Quite regularly we hear about successful transactions. Less frequently we hear about deals that have not closed. Even the M&A transactions that come to a successful end might have had some difficult moments. Also in these transactions possible issues for a deal to not happen can have occurred. This article focuses on deal breakers and to a lesser extend on methods how to prevent them.
A deal breaker can be considered an important enough reason for two parties to stop negotiating about a business sale. It can be described as negotiations related to a M&A transaction (business sale) that stop due to a specific issue (“deal breaker”) not being able to be resolved between the two parties. Hence, there is no further interaction during a M&A transaction as a specific term is not being agreed upon.
In our poll on Linkedin about possible M&A showstoppers quite some people reacted. The reasons for a transaction to stop ranged from valuation and price issues to buyer financing, tax or legal risks and quite some others.
In this article we categorize M&A deal breakers in the following areas:
Valuations and price expectations are of course one of the main deal breakers. Many business owners see their own company as the best business. They have often worked decades before retiring. Hence, it is obvious they think the value of the company is high.
Some advisors go into a sell side process without discussing a possible sales price with a business owner. They try to optimize the possible sales price they can achieve in the market. The view of these advisors is that the ultimate value will be determined in the market when buyers and sellers meet. They highest, and most accurate, value can be achieved via an auction process. Other advisors do detailed valuations and discuss the demands of the business owner in great detail. Valuations are always subjective and depend on the criteria and assumptions used. Valuations done by a technical valuator can differ a lot from a valuation done by an industry expert who looks at the clients, the quality of the contracts, multiples used in the market, etc.
For a strategic buyer the value of a business can be higher than a seller might expect. These type of buyers normally pay more than a manager who wants to acquire the company via a MBO. Overall, the valuation expectations between a seller and buyer can differ and this can be a major (source for a) deal breaker. Managing the valuation expectations of business owners is a crucial task for M&A advisors. The expectations of owners need to be at realistic levels for a deal to be successful.
Have you seen business sales gets stopped due to difference in price expectations?
Buyer financing is always a critical item. Some types (the larger corporate stock listed companies) have limited difficulty getting the required funding. Sometimes they already have the required cash on their own balance sheet. Elsewise, they can get funding arranged via banks if their banking covenants allow this. Other type of buyers can have more difficulty in getting funding arranged and this might end up as a deal breaker in a final stage of a deal. In the past deals might have been leveraged up to 80% of the sales price. In the current markets banks are more prudent and typically demand a 50% equity contribution. Very often they will lend no more than two or maximum three turns of Ebitda. The rest needs to be financed out of the equity of the buyer.
Should a M&A advisor investigate the financial capabilities of a buyer in an early stadium?
Legal items can be a deal breaker as well. If the legal structure of the seller is not well set-up or too complicated this might result in a deal to get to a dead end. Although there are possible workarounds, where the easiest one being an asset sale, it can mean the death of a possible transaction. Buyers can have specific reasons to want to engage in a share purchase (compared to an asset purchase). If a legal structure is not well set-up yet this can delay the project. As an example the real estate can still be included in the operating entity. A buyer might not be interested in the real estate and taking it out of the transaction, although possible, will delay the project and have possible negative tax consequences. If possible legal risks exist like claims, lawsuits or other items this might cause a deal to fall through. Preferably all these items should have been cleaned up before a M&A process starts.
Complex tax structures are a turn-off when it comes to buyers. If you have a business sale in mind it is best to have a clean tax history. Sometimes some owner-managers’ tax planning is so complicated that it’s difficult to unwind in the case of a business sale. Tax planning should be simple and straightforward. Structures which are too complex or possibly not acceptable by local tax authorities can make a deal impossible to complete. We also see business owners in some countries show a lower profit in their books than what is reality. This makes it more complicated to get the valuation you want as a seller. In the end it is more difficult to prove that profits do exist than show actual profits in the books. We always encourage business owners to make the tax fillings represent reality when they want to go for a business sale. This makes a possible M&A transaction much easier.
How do you see tax issues as a possible deal breaker for M&A transactions?
The social (‘soft’) aspects as deal breakers are being discussed less often than the hard financial facts. It has been said by someone in the blog on Linkedin that if both parties want the deal they will find the way. Hence, a good personal chemistry is crucial. In our opinion it is always important to create a good relationship on the personal level. Being soft on the people and hard on business issues is a mentality that is being advocated for a long time already in business trainings. A way to improve the chemistry is how the business is being ‘sold’ to the buyer. Being open about the business is in my opinion the best way. Buyers will find out items in a later stage anyway. Being consistent and predictable as a business owner creates trust and helps in establishing a good relationship with the buyer. This increases the likely hood of a possible transaction.
To give some possible deal breakers in the cultural or personal area of M&A transactions:
Do you see items missing (please comment below)?
Very often business owners have a tight relationship with the business. The company they want to sell depends on them. As an example sometimes a limited part of the revenue is contracted and depends very much on the personal relationships of the owner. This hurts the valuation as it brings risks for a buyer. Worse, it can also lead to a deal not to happen as a buyer gets scared the clients will leave after an owner sells the business. Buyers in larger corporates need the business acquisition to be successful as it can influence their future job and career prospects. This is different in case the buyer is the business owner and main shareholder who is normally inclined to take more risks.
