Buying and selling a business can be a stressful, complex, and arduous process. There are many players involved for both the buyer and seller such as attorneys, accountants, and investment bankers – all of whom are advising their clients on accounting, legal, and general matters regarding the transaction.
Many issues can come up during the due diligence process (which begins in earnest once the letter of intent is signed) that can result in the termination of a business sale.
Below are six key factors that can derail the sale of a business.
- Quality of information. Financial data and other information that is inaccurate or incomplete often lead to questions from the buyer. These issues are usually discovered during the due diligence process, and if pervasive in nature or significant in terms of dollar impact, can lead to buyers backing out of the transaction. Examples of this can include inconsistent accounting treatments, noncompliance with GAAP in the financial statements leading to uncertainty about the reliability of financial information, poor market segmentation information, and poor support related to the financial data presented. It is important that the buyer is prepared to go to market by having quality financial information and backup to support their financial statements and corresponding information.
- Deal issues. This can comprise several issues such as changes in the markets in which the target company operates, potential litigation, taxes issues (including state and local nexus issues caused by lack of tax compliance filings in specific jurisdictions), working capital adjustments, representations and warranties language, indemnification language, and many others. Some of these areas will only be addressed after the letter of intent is signed; however, the more a seller does to address the others, the smoother the potential sale process.
- Changes to deal terms. Too many changes to the terms of the deal can cause the seller to reconsider selling their business to that particular buyer (or sometimes altogether). Changes to the purchase price, stipulating an earnout with targets that are unachievable (i.e., EBITDA targets that are unrealistic based on past performance), and creating purchase agreements that are one-sided in favor of the buyer are some examples that can derail a deal.
- Business concentrations with customers/vendors. Many companies have cultivated relationships with customers, and over time, the business concentration with them grows. Buyers spend a lot of time vetting customer concentrations and may also have direct conversations with customers to get a better understanding of the relationship as well as what expected business levels may be in the future. If a buyer is not confident that the future business with the customer is sustainable or is not comfortable with other factors regarding the future relationship, the deal may be terminated. A concentration with vendors may face the same scrutiny, especially as it relates to commodities or other specialty items.
- Emotional hurdle. Selling a business that an owner has devoted a good part of their life to running can be a gut-wrenching decision. The emotional side of selling can be one of the biggest hurdles in the transaction process. The connections with and sense of responsibility to employees and their families, coupled with the fact that the business was part of their daily life, is difficult to overcome. Sellers are concerned that employees will maintain their employment after the sale, and if they get a sense this will not happen, it may cause a seller to pull out of the deal.
- Expectation gap. An owner’s expectation of what their business is worth versus what a buyer is willing to pay can often lead to a deal being terminated. Sometimes the expectation gap can be closed by using contingent consideration such as an earn-out to close the difference. The earn-out will reward the seller if certain financial goals are obtained, therefore increasing the purchase price consideration. This is an effective tool but it is important that there is a clear understanding of how the earn-out is calculated by both parties (having an example in the purchase agreement is recommended) to avoid misunderstandings and possible litigation after the sale.
Many items can cause a transaction to go wrong. In some instances, these issues can be overcome by negotiations and compromise by both sides. However, if there is a particular issue that is too significant or if too many issues surface, the deal may be either placed on hold or terminated altogether. Proper planning and preparedness by both the seller and buyer can go a long way in helping a deal get to the finish line.
Richard Snyder can be reached at Email or 215.441.4600.
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