Harvey Lee

Harvey Lee is the vice-president of The Summit Group. He has a degree in economics and a graduate degree in accounting. He has been a businessman for 25 years, starting, managing and owning numerous companies. The Summit Group grew out of Campbell Saunders, which has been in business for 25 years, restructuring business selling. The impetus to launch The Summit Group came from the analysis of the baby-boomer generation – which has shown that boomers who own businesses are en masse getting ready to sell them in preparation for retirement.

Don Sihota

Don Sihota is a partner with law firm Clark Wilson LLP (www.cwilson.com). He practices in the area of mergers and acquisitions and business succession planning. He has been practicing law for more than 20 years and has a large amount of experience in helping people buy and sell businesses.

The economy’s good right now. Is it a buyers’ market or a sellers’ market in terms of selling a business?

Harvey: At the moment, I would say it’s neither; it’s about half and half. Our thinking is that in five years’ time it will definitely be a buyers’ market. Statistics show that about 70 per cent of small- to medium-sized businesses will be for sale in next decade.

David: The implication is that it is probably a good idea to sell now. As soon as it becomes a buyers’ market, it will lower the value of your business. Fewer people looking for more businesses are going to drop the price. When it’s a buyers’ market, the price will drop.

Don: I agree with that analysis. I’ve done the statistical research. I’ve seen that today approximately 26 percent of business owners are over age of 55. Eight years ago, it was 18 percent. The number is growing rapidly. Another factor to consider is that the scarcity of labour is going to drive up costs over next five to 10 years. It’s going to drive down profits and therefore prices.

Does the economy affect when it’s a good time to sell a small business or does it not really matter?

Harvey: The economy is hugely important. When a buyer buys a business their goal usually is to pay off the financing they took on to purchase the business. Their goal is to try and pay it off in five years’ time. In a strong economy it makes sense that a successful business will continue to be successful during those strong times. If suddenly the economy weakens, chances are the earnings of the business will go down, and the ability to reduce the debt will go down.

During tough times, credit terms go up a lot. Interest rates don’t necessarily go up. But the risk-reward ratios that banks use, change dramatically. We’re actually seeing a little bit of that right now due to what’s happening in the United States. It’s better to sell during strong economic times.

Can you expand a little on the analysis of the baby boomer demographics you touched on earlier?

Don: As I mentioned previously, the statistics show that year-over-year, more and more baby boomers are getting to retirement age. Baby boomers who own businesses have a different situation to deal with than do baby boomers who are employees. Business owners don’t just retire and collect a pension. Business owners must realize on the value of their business in order to fund their retirement. The danger for these business owners is that if they wait too long and don’t plan for succession, they may not get as good a price when they do decide to sell.

What are the different kinds of sales transactions that people use when buying or selling? What do they typically look like? Is it a complete bank loan to buy all in one shot, or is it a management buyout?

Don: There are basically three ways to sell a business. You can sell to a third party, so a buyer comes along to buy the business. You can sell to an employee or management group. Or, you can pass it on to your children. Within those groups are different types of buyers. For example, a strategic buyer or a financial buyer. So anybody who’s thinking about selling has to consider those options and determine which is best for them.

When should a business owner start thinking about selling their business?

Don: Planning is always important. Anyone who is in business should be thinking of their exit strategy. In fact, on the day you start your business you should be determining your exit strategy.

If you’re a business owner who is 55-years old and you haven’t started planning your exit strategy, there’s a limited time-frame to plan, so you should start now. You will require legal, tax, and business advice to get the business to the stage where it is a saleable entity and can be sold in a tax efficient manner. Therefore, any business owner who is over 55 should definitely be planning for business succession.

Harvey: At least two years ahead. Even longer is better. There are certain rules that the Canada Revenue Agency has to do with divestiture of businesses; the tax rules are quite different if it’s beyond two years versus within two years. The way you restructure a company: for example, if an owner owns real estate from which the business operates, they will want to get tax advice on whether the company should be separated for sale purposes; it can make quite a difference on capital gains tax.

So we always suggest to people, start thinking about this a number of years ahead. Another factor is: is the business ready to be sold? Is the owner too important within the business, such that when he or she sells and leaves, the value of business goes down dramatically because of the relationships that owner has with their customers, suppliers, or employees? In that situation, that owner has to take steps to ensure the ongoing success of the business; perhaps hire a general manager, or promote from within.

David: One of the ways it works is to have the existing management buy the business. Most owners will think that their staff aren’t paid enough and don’t have enough assets, but the reality is they can. For a number of reasons: one, the people who are going to be lending money to a venture love the fact that management is buying it. They’re the people who have been running it anyway; the fact that there’s no change reduces the risk to the lender, so there’s an appetite out there in the lending community to provide loans for these management buy-outs.

