Exitwise

The Top 6 M&A Deal Killers of Any Exit Process

1) Accounting Mistakes

2) IP Problems

3) Financial Slowdowns

4) Key Employees

5) Investor Blocking Rights

6) Time

If Elon Musk’s rollercoaster bid for Twitter taught us anything, it’s that buying a company can be complicated.

Even for the richest person in the world, acquiring another company involves some serious soul-searching, ongoing negotiation and constant debate.

And at this point, investors have no clue whether he’ll even go through with the deal. Only time will tell.

In the modern M&A landscape, nearly all buyers are like Musk: cautious and finicky. So, if you're thinking about selling your company, it pays to be really prepared and understand the major things that can sink your deal at the finish line or before it even gets started.

According to Jessica Fialkovich, co-author of Getting the Most for Selling Your Business, up to 80% of business owners who try to sell their businesses fail to do so within a year.

Additionally, in a 2019 ABA study, up to 95% of reported deals involve purchase price adjustments—and the adjusted price is typically lower than the initial offer.

Why is it so hard for business owners to exit in a timely manner or get what they feel is a great value? Because buyers are worried that they’ll get burned—and with good reason. According to Deloitte, fewer than 50% of M&A deals deliver on their promised value.

Unsurprisingly, most buyers will not hesitate to walk away mid-deal if they notice something that makes them squirm. So, in addition to avoiding the following major M&A deal killers, the more you can do ahead of time to be ready for the transaction process, the more likely your deal will be successful. That means knowing what you want, what to focus on, and what to fix - before you meet with potential suitors.


Seller Story: One of our clients lost a huge exit by changing the way he wanted to sell his company’s real estate just a few days before the buyer was supposed to sign the purchase agreement to buy his company. This lack of preparation and last-minute adjustments delayed the sale process by 3 weeks. The purchase agreement was finally adjusted, and we were just 8 days away from completing the transaction when the buyer canceled the deal claiming the impact of COVID-19 was to blame.


Here are the top six reasons why many M&A deals don’t go through:

1. Accounting inaccuracies are red flags

Here’s a serious question you should ask yourself before you consider exiting: Can your company survive the scrutiny of a financial audit by a potential buyer? Yes, we know your company is private and you may never have needed to audit your financials before, but if you are going to be acquired by a public company or one that may go public in the near future, then it (and potentially you) will be the subject of a full financial audit.

Even if an audit (sometimes referred to as a Quality of Earnings report) is not required by the eventual buyer, having the stamp of approval on your financials by a qualified third-party will bring a lot of confidence to potential buyers that your company is run in a serious manner. If your books have been managed as a secondary responsibility by someone on your management team (or worse, a family member), then there are bound to be inaccuracies or non-standard accounting practices that have been applied somewhere along the way. Despite your best intentions, accounting mistakes can kill deals, full stop.

Any unidentified exposure in revenue recognition, booking, or deferred revenue practices will directly reduce your deal value, at least dollar for dollar. Are your forecasts credible and consistent? Do you have any taxation issues?

This is why comprehensive due diligence (performed by you, the seller) will not only make your company far more attractive, it will also maximize deal value and shorten the timeline to close.

At the end of the day, accurate financials are critical to successful exits. Buyers can and will root out any inaccuracies in statements, reports, or forecasts—and as with a math exam, any mistakes they find will lower your score (AKA your deal value).

So if your company has not had a recent audit, you should definitely schedule one before fielding any M&A meetings. And better yet, if you don’t have an experienced CFO on staff, it may be time to consider bringing on a full-time or fractional C-level professional to spearhead this aspect of the sales process.


Seller Story: Recently, we sold an automotive prototyping business that had some irregularities in how they accounted for inventory. The books were run by a shared resource and their material costs had been all over the map in the last 3 years. The company had a profitable sales process, but without any real inventory tracking system in place, it was difficult to understand their true margins. For the founder, the quarterly profit was all he focused on -- but the buyer needed to truly understand profitability by customer. Because our investment banker had dealt with this type of inventory issue many times before, he was able to recreate a standard accounting view alongside the buyer’s accounting firm to build enough confidence in the numbers for the buyer to move forward. Using a generalist investment bank, without this level of experience, would have been disastrous for our client.

Pricing Guide: A typical sell-side, Quality of Earnings (QoE) report for lower middle market companies should cost between $25K-$50K. If you need a list of high value vendors contact us.

