Why Do Deals Die?
Not all relationships end happily ever after. It’s true in life, and true in business – not all M&A deals close.
You’ve signed the NDA, gone through due diligence, maybe even executed the Letter of Intent – and all that’s left is final due diligence, any regulatory reviews, and contract negotiation. But you still have a significant risk of the deal falling apart.
According to Statista, there were 49,849 M&A transactions completed in globally in 2019 (note 1 below), a near-record number at the time. (We’re a small group here, can’t afford more recent data quite yet!) But despite these sizable numbers of happy company marriages, the fact remains that around 25% of transactions fail to close in a given year (note 2 below). Many of these breakups go unreported, so it could be an even higher rate.
So what happened? Did the seller get cold feet? Did the buyer find a concern in due diligence? Did a legal issue arise unexpectedly? Did a better offer come along? Any number of things can derail a transaction, and some are harder to protect against. No one bet on “global pandemic” entering 2020, but it sure reset things quickly.
The TL;DR version – something changed.
The buyer and seller entered discussions understanding their own priorities, and some idea of what was important to the other party, plus what lenders, investors, other parties involved in the deal cared about. But somewhere along the way, something changed. Something changed for the buyer, something changed for the seller, something changed for someone on the periphery of the deal who still has influence over the outcome of the transaction.
While there isn’t reliable empirical data on the reasons why M&A deals get pulled, we can share some anecdotal experience from the field. This is not a comprehensive list – we’ve intentionally passed over a couple and probably just missed a few others here. Get in touch if you want to discuss your unique experience.
In the meantime, let’s explore a couple selected deal-breakers, plus some bonus tracks:
Buyer’s Remorse (before actually buying)
Seller Pulls the Plug (cold feet)
Misalignment on Valuation
Bonus Tracks:
Regulatory Issue Emerges
Financing Falls Apart
1). Buyer’s remorse (before actually buying).
For any number of reasons, the buyer decides to move along. Maybe they found an unexpected risk in due diligence. It’s possible, too, that the buyer identified a stronger target while getting to know you. Remember, a buyer is putting capital at risk, and that capital needs to produce an acceptable ROI. In the case of a financial buyer (e.g., PE firm), the capital at risk is often not even the financial buyer’s capital at all – it’s coming from lenders, limited partners, capital markets. That changes the risk profile of a deal to a buyer - worry about your own capital contribution but also ensure the lenders and other investors don’t lose money.
One recent example: during final due diligence, the buyer was finally given the opportunity to review the seller’s customer contracts, and learned the contracts allowed the customers to cancel unilaterally upon a change of control. All of a sudden these long-term contracts, the same ones that gave the buyer confidence in the seller’s revenue projections, looked less certain post-deal. The buyer could be forced to renegotiate all the key customer relationships, which could dramatically change the financial profile. The parties couldn’t agree on how to share the risk on this item and the deal evaporated.
For the seller, the best way to protect against a buyer walking away is to be as open and transparent as possible in due diligence – don’t offer any surprises that make the buyer rethink their commitment to the transaction.
2). Seller pulls the plug (cold feet).
For many business owners, especially those owned by founders or families, selling the business is a process filled with emotion. Some have their name on the front door or building signage, and while they know it’s time to move on, they have a hard time letting go. In other cases, the final terms offered may be unpalatable for one reason or another. As a seller, it’s important to give some thought to the questions that will persist throughout the process – what will you do when the business is sold? Is now the right time for you personally, in addition to the market dynamics question? Are you ready and committed to move on if the price is right?
3). Misalignment on valuation.
This one’s tricky but we’ve seen it more than a few times. We’ll spend a little more time here, since this story is pretty common.
Classic example - the seller hires a financial advisor (investment banker) to market the business to potential buyers, and gives the advisor a view on their reservation price – let’s say $100 million. In our example, the advisor knows that the likely buyers won’t pay $100 million – it’s out of line with the multiples seen in precedents, which imply valuation in the $50 million range.