So you can get three layers of financing going with this situation. You can borrow term debt, typically from chartered banks; the next debt layer is called mezzanine or sub-debt, which is slightly more expensive and secured differently. And finally, we often find that the owners in a management buy-out have to provide some vendor financing to make the transaction work. The reality is that a lot of owners don’t believe their management has the financial wherewithal to buy their business. We’ve been able to create situations where management can buy using their own capital, borrowing funds, with the price difference being made up with the vendor take-back.

Harvey: Also half the files we’re handling now are management buy-outs.

Is that because the banks look more favourably on it?

Harvey: It just happens to be that way. It’s not that we’ve created that situation. Owners have come to us saying they want us to facilitate a management buy-out.

David: Often, employees become almost like your family, and a lot of times the owner would like to do whatever he can to give his employees the opportunity to enjoy the success he or she did.

What are the different kinds of agents who can help an owner with the sale of their business?

Don: You need a team of people to work with. You need a sales agency person or a financial advisory person, which is Harvey and David’s area, you need a lawyer, you need an accountant. You need to have tax advice, which sometimes comes from the accountant and sometimes from the lawyer.

Harvey: A real-estate agent would be required if there’s real property involved.

Would you guys be considered brokers?

David: I think there’s a brokerage community that does this sort of thing. We don’t like to describe ourselves as brokers; we like to describe ourselves more as facilitators. We have relationships with tax accountants and lawyers. We’re not hand-holders, but we’re helping the owner, we guide him through the process. We manage the process and we like to think we’re more facilitators than brokers.

Harvey: We call ourselves “business transition specialists.”

For a business owner who’s selling his or her business – say the business has a value of $2 million – what should they expect to pay in commissions and fees on the sale of the business? What kinds of fees would an organization like yours charge?

Harvey: All total, including our fees and an estimate of what they’d have to pay for in tax and legal advice as well as the cost of documenting the sale, they could expect to pay up to 10 percent of the proceeds. It could be higher or lower depending on the complexity of the transaction.

David: Typically The Summit Group will charge a relatively nominal work fee for a couple of things. One is to show good faith in the fact that there’s commitment to do the transaction, but also to compensate for the work we do in preparing documents and managing the process. At the end of the transaction, once it’s successfully completed, we also charge a success fee, which is a percentage of the proceeds. The work fee is deductible from the success fee. The work fee is generally in the range of $10,000 to $25, 000 and sometimes higher depending how complicated and how large the deal is.

Don: I’d also like to point out that fees are important because you need to get the proper professionals to help you. If a person is selling their business, and this is the largest asset they have – $2 million, $5 million, $10 million– they really need to make sure that they get the proper professionals to help them. Sometimes I find people are too focused on how much it’s going to cost, but when you weigh that against how much you stand to lose, it’s a significantly different consideration.

How do you go about determining value for the company? Say a client walks in and asks, “Okay, how can I evaluate my company?”

Harvey: A client always wants to get a really range on the value of their business. There are a number of ways for them to obtain an estimate of value. Firstly, they could ask the opinion of their outside accountant or the outside accounting firm that does their financial statements. They may have someone in-house who can offer a valuation. Also, there are firms called Chartered Business Valuators, and they specialize in valuating businesses.

At the Summit Group, because this is the business we’re in, we have a reasonably good feel for what businesses are selling for, and so we can offer an opinion. We’re not Chartered Business Valuators, so we can only offer an opinion of what our thinking is about the value of a business. There is something that we always emphasize to business owners: we can sit and talk all day long about what we think the business is worth, but the amount of money the buyer can borrow is really going to set the terms of the deal, and possibly the price of the deal. For example, if a business is offered for sale for $2 million and the buyer’s bank says it’s worth $1 million, the bank is only going to loan money based on their valuation of the business.

So, ultimately it’s the bank that’s going to call the shots?

Harvey: In many cases, yes. They are a hugely important factor in determining the final price and terms of a business sale.

David: Not only the bank, but all the people who are dealing with money. Arguably, a business is worth what you can borrow and what you have in terms of cash.

If you were selling your house, you could go to the bank and get a professional valuator to give you an assessment, but a lot of times your realtor will just say, “I think I can sell it for this.” That’s kind of what we do, kind of a drive-by assessment.

Is that based on EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization)?

Harvey: That’s part of it; it’s a very complex analysis. The amount of cash flow that a business produces is a hugely important factor, and that involves a lot of analysis. Also important is the type of industry the business is in. If it’s an industry that is disappearing through, perhaps, technology, that’s a business that’s not going to be worth very much and it could be that no one is interested in purchasing it.

If it’s a business very reliant on the owner’s relationship with customers—that business is going to be worth much less. If it’s a business that relies on generating revenue by virtue of obtaining its next contact, like some construction businesses, that’s a business that is not worth as much as one that has contracts that go on for five years, and therefore has an almost guaranteed revenue stream.

What are the keys to getting top dollar for your business? What do you do in terms of telling your client how to get ready for sale and making it?

