Selling Your Business: Common Deal Drivers and Killers
One of the most common phrases often heard in merger and acquisition negotiations is: “The deal is done; we’re not buying the company.”
As a rule of thumb, all good deals die seven times. Most business owners are under the impression sales are simple, like real estate transactions. However, that’s an unfair comparison. People tend to be stoic about investment real estate, but when they have dumped their heart and soul and decades of their lives into their business, the selling process is emotional and stressful. It’s not dollars and cents to the seller; it’s personal. To the buyer, the economics have to be just right, the risks uncovered and mitigated to justify an expensive bid. To both sides, allowing too much time to pass will cause all mole hills to turn into mountains. As a result, people act irrationally and walk away over superficial negotiating points, but just as quickly as things fall apart, they can come back together.
Taking your company to market for sale is an emotional and difficult journey at the best of times, and it’s vitally important to put your best foot forward to maximize your value amidst incredible competition. Business owners should engage with an experienced M&A advisor with deal experience. A firm with growth advisory services can assist entrepreneurs in understanding the value of their most valuable asset: their business. After instigating and implementing a plan for scaling the business, an advisory firm can then manage the entire sales process and facilitate a successful transaction.
What kills a deal before it gets started?
While every M&A deal is different, there are key attributes which attract buyers, yet others which could make them walk away. Entrepreneurs are great at running their business, but they rarely look at their company through the buyer’s lens. Sellers must check their ego and objectively evaluate their companies in a new light -the way buyers do. They must ask themselves: “What can we showcase to a buyer? What opportunities will strengthen our sellability and maximize value?” An advisory firm can help the seller understand there’s more to a business sale than hard work and the American Dream.
These common drivers of enterprise value which can kill a deal before it gets started:
Financial performance and Accurate Financial Records. There’s an age-old adage that buyers buy companies which are thriving, not surviving. Strong financial performance year-over-year paints a picture of a healthy, growing company with the opportunity to scale. None of this would be possible without accurate and complete financial records. Accrual-based financials are the language of business, so sellers should consider a financial statement audit, or even hiring a fractional CFO or CPA firm to clean-up financial statements. Financial statements can be seen as the resume for a business. Buyers may walk away when financials appear inaccurate or incomplete.
Missing or Weak Management Teams. All buyers spend a significant amount of time understanding the organizational structure of companies they might acquire, especially the strength and experience of the management team. There are many questions to answer in due diligence. Can management take the company to the next level? Will they stay on with the company post-acquisition? Are there management gaps which need to be filled? Are there egos and conflicts which could derail the business downstream? If the answer is yes to any of these, the seller should remedy this before going to market.
Cash is King. In one case study, a business owner packaged a new line of soy sauces with unique and creative ingredients. He’d expanded his business into Walmart, Target and Kroger, and felt he was “on his way.” But he had a cash flow problem. He’d negotiated a contract with his overseas suppliers for 50 percent down upon order and 50 percent due when shipped. His customers paid net 45, which wasn’t bad in the retail sector, but he was upside down from a cash flow perspective. He’d been advised to renegotiate his supplier contracts with better terms and talk to his bank about a revolving line of credit, but ultimately, it was too late. He wanted to sell his business, which had strong revenues, but any serious buyer would walk away because of the cash flow problems.
Market Attractiveness. In his book The Purple Cow, Seth Godin talks about what makes a company a unicorn in a crowded landscape. In business, if everyone is a brown cow, it’s hard to get noticed. Nothing separates you from your competitors. But a purple cow in a sea of cows stands out. In another case study, a commercial cleaner developed a simple solution to an industry problem. She billed her cleaning services a month in advance. It gave her a considerable advantage over competitors. She was paid before the work was done. Competitors did a month’s worth of work, then invoiced the following month on net 30 terms or worse. It was an amazing and simple change which paid off in a lucrative exit for the business owner.
Owner Shackles. Businesses dependent on their owners can be essentially worthless. Unless the owner wants to work for the buyer for several years after the sale, buyers may walk away before making an offer. Most entrepreneurs start their companies as the expert in what they’re selling. As the “hub”, key customers may know them by name, and employees go to them with problems. Buyers look at this and know the business cannot run without them. To sell for maximum value, it’s essential business owners delegate authority to employees and management, and cross-train teams so there’s no gaps in performance.
Automatic Customers and Recurring Revenue. This is a highly sought-after value-driver buyers want – companies which have 50 percent or more of recurring revenue. These businesses seemingly run themselves, as the customer base is under contract and automatically pays monthly or annually, like a cell phone contract. Buyers know this can easily calculate future revenue streams. It’s an attractive business model, and buyers will compete to buy. With a little creativity, something new could make business owners stand out amongst their competition.
High Concentration. Buyers are leery when a large percentage of revenue is from one or a few key customers. The school of thought is 15 percent or more. It’s concerning when a business procures goods/services from one or a few suppliers. In the same vein, it’s a red flag if the owner is reliant on one key employee. Buyers proactively root out these significant business risks.What if the customer goes away? What if the supplier misses shipping dates or the quality of the products/services declines? What if the supplier raises prices? What if the key employee demands ownership, profit sharing or threatens to walk away? All of these questions can cause a buyer to walk away.
When deal fatigue kills the deal.
More common complaints from sellers: “I’m done; it’s obvious the buyer can’t do the deal. There’s something the seller’s not telling us. They’re lying, and we’re missing something. We should just kill this thing.”
These are real statements from buyers and sellers, and they’re a far cry from the honeymoon period when the letter of intent was signed. At the beginning of a deal, everyone is excited and a sale feels imminent. Diligence starts, and everyone assumes the exclusivity period negotiated in the LOI is a fair closing timeline. Yet things never seem to go exactly according to plan. There may be problems with the financials and contracts, outside consultants could flag items, and numerous other complications could arise. Suddenly, a 90-day timeline has become 180 days.
On average, there’s approximately 90 days of goodwill between a buyer and seller in the deal process. If the letter of intent negotiates 90 days of exclusivity, as the deadline approaches, stress and buyer/seller fatigue sets in, and parties begin to assume the worst. Both sides must work to keep the deal on track. Middle-market deals take a minimum of 4 months, and often take 7 or 8. Managing competing personalities and emotions keeps everyone pulling in the same direction.
As many as 90% of M&A deals fail to close for maximum value. Worse, the majority of these businesses stay on the market tied to a contract preventing them from pursuing other opportunities. Among the 10% who sell, 75% of them aren’t happy about it a year later and regret how the process unfolded. It’s important for sellers to keep a level head, leave egos and personal feelings out of the equation, and refrain from burning bridges. Inadequate deal-making, poor presentation and lack of proper planning could derail a deal and at reduce the sale price. Closing the gap on common deal-killers before going to market is vital to a successful and lucrative exit.
By Steve Conwell and Jude David
Steve Conwell, CEO of Final Ascent, is an accomplished entrepreneur with over 25 years of business advisory and financial consulting experience. Steve is passionate about helping business owners creatively tackle their biggest challenges and successfully grow their businesses to a lucrative and successful business exit. Throughout his career, he leveraged Big Four public accounting, internal and IT audit and controls experience with Fortune 500 and middle market companies, always returning to his entrepreneurial roots.
Jude David is Vice President, Mergers & Acquisitions with Final Ascent. As a Louisiana native turned corporate attorney and investment banker, he is a passionate about helping business owners achieve organic growth while also strategically planning for an exit. His specialty is the art of the acquisition, focusing on finding the right buyer, negotiating a deal that creates maximum value for everyone involved, and setting business owners up for a lifetime of success after the sale.