after sale. Usually the buyer is the manager, but in some transactions a financial buyer will plan to depend on the seller to remain as the manager. The terms of the Earn-out will be different if the person to be paid is also managing the results! This article assumes the buyer is managing the business.

Earn-out Benefits and Risks




  •   Resolves doubts about valuation
  •   Less cash required at closing
  •   Opportunity to integrate a motivated seller   into business operations post-closing

  •   Sale becomes more likely due to resolving   different views on value and reducing cash required at closing
  •   Lower taxes from deferring proceeds
  •   Potential upside – higher total sale value

  •   Disputes, especially if the buyer wishes to   transform the business
  •   If seller is involved in the business   post-closing, decisions may tilt toward short-term improvements jeopardizing   long-term growth

  •   Retain risk without control
  •   Limited access to business records
  •   Potential manipulation of performance by the   buyer
  •   Disputes, especially if the buyer wishes to   transform the business

Negotiating Earn-out Terms

The basic Earn-out terms are:

  • duration of the Earn-out period
  • the metrics to be used (there may be more than one)
  • the way the each metric is calculated
  • level of performance that triggers payment
  • amount of payment

Other critical matters must also be negotiated. These include:

  • Number or frequency of payments, and the timing of the payment after a milestone is achieved.
  • Any caps on total amount paid or amount paid per interval.
  • Who calculates the metric? How can the seller verify actual performance vs. reported results?
  • How will disputes be resolved?
  • If the buyer wishes to sell the business within the Earn-out period (“change of control”), will the seller be entitled to an accelerated Earn-out payment? If so, how will it be calculated?
  • Can the buyer deduct from future Earn-out payments any indemnity claims exceeding the seller’s agreed obligations (escrow)? See the next two articles for more about indemnification.


Advice to Sellers

Keep it simple! Negotiate for the shortest Earn-out period, with only one or two metrics. The metrics should be carefully defined, because most Earn-out disputes are based on the method of calculating the results achieved.

Beware of Earn-outs if the buyer plans to transform the business during the Earn-out period, because such future changes create difficulty in agreeing on the proper measurement of milestone metrics, leading to disputes and payment delays. Examples of transformations are integrating the acquired business into the buyer’s other businesses, entering new markets, and launching new products.

Stay involved to minimize your risk! You will want to have a consulting agreement so you can retain access to company records and remain aware of developments. If your key people are crucial to results, negotiate retention agreements with them before you sell.

Finally, pay attention to incentives. Negotiate so that the buyer will spend enough on capital investments and marketing, and will structure employee compensation to motivate the behaviors that achieve your milestone targets.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see


Key Deal Terms: Seller Financing

by Tom Gray | on Jan 22, 2014 |  Comments

When you sell your small business, you want to echo Cuba Gooding Jr. in Jerry Maguire: “Show me the money!” But small business owners typically do not receive the entire payment when the selling transaction closes. Wary buyers usually gain agreement to withhold some of the payment, to protect against the risk that the true picture is not as rosy as depicted by the seller. They want to motivate the seller to tell the truth and help them succeed. Negotiation of these payment-related deal terms is crucial to reaching agreement.

Three methods for holding back funds are seller financing, earnout, and an escrow account for indemnification and post-purchase working capital adjustments. This article addresses seller financing. The next two articles address the other two payment-deferral methods.


“Seller financing is involved in up to 90 percent of small business sales, and more than half of mid-size sales,” according to Options for Financing Your Business Sale | BizFilings Toolkit. Buyers see seller financing as equivalent to a warranty by the seller, a bond that the business can perform as described. Sellers tend to be reluctant to offer financing, but the need to attract buyers by reducing the initial cash requirement usually leads sellers to accept the need to do so.

Other benefits of seller financing include a higher sale price, a speedier sale process compared to the time required for the buyer to get a bank loan, and the tax advantages of spreading the sale gains over several years.

