As I write this month’s newsletter, I am working on an exciting new project that will put a powerful tool in the hands of our readers and clients. Called the Business Sellability Index, it measures the qualitative and quantitative factors of a company that determine how easy it will be to sell, and is founded on the principle that sellability is distinct from valuation. Stay tuned for its release; we plan to offer it for free for the first couple of months, after which we may begin charging a fee.
In the meantime, I want to share data from a very insightful, independent market research report, and provide commentary on its findings. Each quarter, the Pepperdine Private Capital Markets Project, run by professors at the Pepperdine University Graziano School of Business, releases a report assessing the market conditions for small business transactions. In one of their recent reports, they listed five common reasons that companies don’t sell and are subsequently taken off the market (“%” indicates percentage of survey respondents who gave this answer):
- Seller’s unrealistic expectations (33%)
- Lack of buyer preparation (15%)
- Poor seller preparation (11%)
- Unreasonable non-financial demands (9%)
- Personality conflicts (9%)
The study also surveyed M&A professionals about the biggest mistakes made by sellers that ultimately hurt their chance of successfully completing a deal. The top three answers were:
- Unrealistic Expectations (50%)
- Declining Business Sales (16%)
- Poor Financial Records (15%)
As the two lists suggest, the seller has control over the majority of items that can cause a deal to fail. Let’s examine a few in depth.
Unrealistic Expectations, Unreasonable Demands, and Poor Preparation
Transactions require agreement on a broad number of items, from price to deal and legal terms to a general sense of trust that each side develops in the other. Sellers who have unrealistic expectations of the acceptable price and terms or who make unreasonable demands during the negotiation will find it very difficult to reach agreement with a buyer.
It should be obvious why unrealistic pricing expectations can kill deals, yet this prevails as the most common offense. I’ve written in the past about the dangers of improperly pricing a business, but unfortunately most owners enter the process without an accurate understanding of their company’s fair market value. But it doesn’t end with price, as disagreements over deal terms can be equally as detrimental to your success. To succeed, you need to understand the usual and customary terms that apply to companies of your size in your industry.
Why do so many owners make these mistakes? It’s really just a lack of preparation. Most don’t want to pay for a professional valuation, and many would rather try to sell the company on their own than hire a broker. The “fortunate” among this group end up selling, but it takes 2-3 years rather than the customary 6-9 months, and most of them accept a price that is below fair market value. In order to succeed (i.e. actually close a transaction at fair market value in a reasonable period of time), owners must be cognizant of these critical items. How? The easiest and most affordable way is to hire a broker.
Declining Business Sales
Growing businesses will always be more attractive than businesses in decline. Bar none. This is not to say that a declining business cannot be sold, but the likelihood of closing correlates directly with the sales trends. Buyers may price the decline into their valuation; however, if the decline continues or accelerates during the period between acceptance of an offer and closing, many will walk away.
Fair market value for a declining business is obviously less than it is for one that is stable. Many times, based on the lower price, buyers will show initial interest but will end up backing out of the transaction prior to closing as the overall weakness of the business becomes more apparent during due diligence and scares them off. Finally, it’s harder to obtain financing for declining businesses, so even if you clear all other hurdles you are still at the mercy of a lender who is likely to be risk averse.
Poor Financial Records
Financial performance drives valuations, and poor financial records can derail a deal in numerous ways. A buyer may only look at general financial data prior to making an offer, but during due diligence they may dig deeper. If the scarcity or complete absence of financial records complicates or prolongs their due diligence, they may use it as an excuse to pull out of the deal.
Companies with clean financial records are easier to sell because their owners do not run many personal expenses through the business, and therefore there are not any disputes over cash flow and net income. The harder a buyer has to work to understand and verify “add backs”, the more skeptical they become. This skepticism can lead them to rethink the purchase price and, in the most extreme cases, can cause them to call off the deal.
Poor financial records create the perception of a risky transaction. Risk has an inverse relationship with both valuation and closing success rates. Buyers pay less for riskier acquisitions, if they decide to purchase at all. As we wrote in a previous newsletter, the expenses associated with cleaning up your financials pale in comparison to the financial gains you receive when you sell. (read it here)
Successful transactions result in a win/win. A seller receives a good price for the business and is allowed to transition out, while a buyer makes a confident investment and is excited about the future. In order to accomplish this, sellers need to be cognizant of their company’s actual fair market value and the general standards for acquisitions in their industry. Few, if any, can do this alone; in fact, those who fare the best tend to surround themselves with experts who do most of the work for them.
We do not, at any point, suggest that a seller should accept a price that is less than fair market value, or deal terms that are abnormal for their industry or unreasonably impede their goals for the future. In fact, we pride ourselves in generating above average returns for the majority of our clients. All we are saying is that owners need to align their expectations with reality. It sounds simple, but if it were as easy as it sounds then the material for this article would not exist.
Interested in reading the full Pepperdine report? Email me at firstname.lastname@example.org and I’ll forward you the pdf.
To read more about key mistakes to avoid, check out the following articles from last year: