How To Set Up Your Business So You Can Sell It
by Kira Harris, FMZ Business Brokers
I’m a business broker, and I talk to a lot of people who want to sell their web businesses. As with all service based businesses, I encounter my fair share of lovely clients and my fair share of people that make me want to drink heavily.
Many of the clients in the latter category are perfectly nice people, but looking at their financial records you’d think they let their five year olds keep the books. Or, even worse, they don’t HAVE books, or they did everything in cash, or they thought it would be just as easy to sell a business that’s been closed for five months as one that’s currently running. Don’t be one of those people!
One of my favorite clients ever had a small online retail shop and produced items from his basement – not much to look at, but he had perfect financial records, an easily transferable business entity, good documentation of his contracts with his workers, and I sold it in three weeks. Below, I’ll explain several steps you can take when starting your business to become one of the clients I dream about (and, oh yeah, net yourself a better sales price and easier transition when you do sell.)
Quick note! A lot of people think “Well, this one won’t apply to me. I love my business and I would never sell it.” A cursory glance through the tabloids show that we humans are not very good at estimating the chances of love lasting. But even if you truly don’t think you’ll ever sell, it DOES NOT HURT to set up correctly from the start.
Most of the guidelines I have below will be more helpful if you want to sell, but they are also very useful in many other circumstances such as being able to assess profits correctly, not getting your house taken away in a lawsuit, or bringing on new investors with less headache. Also, most of these tips are not going to cost you much, if any, actual cash money – so there’s really no reason not to do them. Taking some extra time now can save you a lot of headaches later on.
Choosing A Business Structure
When just starting out, a lot of entrepreneurs get stuck on the issue of how to structure their business. The most important thing is not what structure you should elect, but that you set things up in the name of the business from the start. Many people just start up their business and put everything into their personal names, using their personal email accounts and Social Security numbers, and only later think about setting up a business name or starting an LLC for their business.
Sole Proprietorship – In the United States, all income of any kind is potentially taxable income. If you earn any money outside of a regular W-2 job, you’re considered a business owner and must file a Schedule C with your taxes. So really, doing any kind of business activity is technically considered “starting a business” in the eyes of the IRS.
Sole proprietorship under your own name is the default setup for all businesses that don’t otherwise declare as something else. If your business is very small – for example, you’re selling handmade items at craft fairs – you probably don’t need to set up anything more complicated. However, this structure is really not very transferable to someone else. If your business grows, you will probably want to change to another form.
LLC – An LLC is a limited liability company. Technically, the purpose of forming an LLC is to protect yourself from liability – so if someone gets sick from a cookie that they bought from your LLC, your personal assets wouldn’t be at stake. In the real world however, an LLC is the easiest way to give your company a formal structure.
Most states have relatively low fees for creating an LLC, and you can apply for company credit cards and open bank accounts in an LLC’s name. This is a great choice for most simple businesses, and it makes transferring accounts much easier. For example, Amazon does not permit sellers to transfer a personal account, so if you started your Amazon account under your personal name, it’s sometimes dicey to transfer it to a new person. However, if you open an LLC and then start the Amazon account under the LLC’s name, you can transfer the LLC to another person and they will be able to transfer without a peep from Amazon.
LLCs can’t be transferred outside the state, so if you sell to someone who lives outside your state, they may need to set up a registered agent within your state who can take care of the LLC for them.
You can set up a sole proprietorship LLC if you’re by yourself, or set one up to accommodate multiple owners/shareholders. It’s quite flexible.
Corporation – S-corporations and C-corporations have their advantages, but are generally not a great choice for a small business. They are more complicated to maintain and pay taxes on. If your company grows larger, in most states you can convert your business to a corporation later on.
Acronyms You Should Know About
Employer Identification Number (EIN) – No matter what structure you choose, every business should have an EIN, or an Employer Identification Number. It doesn’t matter if you’re actually going to employ anyone or not! The EIN is basically your business’s Social Security number. It’s free to get (don’t you dare pay anyone to do it for you) and you won’t need to put your own SSN on most things if you have one.
Doing Business As (DBA) – Whether you are running your business as a sole proprietor under your own name, or you have a formal business structure such as an LLC, in most states you can apply for a DBA. So you could set up something like Katie Smith DBA Yarn Nanny if you were operating under your own name, or Smith Enterprises LLC DBA Yarn Nanny if you had set up an LLC. The point of a DBA is to reserve the name for your use and establish its linkage to you (as well as more mundane things like being able to cash a check made out to your company.) You can have multiple DBAs under one company umbrella.
TL;DR: When in doubt, create a sole proprietorship LLC, name it after your business, and get an EIN. Done.
Setting Up Your Finances
The one thing all of my best clients have had in common is flawless books. And I don’t mean that they paid an accountant a ton of money to do their books, or even that they used professional software (though old versions of Quickbooks are dirt cheap and work great, yo.) All I mean by flawless books is that the business has its own, separate accounts and all of your income and expenses are run through them.
Let me explain a bit here. While you may feel married to your business, you shouldn’t have a joint account with it. Your business needs to have its own separate bank account and PayPal account (if needed.) Any money you earn needs to be deposited into that bank account – even if it’s cash.
On the flip side, any expense that the business racks up needs to be paid from that bank account. This will keep everything together and allow us to create the most comprehensible financial statements when you want to sell the business. Too many business owners just deposit all the money into their own personal accounts, and then pay all the expenses out of their accounts, and are just happy if there’s some left over. This is madness!
I’m not trying to say that all your expenses will be covered by your income. This is in fact quite unlikely at first, and if you always run your businesses this way, you should probably just write a book instead. Most people put their own money into the business at first, and then, not too much later hopefully, they take some back out. To keep me from tearing my hair out when I look at your books, and also to keep yourself out of huge trouble with the IRS, you need to make money moving from your account to the business’s account and back be trackable.