Seller-financing is an agreement – written in a “promissory note” or financing agreement – that the buyer will pay to the seller some part of the purchase price plus interest on a regular basis over the next few years. Sellers can expect to finance 1/3 to 2/3 of the sale price. Interest rates tend to be less than bank loan rates, unless the buyer also has a bank loan (see below). The loan term is typically three to seven years, with monthly payments beginning 30 days after the sale, but the start of payments may be deferred if there is also a bank loan involved.

If there is no bank financing involved at the time of the sale, the seller note will often require a large “balloon payment” at the end of the term. This implies that the buyer will get bank financing after a few years, replacing the seller note with a bank loan, part of which is used to pay the balloon amount to the seller.

If the buyer is getting financing from a bank, the bank may require the seller to finance perhaps 25% of the purchase price. The bank hedges its risk when it requires the seller to risk his own money. The bank wants the seller to stand behind the valuation of the business by sharing in the risk of its future success.

Risks to the Seller

  • If there is no bank loan and the seller is providing the only financing, the business itself will be the collateral, along with the buyer’s personal guarantee. But if cash flow becomes so short that the payments are not being made, the value of the business will have diminished to become less than the value of the loan. So there is a risk of non-payment, and also a risk of insufficient collateral due to changes in its market value.
  • If a bank loan is involved, the seller’s financing usually is an unsecured loan, because the bank loan has a prior claim on all the business assets. So the seller has little recourse beyond the buyer’s personal guarantee if payments are not made on schedule.  In this case, the interest rate should be higher than bank rates, to reflect the risk of an unsecured loan.
  • Because payments depend on the cash flow of the business, the seller who makes a loan still faces the risks of the business after selling it, yet no longer has control of its operations.

Reducing Risk with Seller-Financing

In addition to investigating the buyer’s creditworthiness, obtaining a personal guarantee (including signature by the buyer’s spouse), and charging a higher interest rate, other methods to reduce the seller’s risk include:

  • Requiring the buyer’s other assets as collateral, to the extent they are not already pledged for other loans.
  • Requiring the buyer to get life insurance or even disability insurance with the seller as beneficiary.
  • Requiring the buyer to purchase an annuity contract or zero-coupon bonds for the seller. This means future installment payments of the purchase price would not be dependent on the success of the business. This method still reduces total buyer cash requirements because these instruments can be bought for less than their face value, i.e., their future payouts.
  • Requiring the buyer to provide the seller with quarterly financial statements.
  • Requiring that the loan is due in full immediately if the business does not meet certain performance levels on selected operating ratios (loan “covenants”).
  • Requiring seller approval before making material changes in the business (asset purchases, acquisitions, divestitures, expansions), and even the new owner’s salary, until the loan is paid off.
  • Requiring the buyer to form a corporation to purchase the business, and to pledge the stock of that corporation as collateral for the seller note. This enables the seller to take over the business and replace management in the event of non-payment, and do so much more quickly than the foreclosure process.

Buyers value seller financing as a warranty, and because it seems faster and easier than getting a bank loan. As a result, sellers often find that providing financing is the only way to find a buyer for their business. Given appropriate risk protections, seller financing can be a win-win deal term.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Negotiating Deal Terms for Selling Your Small Business

by Tom Gray | on Jan 15, 2014 |  Comments

Every deal is a package deal. When you sell to your customers, your offer is a package of deal terms: what they are buying, how much they pay, when the money is due, shipping, return policy, etc. You know that if you change some of these deal terms, the price might change as well. The same idea applies to selling your business.

Price is only one of the deal terms involved in selling or buying a business. The seller is also interested in several other commitments from the buyer, such as timing and form of payment, what happens to business debt, and what happens to the employees. Meanwhile, the buyer is interested in getting financing, possibly excluding some assets or liabilities from the deal, and assurances that the business reality matches the seller’s description.

When the buyer provides the non-binding Expression of Interest or the Letter of Intent, they include their positions on a number of considerations (deal terms). They might even organize their positions into an attached “term sheet.” The buyer’s offer is based on those positions. If the seller wishes to negotiate changes in those deal term positions (and he always does), the buyer reserves the right to change the offered price.

The following summary of terms assumes sale of the company intact. Some variations apply when the buyer is buying only the assets of the company.

