Finding a willing buyer for your business is worth celebrating, briefly. In my experience, a majority of owner-negotiated “deals” fall apart before reaching the closing table. In this post I will discuss several common deal breakers that I’ve seen, mostly involving differing expectations and poor preparation, and how you can avoid them.
But first I want to be sure you know what a Letter of Intent (LOI) is. An LOI is a non-binding agreement between a buyer and seller that memorializes major deal terms and steps to closing. It is entered in to BEFORE due diligence, legal documentation and escrow processes. Done properly, an LOI does a lot to align the expectations of each party, which is critical to consummating a sale. Deals also dissolve when a buyer negotiates terms with certain expectations, and later finds reality to be different.
So, what are these deal breakers?
Ambiguous Deal Terms
There is probably no larger risk to a deal than agreeing to ambiguous or contradictory deal terms. Writing an effective Letter of Intent can be tricky because it is negotiated early in the sale process, prior to disclosure of all pertinent information about the business. Nonetheless, the Letter should at minimum include assumptions used to negotiate deal terms, the deal structure with purchase price, a timeline and conditions to close. Additionally, it may include no-shop and confidentiality provisions and other terms to protect the buyer and seller’s interests. Regardless of the Letter’s content it should be clear, comprehensive and sufficiently detailed to anticipate future surprises.
Poor Record Keeping
The Due Diligence process provides an opportunity for the buyer to confirm that the information previously presented to them about the business is true and correct. A company with poor record keeping practices may have a difficult time providing evidence that they are in compliance with applicable laws, have enforceable contracts with suppliers and customers and accurate financial statements. Without accurate and complete records, buyers are uncertain of what risks they are acquiring and will be reluctant to close the deal.
This is particularly true for financial records. A seller should be prepared to provide prospective buyers with clean and verifiable financials for a minimum of the past three years. A special case is if the owner has claimed personal expenses that he has run through the business and wants to “add-back” as part of establishing the value of the business. These expenses should be well documented to be acceptable to prospective buyers.
Prior to taking the business to market it is well worth conducting a pre-due diligence exercise so that any weaknesses in record keeping are identified and corrected.
Misrepresentation of Facts
Business owners are anxious to sell the potential of their businesses. However their enthusiasm can lead them to put a positive spin on information at the expense of accuracy. The first time a buyer discovers something factually incorrect about an owner’s claims their suspicions will be triggered. If more inaccuracies are revealed, confidence in the deal can be eroded. Even if the exaggerations don’t add up to much, many buyers will walk away for fear there are larger surprises hidden in the shadows.
Unaddressed Business Risks
All businesses confront risks that a buyer will learn about either during due diligence or later. For example, a strong new competitor is entering the market or a key employee is retiring. If a buyer perceives that the seller is either not addressing or has not disclosed these risks they may lose interest in acquiring the business. An owner that confronts these risks head-on will be well regarded by prospective buyers and will improve their chances to close a deal. Even if an owner may not have had the time, people or cash to mitigate the risk, a buyer prospect may be able to bring fresh resources to the table and turn what was a problem into an opportunity.
A buyer forms expectations about the future performance of the business based on the financial information provided to them. A buyer is generally willing to pay a fair price for the business based on those expectations. However, if between the time that a deal is struck and the transaction closes, the financial performance of the business suffers a buyer might get cold feet or want to renegotiate terms.
The sales process can consume a lot of time and energy. The role of the intermediary is to assure that the process stays on track while the owner remains focused on running the business and maintaining its performance.
A deal that takes too long to complete is at risk of never being completed. Typically, upon signing a Letter of Intent there is a level of excitement about the prospect of a completed deal. The enthusiasm helps to carry the process during the emotionally challenging due diligence phase.
However, enthusiasm often fades if the process doesn’t continue to move forward. When either party is uncertain of the deal or is otherwise distracted they may be slow in responding to requests for information or completion of tasks. Deal fatigue can also occur when one party makes unreasonable demands or aggressively tries to renegotiate the terms of the deal. The most painful negotiators bring up the same points repeatedly. Eventually one party or the other will walk away.
There are effective strategies to combat deal fatigue: 1) screen buyers to assure that they are serious about and capable of completing the deal 2) disclose upfront material information about the business 3) write clear deal terms that don’t lend themselves to renegotiation 3) develop a deal timeline that compels both parties to keep the process moving forward.
The difference between a done deal and a busted deal is often a matter of setting and meeting both buyer and seller expectations. Employing an experienced intermediary to manage the sale process will help you avoid common deal breakers and address the inevitable biases and personal feelings of parties involved in a high stakes transaction.
Adam Wiskind is a Certified Business Intermediary in Exit Strategies Group’s North San Francisco Bay Area office. He can be reached at (707) 781-8744 or firstname.lastname@example.org.