Avoiding pitfalls when selling a business

Nation's Business, July, 1998 by Abby Livingston

Once you have found a likely buyer, you'll need to consult a lawyer and an accountant with experience in transactions similar to yours. That experience will give them a good feel for the critical points that need to be negotiated or conceded to facilitate the deal.

Counting on a deferred payment. Many buyers of small and midsize companies ask the seller to accept some portion of the purchase price in the form of a note. But taking a deferred payment has inherent risks.

For one, the buyer may run into financial difficulty and not be able to make good on the note. Or the buyer could allege that the seller made certain misrepresentations--regarding, say, customer prospects or product-warranty expenses--and refuse to pay the agreed-upon price.

"Some sellers may opt for a lower purchase price in return for getting cash upfront," says Steven N. Haas, a partner in the Philadelphia law office of Cozen & O'Conner.

Counting on the receipt of other deferred payments, such as an earnout--a contractual arrangement in which a seller agrees to a lower purchase price in return for an additional payment when certain financial goals are achieved--can also be problematic because you surrender control of the company but remain tied to its financial success.

(Buyers often conclude that the firm's continued success is tied to the involvement of the seller/owner and thus ask the seller to sign an employment contract for three to five years, with the additional earnout--or financial incentive--tied to future performance.)

For example, when Gaylord Layton sold his Denver-based software company--Formation Technologies Inc., which specialized in banking applications--to a bigger, public corporation, he signed a three-year employment contract, with an earnout tied to growth of 30 percent a year.

"But no sooner had I sold the company than the dynamics of the management team changed," says Layton. "Everyone had their own agendas. Out of five people on the team, one or two wanted to make their mark in a big corporation or were just immature. But according to my employment contract, I couldn't fire them. The internal disputes resulted in a lack of sales performance, which resulted in a poor chance of me earning my earnout."

Losing your focus. With all these issues demanding your attention, it's hard to stay focused on the day-to-day details of running your business. That was the case for Charlie Klapperich, former president of Western Building Services in Denver, who merged his firm with 11 other heating and air-conditioning firms last year. (He's now president of the new, larger company.)

"For the six months that it took to do the deal, I had to attend meetings, have auditors come go through the books, and just spend a lot of time in activities that didn't contribute to sales," he says. "During that time, we were going to have a decrease in sales anyway, and I knew that I'd have to contribute more than 100 percent of my efforts to pull ahead. I couldn't do that--and we lost some business."