Basic Buyer Deal Terms

In every deal, the seller should expect the buyer’s deal terms to include those listed below, according to The Acquisition Term Sheet – AccountingTools:

1. Binding. The term sheet will state whether the terms in the document are binding. Usually they are not, and it will go on to state that the terms are subject to the eventual negotiation of a purchase agreement.

2. Parties. This states the names of the acquirer and the target company.

3. Price. This is the total amount of consideration to be paid to the seller. There will probably be a clause saying that the stated price will change, depending upon information uncovered during due diligence.

4. Form of payment. This states whether the price will be paid in cash, debt, stock, or some mix of these elements.

5. Earn-out. If there is to be an earn-out, this clause states how the earn-out is to be calculated.

6. Post-closing working capital adjustment. This states any changes in the purchase price that will be triggered if the seller’s working capital varies from a certain predetermined amount as of the closing date.

7. Legal structure. This states the form of the legal structure to be used, such as a triangular merger or an asset purchase. The legal structure can have profound tax implications for the seller, so this item may require considerable negotiation.

Some buyers will prefer to purchase only the assets rather than the stock of the business. Buying assets may enable them to avoid taking responsibility for most business liabilities, and allows them to start depreciation from a new basis. In contrast, buying the stock enables them to retain key contracts and avoid the need to perform a valuation on intellectual property assets.

8. Escrow. This states the proportion of the price that will be held in escrow, and for how long.

9. Due diligence. This states that the acquirer intends to conduct due diligence, and may state the approximate dates when this will occur.

10. Responsibility for expenses. This states that each party is responsible for its own legal, accounting, and other expenses related to the acquisition transaction.

11. Closing. This states the approximate date when the acquirer expects that the purchase transaction will close.

12. Acceptance period. This states the time period during which these terms are being offered. The recipient must sign the term sheet or offer letter within the acceptance period to indicate approval of the terms. Limiting the time of the offer allows the acquirer to later offer a different (usually reduced) set of terms if the first offer was not accepted and circumstances change.

Additional Buyer Deal Terms

1. No shop provision. The seller agrees not to disclose (“shop”) the offered price to other prospective bidders in an effort to find a higher price. This clause can be legally binding.

-        The best situation for the seller is to have an auction involving several bidders. If this is the plan, sellers would not agree to a no-shop term until after selecting the most likely buyer among competing offers.

2. Stock restriction. If payment is to be in stock, the acquirer will likely require that the seller cannot sell the shares within a certain period of time, such as 6 or 12 months.

3. Management incentive plan. The buyer may offer a bonus plan, stock grants, stock option plan, or some similar arrangement for the management team of the seller. This clause is intended to quell any nervousness among the managers, and may gain their support for the deal.

4. Non-compete. Usually the buyer wants the seller to promise not to start-up or work for a competing concern within the same geography for a year or two, though such clauses can be difficult to enforce in the courts.

5. Announcements. Either party may feel that it would be damaging to announce the terms to the general public or news media, so this clause states that doing so must have the prior approval of the other party.

6. Conditions precedent. This states the requirements that must be met before the acquirer will agree to complete the purchase transaction. Examples of conditions precedent are having several years of audited financial statements, the completion of due diligence, the approval of regulatory agencies, the completion of any financing by the acquirer to obtain the funds to pay for the transaction, and the condition of the seller’s company being substantially as represented. The acquirer includes these items in the term sheet or offer letter to provide a reasonable excuse to extricate himself.

7. Representations and warranties. This is a short statement that the acquirer will want representations and warranties from the seller in the purchase agreement. These clauses essentially create a warranty that the business is truly represented to the acquirer.

Following articles will explain a few of the most important terms mentioned above.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Qualifying Buyers and Exchange of Information

by Tom Gray | on Jan 08, 2014 |  Comments

Qualifying Buyers and Exchange of Information

Tired of “tirekickers?” Many of those who respond to the Teaser Announcement will not turn out to be serious buyers. They may be merely fishing for information. They may lack the necessary funds or industry qualifications. Brokers say this group can amount to 90% of responders. In the used car industry, they’re called “tirekickers.”