2. Legal concerns will make the deal team sweat

You can bet that a potential buyer’s due diligence process will reveal any legal “skeletons in the closet”. Unresolved litigation or legal exposure that the sellers either did not disclose or were not aware of will turn up.

These complications can range from litigation involving ex-employees, customers, and vendors to IP-ownership issues and contractual land mines.

No matter the unique circumstances, the existence of unresolved legal hang-ups will create unneeded strain on the new relationship, and potentially kill an otherwise healthy negotiation. If your buyer discovers unresolved litigation or loses trust in your contractual history, or IP ownership, it will be very hard to negotiate from a position of strength.

At best, your buyer won’t appreciate having to clean up old messes and will likely respond with a reduced deal value. At worst, one or both parties will bear the increased costs and incur timing delays, increasing the likelihood of a failed transaction.

That’s why it’s so important to perform a deep review of all aspects of your legal foundation and disclose appropriately before potential buyers have the chance to discover an irregularity on their own. The best advice we can give is to have reputable, trustworthy legal representation review all aspects of your legal standing before your M&A experts market your company for sale. This review can come from internal legal counsel, or a qualified third-party.


Seller Story: An attractive SaaS company “forgot” to highlight the fact that part of their IP’s value came from a third-party licensing agreement that needed permission to be transferred on a sale of the business. The owner chose not to properly address and inform her M&A experts of this fact. The buyer discovered this during due diligence and unsurprisingly, used this misrepresentation to back out of the deal.


Pricing Guide: A typical third-party IP review and valuation would be in the range of $5-$10K


Recommended Resource: Law firm with IP Review Software and Video

3. A revenue dip during the exit process could spell disaster

This is probably the most “obvious” deal killer, right? Yet we’ve seen so many examples of founders getting so excited about the prospect of a successful exit that they lose focus on their business and their revenue/profitability takes a hit.

Like high schoolers experiencing “senioritis,” these seasoned businessmen get distracted and forget that the performance of their business still matters. And after years or even decades of hitting projections and consistently growing sales and profits they miss their targets at the most critical moment in time - in the middle of a sale process!

And if you miss your quarterly projections without good reason, you’ve got a problem.

This is why business owners shouldn’t try to oversee an exit entirely on their own. Selling a company is hard, and requires diligence, endless oversight, and stamina - it’s far too easy to lose sight of your business goals during such an emotional and intense process.

Hiring an industry specialized, investment banker and M&A attorney will allow you, the business owner, to focus on the performance of your business while you let the M&A experts not only drive the best outcome but also minimize your risk of future litigation.

This doesn’t mean that you can’t have a down quarter or year - as long as your financials are in order, and you have a deep understanding of your company’s industry-specific trends and seasonality, your M&A expert will help you craft a story that aligns with the trajectory of your business.


Seller Story: In 2021, we quarterbacked the exit process of a promising technology startup that inexplicably missed its projections, mid-transaction, by nearly 30%. Even worse, they gave us and the buyer limited advanced warning and weren’t entirely clear on the “why”. The founder ultimately accepted an earnout (vs cash), took a reduced management role in the future entity, and ended up receiving significantly less than the original cash-heavy offer. The buyer saw significant value and strategic benefit in the underlying technology platform, but after the sales miss was unwilling to fully trust the leadership team nor distribute cash at closing on the “promise” of future sales projections.


Pricing Guide: An industry specialized investment banker will charge a retainer between $25K-$100K and a success fee of 3%-6% depending on the size of your transaction. M&A attorneys will charge anywhere from $25K-$150K depending on the complexity of your transaction.

4. Key employees quitting can be disastrous

Any experienced buyer will want to know everything there is to know about who your key employees are, what the company’s agreement with them looks like, and what could happen if they leave after the deal concludes.

Key employees—like your COO, CTO, or CMO—are critical to any M&A deal. If you have any concerns about key employees leaving during or after a transaction, it is imperative that you have the proper discussions, nondisclosures, non-competes and employment contracts in place to protect yourself and your business and minimize the negative consequences of these key people leaving.

Before you even consider a sale, you should understand who you think will stay and who you think might run for the hills if you decide to sell the business. Then take the proper steps to ensure that all employee records, contracts and agreements are current, signed, and organized in a secure, easy-to-access online dashboard for potential buyers.

Proper communication with your key employees can be just as important as the paperwork. This means knowing who to include in the process, and who to keep on a “need to know” basis.

One of the first people you should inform and include in a “sell-side” exit process is your CFO, who will serve as your financial partner throughout the M&A process. A good CFO will save you countless hours and be invaluable to your M&A team to not only present data clearly directly or via your data room but to also answer buyer questions on the fly or with minimal delays.

