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How To Sell Stock In Your Company

Stephen D. Simpson, CFA

Starting a business, building it and owning it lock, stock and barrel is a very rewarding endeavor for many entrepreneurs, but it's not always a practical goal. All businesses require capital and some require a lot of it. What's more, sole ownership may be not be the optimal structure when it comes to transitioning leadership or incentivizing workers. Consequently, many business owners find at some point that they need to explore ways of selling ownership in their company.

Reasons to Sell
There are many valid reasons to sell all or part of a business. Selling shares in a business can generate significant cash – cash that can pay down debts, be invested elsewhere or go to charitable causes or heirs. That cash can also go right back into the business, where it can fund expansion. Likewise, selling part of a business can reduce the owner's risk and allow them to diversify their personal assets.

Those aren't the only reasons why an owner may wish to sell shares. Selling shares over time can be a means of preparing for eventual succession and transferring ownership in a way that minimizes the tax shock to the eventual new owners. Last and by no means least, selling shares in a business can be the end result of burnout or an unwillingness to grow the business further.

A Complete or Partial Sale?
The first key question in the process is whether you are looking for a complete or partial sale. A complete sale is pretty straightforward - it more or less ends your involvement with the enterprise (unless there's an employment or consulting contract that continues the relationship). While sales can be structured in a way that essentially offers annuity payments, a complete sale makes sense if the owner is looking to move on financially.

Partial sales are a different matter altogether. Partial sales can be a means of raising capital (trading partial ownership for capital), incentivizing employees or starting ownership transitions. Before contemplating a partial sale, it's very important to consider the ramifications of just how much you wish to sell - sell too much and you become a minority investor, and you may no longer have the ability to control, or at least influence, decisions.

Different Options For Selling
Going Public
For the large majority of business owners reading this, going public is not going to be an option. Pursuing a public listing for your business is the most expensive option and the most demanding in terms of legal, auditing and disclosure requirements. Still, it is generally the best option for raising large amounts of capital and/or maximizing the value of a business.

While a reverse-merger with a shell corporation is a cheaper option (it doesn't technically require a broker/dealer, and the standards are lower), companies that go public via this route often carry something of a "guilty until proven innocent" reputation with investors and analysts.

Selling to Large Private Investors
Companies do not have to go public to attract investment dollars from institutions. While there are limits on the extent to which a company may solicit investors without filing with the SEC (and abiding by certain rules, regulations and laws), it is considerably easier, faster and cheaper to sell shares on a private basis. These sales not only offer the same advantage of raising capital, but the presence of large and well-respected investors can open doors to companies and bring access to future funding, customers and employees.

In most respects this category includes venture capital financing. In venture funding, a business or business owner sells shares to venture capital investors in exchange for capital that the business needs to grow or expand. In many cases, significant share sales to large private investors also require that the company give representation to the investor(s) on the board of directors.

Selling to Smaller Investors
In some respects, selling shares in your private business to small private investors is both more difficult and easier than selling to large, sophisticated investors. On the plus side, it's easier to hand-pick the investors and there are often pre-existing relationships, if not friendships. These investors are also less likely (or able) to force some of the bigger compromises that bigger investors may demand (including board representation and/or the replacement of the CEO (that means you!)).

On the other hand, smaller investors typically have less money and it can be very inconvenient (and legally complicated) to involve enough investors to raise a substantial sum. What's more, less sophistication may seem like a good thing when it comes to fielding pointed questions, but it can also lead to messy lawsuits if the investors don't appreciate what they're getting into (or simply don't like the outcome).

Selling to Employees
Selling shares of your business to your employees is another option to consider. Establishing an Employee Stock Ownership Program (ESOP) is not only a way of increasing loyalty and retention, but it also reduces a business's cash compensation needs – awards or bonuses that would otherwise be paid in cash can be paid in stock instead. What's more, these contributions are usually tax-deductible. While it is possible to create direct purchase plans that actually transfer money from employees to the business for shares, selling shares to employees is not really a practical option for raising capital.

Another significant option to consider is franchising. Although franchising arguably does not belong in this list (as it does not involve actually selling shares of your business to others), it's a significant option in some circumstances. For businesses that are built around providing services, franchising offers a means of expanding the company while using other people's money and retaining control of the strategic direction of the company.

Typically franchising arrangements require a would-be franchisee to pay an initial fee, provide the capital needed to build or open their franchise and then send a percentage of revenue or profits to the franchiser every year. While the assets typically remain the property of the franchisee, the franchise fees and annual royalties represent excellent return on capital for the business.

Important Steps in Selling a Business
To sell shares in a business, an owner has several responsibilities and steps to complete. To start with, establishing a value for the business is critical. This process may require the services of an accountant, independent analyst and/or consultant, and they will expect to be paid for their services (whether you sell or not). At a minimum, an owner should have some idea of a fair value for their business and then solicit multiple bids (at least three if at all possible). If the bids differ significantly from the owner's idea of fair value, it may well be necessary to rethink the assumptions. It's also worth mentioning that private businesses almost always sell at discounts to public companies, but a controlling stake is often worth a substantial premium to a non-controlling minority investment.

It is also important to properly market a business that is to be sold. There are internet sites built around helping owners sell their businesses, but owners need to be prepared to create their own sales materials. At a minimum, a well-formatted, one-page summary is critical, as is a more detailed package for serious bidders. These materials need to include details like the sales, profits and cash flows of the business, a detailed description of the business and other pertinent details, like the assets to be included.

Along with preparing the marketing package, it is important to get the business in order before attempting to sell it. Just like a house needs "spit and polish," so does a business. Make sure that cosmetic details and repairs are attended to, prepare a detailed inventory and equipment list, have multiple years of financial data and tax returns on hand, and proceed with discretion; employees or clients who know that the business is for sale may choose to leave, instead of hanging around to see how the new owner treats them.

Other Details to Remember
There are several other key details to keep in mind when considering selling part or all of your business. Above all else, remember that it takes time; an IPO or venture round of financing takes months to organize and getting a good price for a private business can take a year or more. Patience is vital, the stronger your rush to sell, the worse the prices you'll see.

It's also important to contemplate and plan for the tax and cash flow consequences of a sale. Public companies have higher expenses (auditing, SOX compliance, etc.,) and even a group of private investors may insist on more rigorous auditing or reporting. What's more, if you sell shares with the promise of regular dividends, you had best have the cash flow to support them. Likewise, it is vital to consult with accountants and/or lawyers regarding the potential tax consequences (both to you and the business) of a sale.

Last and not least, don't forget to consider the psychological implications. Are you ready to walk away? Are you prepared to have new "partners" that will be looking over your shoulder at times and questioning your decisions? Having investors in your business makes you legally accountable to others and requires more transparency than a sole proprietor may be accustomed to; these are decisions that are not easily reversed or canceled later.

The Bottom Line
Selling even a small part of your business is a serious undertaking. At a minimum, make sure to be thoroughly prepared and to have clear expectations for the process. Selling shares in a private business can be a great way to raise capital, incentivize employees or bring new talent and ideas into a business, but it requires patience, hard work and a willingness to negotiate for the best price.

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