To avoid spending time on this type of responder, the seller uses a qualifying process and often assigns the broker to manage it. Thus the term “Seller” in the following process description also includes the broker acting as the seller’s agent, if desired.

The Buyer Qualification Process

1. Seller sends Teaser Announcement.

2. Buyer sends Confidentiality Agreement, Buyer Profile, and Buyer’s Personal Financial Statement.

3. Seller assesses Buyer according to Seller’s requirements

- Ability to pay cash required on closing date

- Ability to finance purchase price (if Seller loan, what Buyer collateral is available?)

- Buyer’s timeframe vs. Seller’s

- Buyer’s industry qualifications or other ability to operate the business.

4. If satisfied, Seller calls Buyer to discuss the transaction and seller’s requirements in general terms.

5. Optional: If the Seller is satisfied and Buyer remains interested, Seller signs Confidentiality Agreement and sends OM summary without key information (customers, financials), and requests Proof of Funds from Buyer.

6. Optional: Buyer sends Proof of Funds.

7. If satisfied, Seller signs Confidentiality Agreement and sends OM, and requests the Buyer respond with a nonbinding Expression of Intent. Seller states what it should include, such as:

- Buyer’s expectation for type of transaction: purchase of assets or total business, cash, stock swap, cash plus earn-out, other.

- Buyer’s price range, payment timing, and method of financing

- Buyer’s timeframe for closing

- Buyer’s qualifications to operate the business

- Buyer’s need for transition assistance from Seller post-closing: expected duration, hours, and compensation.

8. If satisfied, Seller schedules a meeting with the Buyer.

Comments on the Process

When the buyer provides qualifying information, the seller provides more information about the business.

The process is a disciplined step-by-step procedure where buyers can be progressively qualified, protecting the seller from divulging information to parties who lack either legitimate interest or the financial resources to complete the transaction.

Recognizing that excessive confidentiality narrows the pool of buyers, sellers may decide to accept some confidentiality risk and combine some steps, such as excluding 5 and 6 above if they already know the financial strength of the buyer from Step 2. Once the process is complete, the Seller sends the Corporate Book to the buyer, and preliminary discussions on price and terms can begin.

Interested potential buyers usually request a meeting to discuss the material provided, some of their due diligence concerns, and some potential deal terms. After the meeting, they will submit a non-binding Letter of Intent (LOI), with a price and deal terms contingent on full due diligence findings. After Due Diligence (Stage 4), serious negotiations on deal terms take place.

Although deal term negotiations happen both before and after Due Diligence, we discuss deal terms first, in the next few articles, because the seller may reject the LOI based on preliminary discussions, and refuse to allow due diligence.

Thanks to Bob Fader for his comments to improve this article! Bob is a Senior Consultant at MidCap Advisors, a nationwide boutique investment banking firm.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Identifying Buyers for Your Business

by Tom Gray | on Jan 01, 2014 |  Comments

Be ready before you try to sell the business! When you are ready to start the search for buyers, this is the situation:

  • You know your goals, and the type of transaction that fits them best.
  • You have optimized the business, making key changes to get it ready for sale.
  • You have probably engaged a business broker.
  • You have a valuation, and have identified a range of expectations for selling price, and decided what price to ask for.
  • You have developed an Offering Memorandum, Teaser, and possibly a summary of the OM.
  • You have also prepared several documents to use with buyers: a Confidentiality or Nondisclosure Agreement that covers both your information and whatever they disclose to you; a buyer profile questionnaire; and a buyer’s personal financial statement template.
  • You have developed a Corporate Book, and will create due diligence binders during the buyer search, adapting them later to address particular concerns expressed by potential buyers during preliminary discussions.
  • You know what you want to see in a buyer’s Expression of Interest or Letter of Intent.

First, Identify Potential Strategic Buyers

Typically, strategic buyers are operating in your industry, so they could achieve growth or efficiency synergies by acquiring your company. As a result, they will often be willing to pay a higher price than financial buyers. See Getting Your Business Ready for Sale – Major Changes. Since they are likely to offer the best price, it makes sense to solicit them first.

