Conventional wisdom tells us that we learn more from our failures than from our successes. With this in mind, a review of failed transactions of recent years has allowed me to compile a fairly rigorous list of pitfalls that derailed business sales, so that I may better pre-empt these issues before they arise. So that others may also learn from previous mistakes, I present my list of top 10 reasons for sale transactions falling over:
1. Over-inflated expectations – It is not unusual for a business owner to place a higher value on their business than potential buyers eventually do. After all, the business has provided a certain level of financial benefit over the years and the vendor has no reason to believe that this same benefit will not continue post-sale. One of the factors often overlooked – or not given any gravitas by the vendor – is the buyer’s cost structure to support the business. In a smaller organisation, the owner wears a variety of hats, from CEO to BDM to accounts clerk. As such, the cost of these “corporate services” is limited to the direct cost of the owner(s) and the amount of time and effort they are prepared to sacrifice above and beyond.
A larger organisation, however, tends to have a more considerable overhead cost structure to spread across its operating entities. The end result is an adjustment to the bottom line contribution of the mooted acquisition and the corresponding price they are prepared to pay. The subsequent gap in expectations is the downfall of many transactions.
2. Poor choice of advisor – most owners are novices when it comes to selling their business, so they rely heavily on their team of advisors, comprised mainly of their accountant, lawyer and broker. A poor choice of any of these three is likely to result in disaster: an incapable accountant can make a hash of due diligence, an inexperienced lawyer can turn contract negotiations into a needlessly protracted and expensive affair (that ultimately forces one or both parties to become disenfranchised and walk away) and the wrong broker can make misrepresentations or negotiate poorly with similar results.
3. Incompatible cultures – I have blogged before about the Three F’s of Acquisitions: Fit, Future and Finance. It is not uncommon for both parties to neglect Fit in favour of Finance, attempting from the outset to negotiate the numbers before establishing the cultural alignment of the two organisations. The vendor is initially happy with the financial construct of the deal, but through the due diligence and contract negotiation processes begins to feel uncomfortable with the culture she is selling into, particularly when earn-out periods are involved. Fit is crucial and can’t be manufactured – the numbers and the future strategy can be negotiated.
4. Inability of the buyer to secure finance – this is a particularly frustrating one. Whilst due diligence on the business to be acquired is part and parcel of every sale transaction, a detailed investigation into the buying entity is less common and generally restricted to publicly available information (i.e. listed company financial reports and credit checks) and the purchaser’s verbal assurances. Unbridled optimism can be a wonderful thing, but when applied to what someone thinks a bank or investor will do when push comes to shove, a conservative expectation is far more reasonable. So beware of “subject to finance” clauses in sale contracts or earlier stage agreements such as Terms Sheets, Non-Binding Indicative Offers or Heads of Agreement. Whilst a common phrase, it should give pause to ensure the purchaser has financing in place before both parties spend many thousands of dollars on professional advisors.
5. Business was not effectively transferable – of the 2 million or so privately-held businesses in Australia, at least 65% are personal exertion micro-businesses with less than 5 employees, according to the latest research. And it is these smaller businesses that are the most difficult to sell, more often than not because the owner(s) are the business. They are responsible for business development, client account management, management, back-office, branding (i.e. their name is on the door), PR and almost every other aspect of the business. And whilst the business may be providing a decent return for its shareholders, the reality is that when it is so dependent them it is simply not transferable as a going concern. Its assets – database, intellectual property, etc. – may have some value in isolation, but at a far lower value than originally expected.
6. Time – one of the first lessons I learnt about sales was “time kills all deals”. This could not be more true when it comes to selling a business. Both parties enter into discussions with the best intentions, but for whatever reason the negotiations drag on many months beyond what was originally anticipated. It is often the buyer in this case who gets fed up and withdraws their interest, opting to pursue newer, more appealing opportunities, leaving the vendor to start the process all over again, frequently with an asset of lesser value.
7. Lack of commitment – nothing is more frustrating to a buyer or intermediary than a business owner who has apparently made the decision to sell, only to terminate the process and retain the business after all. Not only does it waste a lot of time and money, treating the exercise as a way to essentially determine a market value distracts and inconveniences the other parties involved in the process and ultimately reflects poorly at a personal level. There are far less expensive and more professional ways of determining a market value than dipping one’s toe in the business for sale market.
8. Lack of transparency – “holding your cards close to your chest” is fine advice when playing poker, but taking the same approach into a business sale/purchase process is less advisable. Unlike poker, selling or buying a business is not a game of winners and losers: both parties need to win in order for a transaction to proceed. As such, willing transparency and full disclosure of all facts and influencing factors is a more effective attitude to take into the process, as it pre-empts and ultimately eliminates any potential surprises that are apt to derail negotiations.
9. Change in personal circumstances – whilst virtually impossible to prevent, divorces, relocations, serious illnesses and deaths are frequently responsible for prematurely bringing an end to sale negotiations. The only real way to mitigate risks posed by such changes is effective preparation, 100% commitment and a focus on timeliness, so that other potential pitfalls are pre-empted and eliminated.
10. External factors – it would not be an accurate top 10 list if it did not include factors that you have absolutely no control over. The Global Financial Crisis that came to a head in 2008, for example, was a game-changer for merger & acquisition activity. Not only did lending and investment all but dry up in the SME sector, but confidence was decimated with buyers and investors turning their attention to distressed assets and fire sales. There is not much you can do about this, unfortunately, except do everything you can to survive and prepare for the inevitable return to more “normal” conditions.
Research from the US market for private business sales suggests that no more than 25% of companies that go on the market end up completing a sale, leaving more than 75% of business owners wondering where it all went wrong. Hopefully these tips provide some guidance on how to prepare your own business so that you will be one of the minority who successfully complete a sale transaction when the time comes.