Deal Killers and How to Avoid Them
You hired an investment banker and ran an effective process. You’ve received tons of interest, dozens of Indications of Interest near or above your expected closing price for your company, and you’re feeling pretty good right now. Unfortunately, this is where the real work begins, and the results are in your hands.
Once you’ve agreed to terms on a Letter of Intent (LOI), the buyer’s job is to validate that their thesis about your business is accurate. The thesis is based on the market, product, and the team’s ability to execute. That means that they want to know that what you told them is true. Anything that causes the buyer to doubt the information is potentially threatening to the deal.
Get your facts straight
First and foremost, make sure that the data you provided your banker with during the discovery phase of the relationship is accurate. It’s not uncommon for systems to not reconcile because accounting systems and operational systems are often used for different processes and reporting. Still, there should be a rational explanation for the discrepancies, and it should always be footnoted.
During the “selling phase” of the deal, the CFO’s responsibility is pretty light other than simply reporting on things they typically write on regardless. However, once the LOI is signed, the CFO’s responsibility goes into hyperdrive. Suppose the CFO didn’t correctly plan resources before this phase, their lack of ability to deliver will not only put their job in jeopardy after the transaction, but it will also delay the transaction, casting doubt on the team’s ability to execute.
The buyer’s valuation and thesis are predicated on the company continuing to perform up to and through the transaction’s closing. A common mistake made in the process is to take your eye off the ball, especially when it comes to revenue. It’s easy to get consumed by the resource requirements of closing the deal. However, if you don’t have a hyper-focus on maintaining your current revenue rate and deliver on projected revenue, the buyer will think that something is systemically wrong with the business. This can kill a deal.
Technology Land Mines
If your business relies on technology or your product IS a technology product, there are several land mines that you must consider addressing before due diligence. If you wait until diligence begins, it will be too late to fix certain things. Many buyers are now contracting with “Technical Diligence” firms like Crosslake Technologies to do technical audits. The buyers recognize that they may be great at understanding the fundamentals of the financing or operations of a business, but technology is an entirely different language. Proactive technical diligence work can mean the difference between a clean closing and a deal getting flushed.
We had a deal last summer that brought this one home. The seller needed to sell for strategic reasons, yet the most significant customer was on the ropes for reasons unrelated to management. Businesses commonly sell for either a multiple of EBITDA (profit) or a multiple of Annual Revenue Rate (ARR). Regardless of which yours is, the loss or threatened loss of a strategic customer relationship will reduce revenue expectations and threaten a deal. At the very least, it will allow the buyer to retrade the deal at a lower valuation. Managing this customer relationship during the selling process is critical to the success of a transaction, especially if customer concentration is a lurking issue.
Hire the Experts
There are as many categories of attorneys as there are businesses. Just because someone has the title and is your friend doesn’t mean they should manage your transaction. I watched a deal almost get killed last fall due to a seller wanting to use their corporate attorney to run the transaction. We emplored them to use a reputable “deal attorney,” but they chose a friend of the corporate attorney who had been with them for years. Ultimately, the choice was a bad one. The mistake cost the seller hundreds of thousands of dollars in extra fees and created a credibility gap for the CEO due to poor judgment and decision-making.
The Tax Man
Several years ago, we were in the process of selling my first business. The deal looked great. A strategic buyer had submitted an LOI, and we were deep into diligence. Everything looked good, except the tax treatment of the deal became a sticking point in the transaction. Ultimately it got resolved; however, it was a great reminder that you need to consider the tax impacts of the deal and how it will affect you and the buyer. An appropriately-sized wealth manager working with a competent tax planner can be worth millions and can head off issues that could cause you to say no to a deal before you ever get there.
Expectations of Management
Nobody likes to be the “bad guy.” It’s also common for people to set optimistic expectations, especially entrepreneurs. The reality is, the process of diligence is stressful for everyone involved. If expectations about this aren’t communicated well in advance, some people may struggle to get through the process, sabotaging a deal. Ensure that everyone who needs to know is well-versed on what will happen in the process so they can plan for it in advance and keep the process on the rails.
At the end of the day, buyers will:
(1) trust that we’ve done our diligence on the company and won’t represent a company that we aren’t proud to represent
(2) trust the company to deliver on it’s promise.
If that trust is violated at any part of the process, the deal won’t get done. Every issue listed above ultimately comes down to trust and integrity in the process.
Want help with guiding the preparation process? A seasoned Investment Banker can help provide valuable insights on how your company can achieve exit velocity.
To arrange a confidential call to discuss how Merit Investment Bank helps companies and their leaders prepare for and achieve exit velocity please call Todd Ostrander, Managing Director @ 253-377-5767 or email Todd.Ostrander@meritinvestmentbank.com or Book A Discovery Call