The business owner is the one most likely to know which companies or individuals might be strategic buyers. Consider your competitors, suppliers, and customers. Consider also companies who sell similar products in different markets than yours. If you were expanding your business, which of these would you be interested in buying? These may be the best candidates to buy your business.

However, approaching them may disclose the identity of your business, and this might hurt its performance or competitive position. When selling a business, one of the trade-offs is that attracting the widest market of buyers implies the greatest loss of confidentiality.

Techniques to minimize this risk include (1) masking the identity of the business until buyers appear to be both interested and qualified, (2) confidentiality agreement, and (3) using a broker to handle the communications rather than doing so yourself.

Second, Consider Your Own Network

Aside from people or companies you know that may be potential strategic buyers, your network will include people who may be financial buyers. Most importantly, your contacts may be able to forward your invitation to potential buyers in their networks. People are more likely to respond to an email from someone they know than to a broadcast from a broker.

Your network of connections may include:

  • Some people in your email address book.
  • Your LinkedIn connections.
  • Members of LinkedIn groups such as industry-oriented groups or alumni from companies where you’ve worked.
  • Members of associations you have joined, such as a Chamber of Commerce or a trade association.

You may invite them to forward your Teaser Announcement to people in their own networks, widening the circle even further.

Note that your deal with a business broker could provide for a reduced fee if the buyer turns out to be someone you identified, rather than someone responding to the broker’s solicitations.

Third Priority: Business Broker Solicitations

In addition to serving as the middleman to deal with your contacts, one of the primary services of your business broker is their ability to reach a wider circle of potential buyers. Brokers use these channels of communication:

  • Their own network of transaction professionals, who in turn have their own networks of potential buyers. These professionals include accountants, attorneys, bankers, and other brokers.
  • Their own database of qualified potential buyers.
  • Their own website and monthly newsletter.
  • Memberships in subscription-based deal groups and websites.
  • Brokers may also advertise on the web or at industry events, or even use direct mail.

Thanks to Bob Fader for his comments to improve this article! Bob is a Senior Consultant at MidCap Advisors, a nationwide boutique investment banking firm.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Documents Needed to Sell Your Business

by Tom Gray | on Dec 25, 2013 |  Comments

The business is not what you say it is. It’s what the documents say it is.

Business buyers want to minimize risk. They want to see the documents that prove the seller’s assertions. You will need to gather the following documents, and organize them into binders to facilitate review by the buyer during the due diligence process.

Some of these documents will be needed to prepare the Offering Memorandum in Stage One. These documents go into the “Corporate Book.” The remainder should be gathered and filed into binders during Stage Two, while you are waiting to receive offers.  However, some of these other documents may also be filed in the “Corporate Book” provided to serious buyers prior to the Due Diligence stage. Such documents are marked with a * in the list below.

Needed in Stage One

  1. Financial Statements for current and past three years: balance sheet, income statement, tax return for business
  2. Statement of Seller’s Discretionary Earnings or cash flow
  3. Financial ratios and trends
  4. Photos of business
  5. List of opportunities for improvement with revenue/profit projections for each
  6. Marketing Plan and samples of marketing materials
  7. Evidence of major obligations (loans, leases), customer commitments, and policy decisions.

Needed for Buyer’s Due Diligence

  1. Governance documents: board minutes, policies, announcements to employees*
  2. Note for seller financing
  3. Accounts payable and accounts receivable aging reports
  4. Inventory list with value detail
  5. List of furnishings, fixtures, and equipment with value detail*
  6. Asset depreciation schedule for tax returns
  7. Supplier and distributor contracts*
  8. Client list and major client contracts*
  9. Staffing list with hire dates and salaries; employment contracts and Independent Contractor agreements*
  10. Organization chart*
  11. Business formation documents*
  12. Leases*
  13. Business licenses, certifications, and registrations*
  14. Professional certificates
  15. Insurance policies
  16. Copies proving ownership of patents, trademarks, and other IP*
  17. Outstanding loan agreements*
  18. Description of liens*
  19. Product or service descriptions and price lists*
  20. Employment policy manual
  21. Business procedures manual
  22. Other documents unique to your business

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Owner Goals and Selling the Business

by Tom Gray | on Dec 18, 2013 |  Comments

Before selling the business, owners should take a moment to consider their goals at this moment. There may be other ways to meet the goals. There may also be interim steps, so that timing becomes a tool to maximize returns.

