Three Pitfalls for Sellers to Avoid
You’ve spent years building your brand, your customer base, your revenue, your profits, your company. When it comes time for “Act II” – moving on, selling the business – you want to ensure you get maximum value and the business ends up in good hands.
Seems pretty straightforward, right? Find the buyer willing to pay the highest price, and strike a deal. But not all deals are created equal – and not all deals get to the finish line, or if they do, they can often look different between announcing and closing.
Suffice to say, a lot can happen between deciding it’s time to sell and deal closing – a lot of things that can cost you time, money, effort, or even worse – put the entire deal at risk. A report (see note 1 below) by Valitas Capital Partners which reviewed 25 years of M&A data showed that typically between 4-10% of transactions fail to close – with an average fail-to-close rate of 7.6%. And a June 2020 BCG poll (see note 2 below) of M&A professionals showed that in the early part of the COVID-19 pandemic, 73% of respondents saw deal values being renegotiated during the pandemic, 67% saw deals being shelved altogether, and 55% saw timing slip.
In this post, we’ll touch on three pitfalls for sellers to avoid:
Not hiring transaction experts
Not performing due diligence on the buyer
Not preparing for due diligence
1. Not hiring transaction experts.
The professionals – bankers, lawyers, accountants – don’t come cheap. They can eat a significant portion of your total transaction value. Investment bankers’ fees can cost up to 5% of the deal value in some cases (or even more for smaller transactions). Lawyers and accountants often charge by the hour. Depending on how complex your books and records are, the fees can add up quickly.
But the benefit of bringing in experts can far outweigh the cost in many cases. The right bankers, lawyers and accountants can bring significant transaction expertise and experience, helping you avoid issues that they solve every day, and maximizing the purchase price while minimizing any purchase price adjustments. An example – if accountants produce a quality-of-earnings report at a cost of $100,000 that helps identify or preserve $1 million of deal value, easy to see that’s money well-spent. It’s hard to know in advance whether expert advisors will help you get the best purchase price and minimize deductions – but for inexperienced sellers, they can often be well worth the investment.
2. Not doing “reverse due diligence” on the buyer.
In many cases selling a business is an event that has a long lifespan – sometimes lasting for years after closing, depending on employment agreements, escrow and holdbacks, non-compete agreements, and other factors. Inevitably, you’re going to have a relationship with your buyer for a while after the deal closes, so you better know the buyer well.
For example, as a condition of closing, a buyer may request the seller to stay on board in a management role for a period of time after closing. Or there may be financial incentives – including earnout structures, contingent payments or holdbacks that extend well beyond the closing date.
Before you sign the deal, it’s important to understand who your buyer is. What have they done in prior transactions? Did they pay the earnout to their targets? What have other founders who have sold to them said about their experience? What has happened to the companies they have acquired? Have they flourished under new ownership?
Past behavior isn’t a guarantee of future performance, but it can be informative. If the buyer has entered into litigation with every company it has ever acquired, you’d probably want to know that before you sell to them.
3. Not preparing for due diligence (in advance).
Typically buyers aren’t going to be looking in due diligence for opportunities to raise their offer. Buyers generally use the due diligence process to identify areas of risk and concern – and structure the deal to protect against these items. Buyers don’t like surprises – surprises often lead to increased scrutiny and reduced confidence, and that can translate into a lower final purchase price.
By spending the time and effort to review your own books and records and taking an objective view of the situation, you can identify and anticipate things that a buyer will focus on during their due diligence, and decide on the best course of action. Sometimes the best plan is to address it before the sale but there are also situations where it’s advantageous to let the buyer handle it post-closing.
Either way, you can control the conversation much more effectively when you have a full picture of what a buyer will find when they start looking at the business in detail.
Bonus tracks - and now for the encore, two more potential pitfalls:
1. Letting emotion drive negotiations.
It’s easy to let emotion seep into M&A negotiations. As a business owner, you’ve invested a lot of time, money and effort to build your business. You want a buyer to see this and give you credit for what you’ve done (and therefore pay you a high price). But it’s important to stay focused on the facts, the numbers. That’s how most buyers approach M&A opportunities - calculating the value they can gain through a transaction and paying a fair price for that value.
True, there are often intangible elements that can influence the price paid - but they are usually very situation-specific. The acquisition price for a business is typically grounded in some market basis, like a multiple of revenue or earnings that compares favorably with peers or precedents, a premium to current market price, a return on the capital invested in the past. Don’t let emotion dictate your reservation price, let the market guide you to a realistic estimate of value.
2. Not being specific in defining the earn-out parameters.
Many transactions are structured to limit some portion of the risk to the buyer - and this is often done by tying some of the consideration to future milestones. An earnout can be a way for the buyer to limit risk and the seller to participate in the upside for meeting or outperforming the forecasts. But it’s important to ensure the earnout provisions are measurable, achievable, and objectively clear, so that the only obstacle to earning the additional consideration is performance.
Selling a business can be a complicated process with a lot of unexpected challenges and risks – and these are just a couple of notable examples. But when a transaction is done properly, all parties feel good at the end of the process. The buyer has confidence they’ve bought a good business and know what they have post-closing. The seller feels that they got a fair price that reflects the true value of the business. As we said at the beginning, as a seller, you’ve invested a lot to build your business. Avoid the pitfalls and get the deal you deserve.
Amplify Consulting Services LLC provides support to businesses in transactions and transitions. If you’re considering your future plans for your company, let us help you work through it. We offer coaching through webinars and seminars, hands-on transaction support throughout the planning, prep and process, and will roll up our sleeves to work with you at every step. Reach out and let’s discuss your objectives and let us help you achieve them. Visit our website at www.amplify-cs.com or get the conversation started by reaching out at info@amplify-cs.com
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