March 21, 2022
In last month’s GaP Insights “Value Killers” - Key Business Characteristics that Erode Transferable Value | GaPAdvisors (gap-advisors.com), we shared five business characteristics that reduce transferable value when selling your privately-owned business. This month we want to share five main deal killers that will stop the sale of a business in its tracks. We’ve often warned that choosing the wrong transaction advisor can be akin to rolling out the red carpet for deal killers. Many well-healed buyers tell us they won’t even look at opportunities presented by certain business brokers and transaction advisors because they know they utilize weak processes.
Below are the five most common mismanaged deal-killers:
1) Business owners having unrealistic expectations regarding the value of the business ordeal terms:
· It’s the transaction advisor’s responsibility to help business owners understand why the market values their business the way it does. It is always recommended to get a current business valuation of the company. Valuations should include external factors such as comp sales, interest rates, credit availability, and alternative investment opportunities available. Those factors are meshed with company-specific factors such as margin stability, management team competence, work pipeline, headwinds and tailwinds in supply, age and useful life of equipment, geography served, credit availability, and much more. If an actual valuation cannot defend the business owner’s value expectation with respect to these influencing factors, the results will inevitably be disappointing. As a result, many businesses fail to sell.
· For example, let's say your business is worth $20M, and it’s been proven it can be sold for that amount through a solid valuation. What about the deal terms? Would you accept a $20M offer that had $4M down, $14M owner financing for 7 years, and $2M in rolled equity? I wouldn’t, but technically that is a $20M offer. Deal structure matters a lot.
2) Sellers or advisors are unprepared for the rigorous vetting process and are slow to respond to buyer inquiries:
· Selling a business is not an over night process. A typical sale will take an average of 6-8 months. Within that period, the time required to share the vast amount of information requested by potential buyers and their capital sources – so that they can get comfortable with the deal – can amount to a full-time job. If your advisor doesn’t have robust processes to build an information repository prior to marketing the business for sale, the lag time for responding to inquiries will be a red flag to buyers and their advisors. Financial data defense, HR metrics, environmental studies, CapEx plans, preventative maintenance records, warranty exposure, and a myriad of other variables can be overwhelming to produce, reconcile, and strategically release when a buyer is waiting expectantly. It pays to prepare well.
3) Unsupported too-good-to-be-true business performance forecasts that fail to materialize during the sale process:
· A critical component of the sale process is sales forecasting. Buyers need to understand how the business will provide a return on their investment, and forecasts set those expectations. However, too rosy of a forecast can prove problematic in a process that spans many months. If you start missing your own forecasts during the phases of courtship, vetting, due diligence, and final steps before closing, buyers will become concerned about revenue stability as well as management’s ability to plan and predict. Conversely, forecasting too pessimistically can produce concern about management’s inability to see and plan for what’s coming. The art of accurate and defendable forecasting is critical in M&A.
4) Loss of a key employee, key customer, or key vendor during the sale process:
· Most buyers in today’s environment are not experts in your specific business. They are what we call “financial buyers” or those looking to deploy capital into existing businesses. (The most common are Private Equity firms.) Thus, reliance on key relationships all throughout the value chain is a necessity for this type of buyer. The business performance risk associated with losing a key person, a large customer, or a strategic vendor introduces substantial uncertainty into the buyer’s probable success. Consequently, they’ll look for the existence and transferability of employment agreements, non-compete agreements, vendor service agreements, contractual relationships with customers, etc. as security that everything has been done to ensure against a critical loss in these areas. The more confidence you can instill that these key components are secure, the less risk they’ll perceive, and their offer and deal structure will reflect that.
5) Undisclosed liabilities, safety concerns, or surprises that have a negative value-impact:
· Look, you know your business inside and out. But business owners often forget to put themselves in the buyer’s shoes when it comes to learning about and vetting a company they hope to acquire. Statements like “trust me” and “it’ll all work out” won’t fly. Your buyer and their capital sources will insist on studying everything about your organization. They’ll often bring in outside consultants with expertise in accounting, HR, equipment valuation, engineering, legal, etc. to help them do a thorough job of evaluating the opportunity. These consultants also serve as a safety net for some buyers who like the idea of having an outside professional opinion as a financial backstop.
· As you might imagine, any information that contradicts previous statements and material on which they’ve relied has the potential to send a group like this into a spiral of concerns that are rooted in questions like: “What else don’t we know?” and “If they misled us on that, where else have we been misled?” This is often a slippery slope that kills a transaction. It is imperative that you and your advisor know and script out the entire process intimately before you embark upon it. This also makes it vital to ensure all information and details are disclosed early and in such a way that no surprises will surface during due diligence.
In our Houston M&A practice, we frequently have buyers tell us the reason they gravitate to our clients’ businesses is because our reputation as a leading transaction advisor gives them confidence regarding thorough sales preparation. This preparation increases the probability the acquisition will cross the finish line. Even for the most seasoned acquirers, buying a business entails a bit of faith that their team has done all it can do to learn about and understand the business, to quantify the upside, and to mitigate perceived risk. Knowing these five deal killers and avoiding them in your transaction will help you go a long way towards ensuring success in the sale of your business.