The Goals in this table are about time and effort. The strategy alternatives consider different selling approaches, tailored to the adjacent goal.

-        Time: Do you need all the proceeds of a sale now, or a large portion of them, or are you simply establishing a retirement fund to be drawn on over decades?

-        Effort: Do you really need to sell now, or is your real goal just to find a way to cut back your own day-to-day involvement?

Owner   Goal

Strategy   Alternatives

1. Capture the value of the business to create a retirement fund for   the owner, to be drawn on monthly over decades. A. Sell business to employees gradually via ESOP; reap tax   advantages.B. Sell the business and reinvest after-tax proceeds. Accept payment   terms that maximize price, e.g. earn-out; stock swap or stock payment;   owner-financing.
2. Capture the value of the business to pay for a large immediate   expense. C. Sell the business and reinvest after-tax proceeds. May accept   earn-out or partial payment in stock.
3. Work less – reduce the time and effort the owner devotes to the   business. D. Hire managers to perform owner’s operational functions; owner   works 1-2 days/week on getting new customers; retain profits now and sell in   2-3 years.- May sell only a portion of   the business, retaining some stake
4. Exit now, before a change in the business environment reduces its   value. E. Sell the business and reinvest after-tax proceeds. No “earn-out.”   Cash payment, not stock.


Key Point

The longer you can wait for the deal to mature and pay out, the more likely you will capture the highest selling price and the best tax treatment for proceeds.

However, waiting involves risk. Changing conditions may diminish the buyer’s ability to make deferred payments as agreed.


If you can wait,

  • You have time to change the business to improve valuation, per prior articles.
    • Risk: business results may weaken during change period.


  • You can accept part of the selling price over two to four years after the sale based on business profits in those years, called an “earn-out.” If the owner accepts this risk, the buyer needs less cash so he may be willing to pay more, and more buyers may find the deal feasible.
    • Risk: business results may fall short of target during earn-out period.


  • You can accept part of the payment in the buyer’s stock, and sell it in portions when it has a favorable market price, keeping your tax bracket low. Since the buyer will need less cash at the time of the closing, he may accept a higher selling price.
    • Risk: buyer’s stock may lose value for any number of reasons.


  • You can offer seller-financing to the buyer, being paid part of the selling price over five to ten years with interest. Collateral is the business itself. Again, since the buyer would need less cash, the selling price may be higher.
    • Risk: buyer may be unable to pay the loan for any number of reasons; owner may not want to take over the business again; business value (collateral) may have declined to be less than the value of the loan between the sale and the time the former owner decides to call the loan and take over the business again.


  • You can sell to employees at an appraised market valuation via an Employee Stock Ownership Plan (ESOP), getting the most favorable tax treatment for proceeds. See Chapter 16 in Business Techniques in Troubled Times.
    • Risk: cost of administration.


Understand your own goals. Fit your strategy to them. Use time to enhance the value of the company. My preferred approach is to hire to replace one’s owner/operator role, work one or two days per week on new customers, sell two to three years later, accept an earn-out or stock swap but not seller-financing, and use an ESOP if it appears feasible.

Thanks to Bob Fader for his comments to improve this article! Bob is a Senior Consultant at MidCap Advisors, a nationwide boutique investment banking firm.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

Getting Your Business Ready for Sale – Minor Changes

by Tom Gray | on Dec 11, 2013 |  Comments

We learned in high school that an attractive first impression makes other people interested in knowing more about us. The same is true when selling your business.

Buyers are attracted to businesses that appear to be well-managed. They prefer to avoid surprises after the transaction. Seeing tidy management before the deal gives them confidence that the business will run well after they buy it. The pay-off for tidy management is more buyers and a higher selling price for the business.