The short answer here is that if you are putting your money into the business, write your business a check. If you’re taking money out, have the business write you a check. DO NOT UNDER ANY CIRCUMSTANCES have this mental conversation with yourself: “Well, I need to buy a new TV. The company has some money in the account. I’ll just use the company debit card to buy the new TV.” No! Noooo! Do not do this. Write yourself a check for the amount of the TV, and buy it with your own debit card.
Also, don’t think that hiding expenses or failing to present a true picture of what the business spends will help to sell your business. Buyers are actually quite nervous about a business that appears to have too much profit relative to expenses – it looks like you’re not being fully forthcoming. Understanding what the business needs to spend money on is also helpful for understanding the business’s inner workings and processes.
Finally, keep some kind of record of all your transactions. Excel is fine, as long as you keep it simple (I once had a client color code his transactions and put the dollar amounts in random columns.. that was not fun.) If you’re running all your transactions through one bank account, you can just download them once in a while and categorize them and be done with it. It will make your life a lot easier come tax time as well.
TL;DR: Keep your business’s money completely separate from yours, run all income and expenses through one bank account, and record all your income and expenses somewhere.
Pay Your Damn Taxes (And Otherwise Stay Legal)
One red flag that makes me wary about a new client is if they haven’t paid their taxes. A lot of small business owners try to fly under the radar of the IRS, or just hope they’re small enough to not attract any attention. And you’re probably right – the IRS is underfunded and more interested in people with a lot more money than you probably have. And yes, trying to make sure you get your sales taxes paid and your quarterly estimated taxes paid and your wombat taxes paid and God knows what else can be confusing. But. That does not give you any kind of free pass to just not get your stuff done.
I sign a confidentiality agreement with all my clients, so if you haven’t paid your taxes, I won’t turn you in – but it WILL make it much harder to sell the site. Buyers want to ensure they won’t be inheriting a huge mess, and while a sales contract can stipulate that any financial dealings from before the sale are your mess, the IRS might take years to absolve the new owner of your misdeeds.
Buyers are also on the lookout for other kinds of legal issues that might crop up – for example, if you hire an artist to create posters that you sell, have them sign a work for hire agreement. This is a simple contract stipulating that even though they created the piece, they do not own the copyright or have any other claim on it. Most artists won’t have an issue doing so (it’s usually implied, if you aren’t paying them royalties) and it’s a great thing to show buyers. If you need stock images, obtain them legally. There’s too many places to get cheap or free stock images to justify stealing pictures off Google. In general, buyers want to see that you are an upstanding sort of individual whom they can trust, because in the end, they won’t buy it if they don’t think they can trust you.
As you build your business, think about what you’re bringing to the business that someone else might not have. How would the business survive without the skills, connections, and institutional knowledge you’ve built up? This is sometimes referred to as “hit by a bus” planning (jokingly, one hopes) because if you are suddenly incapacitated, it is crucial that you have plans to keep the business running.
I require all my sellers to write a handbook detailing exactly how to carry out day to day business activities, as well as advice on marketing techniques, where to order supplies, contact information for vendors and freelancers, and anything else you know that they don’t. I ask the sellers to begin writing the handbook as soon as we list, because it takes a long time to write a good one. I flipped several businesses before I became a broker and my handbooks were often ten to twenty pages long, even for fairly simple businesses.
The handbook is a terrific talking point for buyers – it makes them feel like you’ve really thought this through and have prepared well to sell the business. Having all this information in one place also makes handover much more organized – if you have all of your passwords in one place, you can just give them one document. But mostly it helps you, the seller, because you don’t need to answer ninety bajillion simple questions. Remember, the buyer won’t have access to your emails, so they can’t just look it up if they don’t know who designed your website.
Even if you’re not planning to sell, having a handbook of contact info and logins is immensely helpful if you do actually get hit by a bus (or eaten by a velociraptor, what have you.) It’s a bit of a task to go back through all your activities and get contact information for that one guy who designed the t-shirts three years ago in case you need to contact him again – much easier to do it as you go along.
Business Sellers Are Very Different People Than Business Buyers
Something I always try to keep in mind when talking to buyers is that they’re quite different than you and me. Entrepreneurs are generally younger, have less cash on hand, and are more willing to take risks than buyers. If you’re a typical young entrepreneur who’s started one business and is already looking to start a second, you won’t have a lot in common with my typical buyers: 40-65 years old, well established in their careers or retired, and looking for something that’s a bit fun and makes some money. Smaller businesses are often purchased as a sort of self-sustaining hobby by these buyers. Consider that probably none of your entrepreneur friends have $40k cash in the bank, and you get one part of the difference there.
But the most important difference is the appetite for risk. Just by dint of your willingness to start something new, probably without knowing much about it, and seeing how it goes, you’re exhibiting a much greater tolerance for risk than any buyer I’ve dealt with. Buyers want to run a business without having the regular heart attacks that any budding entrepreneur is subject to – mostly, how do I know this is going to work? They’re buying your business because you’ve already proven it works, to some extent. After all, if you had failed, it wouldn’t be for sale!.
So the whole point, the end game, of having well-organized finances, a great handbook, and clean taxes is to lower the risk in the buyer’s eyes. A business that is easy to sell is one where the buyer can be pretty confident of how the money comes in and where it gets spent, has a good understanding of the operations and feels they can operate the business using your instructions, and trusts you won’t have left any nasty surprises for them to uncover later. Those are the businesses I salivate over, and buyers will too!
Got questions? Contact me for more info at [email protected]!