The best advice is to “make yourself redundant” before a business sale starts as elsewise this can become a deal breaker. A buyer should be buying your business and not you. You need to demonstrate that the business can flourish without you so that you can exit.
A seller has the best chances for a successful business sale if he is well prepared and has done a real effort. It is important to show commitment as most buyers have limited time and only want to deal with serious sellers. Many ways exist to show you are committed and well prepared. The best one is to hire a M&A advisor that helps in preparing a detailed deal book (Information Memorandum) that describes your company to potential buyers. This is a sign you have committed yourself and paid an amount to get the documentation drawn up. Not only gives it valuable information to buyers but it also shows that you are serious. Some buyers only want to speak to a seller if he has committed himself and given a mandate to an external advisor. So, preparation is a clear way to improve the chances of a successful business sale.
If you want us to write a full article on how to best prepare for a business sale please let me know.
The selling process is pretty demanding for the middle market business owners we deal with. Most of the time they don’t devote a lot of resources to the process of a business sale and need to do a lot of work next to their normal job. The selling process is just one more task the owners must execute while operating the business. Data accumulation and due diligence are burdensome and time consuming. This all puts a heavy burden on the business owner. If a business owner is not supported enough by its advisor we have seen cases where sellers became stressed and backed out of the process. Our objective is always to take out as much work of the hands of our clients so they can concentrate on running the business. If we work for buyers this is of course less important as many buyers we work with have done more acquisitions in the past.
Have you seen stories where a business owner backed out of the process unexpectedly?
The negotiation behaviour can cause risks for a failure of a business sale as well. In a M&A transaction it is good to negotiate tough every now and then. However, the best is to only do this on major items. It is important to show that you care and defend your interests well. However, we also see business owners that want compensation in very late stage for minor items with limited relevance. This can be a tricky strategy as you are able to win only a little more. On the contrary, the risk exists that you lose a complete deal on small items and that the deal falls through. Continuing discussions about minor items can be an unexpected deal break that one has to be careful about.
A list of possible deal breakers in the negotiation area:
We suggest to be open about your business and the issues that exist. Also keep the possible buyer(s) updated on the progress of your financials is important. A buyer will find out the problematic area of your business anyway even if it is during the Due Diligence phase. Be it in accounting, customer base or banking relationships. Due diligence uncover flaws in your business and it will write them up in a big way so the buyer will become very much aware of it. This can hurt the relationship and become a deal breaker because the trust is gone. Sellers can carry out their own due diligence exercise with their advisors prior to putting the business on the market so that any loose ends can be identified and tidied up. Trying to hide something can very likely be counterproductive. If a purchaser finds the issue during due diligence the response will be much more dramatic. It may also have a big impact on the purchaser’s confidence in you and in everything else you’ve told them.
How do you think a seller should deal with the weak points of its business?
Possible deal breakers in the area of housekeeping can occur. These cases make an advisor feel sorry as they can be prevented by a seller. The worst cases of deal break-down happen when good businesses fail to tie up all the loose ends regarding bank accounts, suppliers, customers, staff, accounting or other small items. A buyer will be looking for areas of risk during due diligence and issues can impact price or if extreme lead to a stop of the deal process. Get contracts signed, get accounts audited and collect overdue debts. It is unnecessary to have a M&A transaction get stopped due to minor items in housekeeping not being taken care of. It is the responsibility of a business owner to have its employees organize this.
Buyers don’t want risks. Try to get out all possible risks that exist. Here are few general risky items that can become a deal breaker:
To elaborate on the first item, I recently looked at a business in the forwarding industry that had good profitability and growth. However when we got a bit into the detail we discovered that a large part (around 40 per cent) of its sales were from just one client. This client depended very much on the personal relationship of the seller. The buyer I represented quickly walked away from the deal.
If you don’t know the industry your potential client is in this can cause an advisor to go after the wrong buyers. Even if at first sight they look like interesting buyer targets a more detailed understanding will show they might not be qualified. Understanding of the dynamics and real interests of buyers in the industry can help to prevent this. So better hire a good M&A advisor that understands your industry and has access to the right buyers. Elsewise you run the risk that this topic becomes a deal breaker.
Do you have experiences where the wrong buyers were approached?
We are happy to discuss possible ways to prevent deal breakers for your business sale. If you want to discuss this please do get in touch. Maybe we will write a separate article about ways how to prevent deal breakers during your business sale.
What are your thoughts, how should one prevent possible deal breakers in M&A?
iDeals | Tuesday 20 October 2015 | website: https://www.idealsvdr.com/
Being soft on the people and hard on business issues is a mentality that is being advocated for a long time already in business training. A way to improve the chemistry is how the business is being sold to the buyer.
gennady | Tuesday 31 May 2016 | website:
Hi I am doing research and trying to find any deals that have broken apart in the final stage, after all approvals received and a close date has been announced. so within the last few days before stock was to be delisted. Any that you are aware of would be helpful or a place to start searching?