David: Sometimes it happens that a business owner approaches the decision to sell and the owner’s been running this business for 25 years, and of late has not always been on their game. They have not had a lot of growth ideas lately, or there are some obvious growth strategies but, for one reason or another, they have not moved in that direction.

In many cases, the ideal thing would be to execute a growth strategy so the owner can demonstrate the growth success, and that the company has been hitting certain financial targets. The seller should always identify areas for growth, so the buyer knows the business has growth potential.

Don: Business owners should de-personalize the business. Minimize the amount of business that relates to the individual, and make it into a commercial organization. Make the business into a “turn-key” operation: when you sell it, you hand the keys over, the new owner opens the door and the business is still going to run the same as it was the day before.

From a legal perspective, business owners should think about what happens when they have named the business after the owner. When the business is sold, the new owner is going to want to buy your name. So you might want to think about rebranding, unless you want to be selling your name to a buyer who will operate the business under your name. That happens more often than people realize.

Harvey: The other things we see are that the records of the business are often not current, nor are they very detailed. Business owners should make sure that their financial records, and any other important records of the business, are right up to date and go back a number of years. That shows a focus on running a business professionally. That’s very important, as Don said, to depersonalize the business, to make it appear more professional.

Have management that is deeply involved in managing the business, managers who are familiar with the customers, the suppliers, the bankers, that type of thing. Then that business can potentially attract an investor who wants to buy it but doesn’t necessarily want to manage it, and holds it as an investment. Without that management depth, it immediately precludes the investor-buyer, and you’re shutting off a big part of the market.

Don: I agree with Harvey that ensuring the books and records are accurate and up to date is important from a legal perspective. The same attention should be given to all the contractual relationships for the business. Sometimes there are no written contracts in place but a buyer wants to see some tangible evidence of these contractual relationships. The buyer needs to be assured that the contracts are going to continue after the sale. Therefore, the business owner needs to look at contracts with suppliers and contracts with customers and try to get them in writing if possible. Sometimes there will be written contracts in place, but they may have onerous provisions in them. Such provisions can cause problems for the seller and it is important to have identified and dealt with these issues in advance.

What’s a common mistake that a seller typically makes when they walk into your offices for your services?

David: That the process will be quick. The mistake that people make and that I always hear is, “This is a simple transaction, my company’s very clean, and it’ll be done in a week or in a month.” Every company is different, every situation is different. I’ve never seen an absolutely clean business that doesn’t need some professional lawyer or accountant or tax adviser help.

So how long does it typically take to sell a business? What’s the fastest, what’s the slowest, what’s the average?

Harvey: There’s always the extremes, where you can close a deal in three weeks or three years. We tend to find it takes between six and 12 months, and it depends on the time of year. If the deal is occurring through the summertime, that will slow it down because there is always someone who is part of the process and is away on vacation.

David: It is generally the purchasers who take a long time, because they’re going to be taking on the risk. Also, a lawyer who’s acting for a purchaser has to conduct due diligence, and a lot of times that means contacting government agencies that are just not interested in responding or their response process is lengthy. It could be six weeks before an answer comes in.

These delays have to be built into the process, and the buyer has to decide; are they going to buy the business without the response from the Canada Revenue Agency that there’s no tax owing, or are they going to wait the six weeks to determine whether it’s clear?

Is there anything you gentlemen would like to add in closing that we didn’t really cover that you think it’s important for businesses to be aware of?

Don: When someone is selling their business, they should be aware that there are two ways to it, by way of a share sale or by way of an asset sale. Each of these two methods will have different legal and tax implications to buyers and to sellers.

For example, in a share transaction, if the individual owner has 100 common shares in a company that individual will sell those 100 shares. As a result the entire business will be sold just by selling those 100 shares. In an asset transaction, the seller is the company, not the individual owner. The company sells its assets, and the sale proceeds end up in the company. For the individual owner to get those sale proceeds in his or her hands, they must pull the sale proceeds out of the company and there are tax implications to that.

David: The reality is that every owner, from a tax perspective, would probably prefer to sell shares, and every purchaser would probably prefer to buy assets. So it’s always a little bit of a negotiation.

In conclusion, I would say to people in business getting into that age group, they should at least start thinking about selling, they should start learning about selling and they should start talking about selling with their family and advisers. It’s not simple; it’s emotional, and if you’re starting to hit 50, you should be thinking about this very seriously. We spend a significant amount of our time just talking to people in this age group. We’re happy to talk about the process and help them understand the process without charging a fee.

If you just come in here and talk to The Summit Group about selling, or buying, that is something we’re happy to do. You need to get that process started, and the best way is to speak to somebody about it.

Harvey: If people want to learn more about selling, they should come to the seminar that Don and I are putting on April 17th.

They can contact Jessica Mitchell at jcm@cwilson.com for more information.