But the advisor might lose the mandate to sell the business if they tell the seller the “uncomfortable truth” – that their expectations are out of line with the market. And besides, maybe one buyer will be willing to pay a big premium because this is a “must-have” deal…right?
(It can be quite hard to predict buyer behavior when there is some element of scarcity value to a company or its products or technology. So we’re saying…there is a chance… But we digress.)
The parties continue on, bids come in, but at an unexciting level, say $60 million. It’s better than the advisor might have feared, but not close to the seller’s reservation price. Seeing their contingent fee quickly vaporizing, the advisor urges the seller to keep moving forward with parties who’ve bid, and encourages the seller with a message along the lines of, “we’ll tell the buyers their bid is not high enough but that we’re willing to keep them in the process so they can better understand the business through due diligence and revisit their bid - upwards.”
The hope, however unrealistic, is that a buyer will raise their bid through the due diligence process. Either because they find some hidden gems, or because they get a sense for heavy competition in the sale process. (In our experience, a competitive deal process can actually lead to an increased bid if the process is managed well. But it’s not at all certain.)
Often, if the seller’s expectations are unrealistic based on market dynamics, the story will end with the buyer not getting close to the seller’s reservation price, no one happy and no deal done.
It doesn’t matter what you think your business is worth if no buyer will pay that price.
As a seller, manage this risk by doing homework on the market. Find the relevant deal precedents. Understand what “x-factors” drive buyers to pay more or less than the market rates in these deals. And take an honest look at your own business and see how it compares.
And conversely, press your advisor on what valuation they believe is truly achievable and what needs to happen to reach it. (If they won’t answer the question directly, look at how they’ve structured their fees for clues.) If your advisor tells you a lightning strike is needed to get $100 million, you may need to reset expectations to a lower threshold.
Bonus tracks: Outside influences on deal closing
4). Regulatory issue emerges.
This is somewhat situation-specific, but it does happen. One typical condition to closing deals is to clear any anti-trust concerns. Failure to clear this hurdle can lead to the deal being shelved altogether, or the buyer being forced to dispose of one or more business units to gain approval. This one falls to both the buyer, who should explore the risk of failing to gain approval, and the seller, who needs to raise this question with the buyer early on in the process.
Buyers will typically examine the potential for regulatory issues with their advisors early in the process – they don’t want to invest time, energy and money on targets that the regulators will likely block. But as a seller, you should not rely on their assessments. Do your own review of which buyers might encounter roadblocks to a closing. “Not doing a deal” can be very disruptive to sellers. So worth asking your advisors where a reverse breakup fee may make some sense.
5). Financing falls apart.
Just as it sounds – the financing needed for the buyer to make the purchase is no longer available. Perhaps market conditions have changed, perhaps the lenders or investors found something in due diligence that gave them cause for concern. But many deals have a financing contingency as part of the agreement – if the financing required falls through, the deal is terminated.
The best thing a seller can do to help reduce this risk is to be transparent throughout the diligence process, and realistic in developing the company projections. The more uncertainty can be reduced for the parties financing a deal, the more likely they will be supportive and the deal will proceed.
Of course, as we noted, there are numerous ways that deals can get derailed. Let us know your comments and feedback. And reach out if there are others you want to discuss, or if we can help you get ready for your own courtship.
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
Sources:
1). Statista, “Number of Merger and Acquisition Transactions Worldwide from 1985 to 2019”, as published at https://www.statista.com/statistics/267368/number-of-mergers-and-acquisitions-worldwide-since-2005/#:~:text=In%202019%2C%20there%20were%20under,from%20the%20previous%20three%20years.
2). Merger Resources, “Mistakes that Kill M&A Deals” as published at https://merger-resources.com/mistakes-that-kill-ma-deals/
h/t to Peter Williams who helped with editing - thanks!