The website is the business’ front door. A well-designed website implies a well-designed business. Revamping your website may take several months, and you should complete it before beginning the sales process.

Organize your website by customer group. Hopefully you are serving more than one industry or segment, to reduce risk of customer concentration. The home page should have an entry point for each of these customer groups. Then the pages for each group should be organized around their needs. Your products or services make sense only in relation to customer needs.

Your site will have plenty of content, attractive and uncrowded graphics, and error-free navigation and spelling. The content shows how your services are different from competitor offerings. It also emphasizes the benefits customers gain from those differences (your “positioning”). Your service offerings are grouped into three tiers, with names communicating basic, standard, and premium. Customers can order a tier plus additional a la carte services.

Be sure to include success stories and testimonials to prove credibility. See Tips for Your Website.

Marketing Materials

Your marketing materials invite customers to your front door, the website. They must be up-to-date and consistent with the website’s message and appearance. They convey your positioning with a clear message and graphics. Test a variety of marketing materials for each of your customer segments to find which get the best results.

Appearance of the Facility and Equipment

First impressions matter. Just as sellers of houses invest in the appearance of their house before putting it up for sale (called “staging”), business owners can get the best selling price when their place of business appears well-organized, clean, and has books and records readily-available. Remove clutter, clean and spruce up the premises, and organize your records!

Operations Documentation

Most small businesses do not take the time to document how they operate, but do so if you want to demonstrate topnotch management to a buyer. The impression is:

“This business is well-organized. They know how they do things, and they do things in a consistent way. They have anticipated problems and limited their impact, so I can be confident even about the things I don’t know.”

In this way, documentation makes the sales process faster and keeps buyers interested. Here are some examples of operational documentation:

  • Process maps for key processes, with standards of acceptable performance
  • Standardization in bills of materials, quotes, and wherever else possible
  • Quality control standards and quality measurement process
  • Job descriptions
  • Training and job aids, i.e., small reminders of how to do a task, posted near the work station
  • Employee manual
  • Organization chart
  • Delegated limits of authority
  • Floor and circuit layouts, and emergency (fire) procedures

Governance Documentation

“Governance” has to do with the way decisions are made and the business is administered. Documentation of governance means the written policies that define who does what, who makes what decisions, and even what they consider when they make those decisions. These are often called “company policies.”

Governance documentation also includes evidence that certain decisions actually were made, such as minutes of the board of directors, annual reports, regulatory filings, tax filings, and announcements to employees. In addition to signifying good management, having these documents can also prevent unpleasant legal consequences.

Documents for Due Diligence

Many of the documents required for the buyer’s review during Due Diligence should be gathered during the preparation stage, because they are needed to prepare the Offering Memorandum. Examples are three years of the business tax returns and three years of the business income statements and balance sheets. A future article will provide a list of all the documents needed for Due Diligence.

Assembling these documents into binders sorted by subject matter makes the buyer’s Due Diligence effort go smoothly. This is more evidence of good management, making the business more attractive to buyers.

Valuation of Intellectual Property

Owners have the alternative of selling or licensing their intellectual property (IP), rather than selling the business. This may make sense if the IP seems to have more value than the business at the time of sale. If so, calculating the value of the IP is worth doing before trying to sell the business. Methods for valuation of IP are not as settled as they are for hard assets or for entire businesses, but there are firms who perform this service.

All these activities can result in a higher selling price, but they take time to implement – perhaps six to nine months if they are not all undertaken at the same time.

Thanks to Bob Fader for his comments to improve this article! Bob is a Senior Consultant at MidCap Advisors, a nationwide boutique investment banking firm.

Tom Gray helps owners save and grow their companies. He is a management consultant focused on small business and telecom, a Certified Turnaround Professional (CTP), a Certified Business Development Advisor, and a Certified SCORE Mentor. He can be reached at 630-512-0406 or See  For Tom’s new book Business Techniques in Troubled Times: A Toolbox for Small Business Success, see

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