Finally, as the deal gets closer to the finish line, inform key personnel (like your CMO) who may not have influence into the deal, but needs to be a part of the future strategy of the partnership to make sure they are excited about their personal future opportunities.

These can all be delicate conversations, but we are happy to help you strategize and traverse these tricky interactions. It also helps to have someone in your corner to blame when things get emotional or backfire.


Seller Story: We were days from signing day on one of our largest clients exits when the head of our client’s software team decided he was not happy with his proposed employment contract from the buyer. Since this employee was key to a successful transition of the business to the buyer, he was in effect, threatening to blow up the deal. Fortunately, our M&A expert had a personal relationship with the buyer’s VP of HR and was able to elevate this reluctant employee’s employment level within the acquirer's organization. This new status allows the buyer to approve a significant salary and bonus increase which made this key employee happy and we closed the sale of the business.

5. Blocking Rights can “block” deals

Blocking rights can be a bit scary so you should know which shareholders, stakeholders and/or customers may have blocking rights in any “change of control” transaction.

Once you have identified these parties, you should inform them of your intentions and ask for their consent where appropriate and then keep them informed along their way. Getting their buy-in early will minimize the likelihood of them throwing you a curveball in the eleventh hour of a transaction and holding the deal hostage until they are satisfied.

We often meet with investors and board members alongside each of our clients to explain the process and hear any objections. We can usually get everyone on the same page by clearly presenting options and scenarios and maintaining appropriate transparency throughout the exit process.


Seller Story: We had a fellow entrepreneur selling his company to Facebook. The Founder’s original angel investor was not happy with his share of the sale price. Since this investor had a “blocking right”, this investor required an additional $500K bonus payment to not disrupt the deal. This was a tough pill for the founder to swallow but he made the payment and sold the business. This is a clear reminder to fully understand the rights associated with any contract you are signing with third parties and investors.


Additional Reading: Confidentiality: When to Tell Employees & Customers You're Selling Your Business

6. Remember: “Time kills all deals”

Always remember that, during an exit, time is never your friend. The faster you can move things along, the more likely the deal will go through. The longer a seller takes to respond to due diligence questions and concerns, the longer the sales process drags on. And delays can cause even the most sophisticated and experienced buyers to lose interest.

Buyers are going to want and need access to your team, historical financials and future projections, strategic and operational details, and most importantly - time with the founder and the management team. Lots of data needs to be shared. There will be a steady flow of emails and calls. Eventually, in person meetings will be required. It will seem overwhelming - but there is a process to successfully work to completion, and with the right M&A team, the finish line will not be as far away as if you are trying to sell the business on your own.

If you’re slow to respond or take forever to get your data in order, this will not reflect well on you personally. You need to be prepared to support the pace of an M&A transaction, 100%.

A great M&A Expert will keep all interested parties on a strict timeline by subtly reminding everyone of the competitive nature of the process. The right M&A expert is trusted by the buyers which means if the buyers are truly interested, they will stay on pace to not extend the sale timeline.

Seller Story: We had a founder of a digital marketing agency who came to us for advice based on some inbound interest from a buyer in his industry. After much debate he decided to try to sell on his own. He was eventually successful selling the business, but the business suffered during the sale process. His customers felt the loss of the CEO’s attention during engagements which slowed the development of new projects. Because of the company’s revenue and pipeline slowdown, the final purchase price was lowered AND deferred into an earnout structure which continues to put a burden of growing the company on this founder to this day.

Successful exits are harder than you think

When it comes to due diligence, modern M&A buyers have high expectations of the companies they look at to acquire. There is a lot of cash out there looking to buy companies. If it’s your time to test the business exit waters, you need to be organized, committed and prepared for anything. Since many business owners will only get one shot at selling their company, there is no better way to launch a successful exit process than to hire an industry specialized M&A expert to help maximize your exit.

Author
Todd Sullivan

Todd graduated from Yale University where he was a 2-time MVP of Yale’s ice hockey team. After a year as a minor league hockey player in the San Jose Sharks and Toronto Maple Leafs organizations, Todd returned to school for his MBA at the University of Michigan where he graduated as Entrepreneur of the Year. Todd went on to build and sell four companies over the next 25 years with offices in Boston, San Francisco, Chicago, New York and Detroit. After the sale of his last business in 2015, Todd has dedicated his time to educating his fellow founders about the M&A process and helping many of them maximize the sale of their businesses.

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