5 M&A Deal Killers: Common Deal Breakers in Transactions
March 31, 2022 •Oak Street Funding
M&A activity is historically high, but not every potential transaction makes it to the finish line. If you are looking to buy or sell soon, be aware of these five deal killers.
1. Unrealistic expectations
Both buyers and sellers can enter a transaction with unrealistic expectations. However, most commonly, sellers enter the transaction with an inflated expectation of their business’ value. Owners often have a more difficult time seeing the risk associated with their business than an outsider. Brian Henson, Underwriting Director at Oak Street Funding said, “A lot of times people will expect to sell or be appraised for the same value as the business down the street, but not every company is the same.” There may be hidden value that increased the value of another seemingly similar business down the street.
2. Business Decline
Sometimes an owner decides to sell after aggressively growing the business, but when their attention shifts to selling, the business starts to decline. The selling process can be stressful and requires a lot of time and attention, but owners cannot afford to neglect the business itself. A growing business commands more value than a stagnant or declining business. If the value of the business begins to decline prior to or during the negotiations, the buyer may withdraw their offer and cancel the deal.
Sometimes clients and customers begin to feel neglected during the process and move their business elsewhere. Since that book of clients holds the value for the deal, it is imperative that business owners maintain their levels of service. Frequent communication with clients can ease their worry and smooth the transition. Keep up employee morale during this time and consider offering ‘stay’ bonuses. Reassure employees that their jobs are secure. It is vital that employees continue with the business and do not leave, potentially taking clients with them.
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3. Lack of Consensus
Sometimes the deal fails due to disagreements, not between buyer and seller, but between partners of the same firm. For example, in a firm with multiple partners of varying ages, oftentimes the partners do not agree on the deal structure. Typically, younger partners want to enter the new firm as equity partners. Middle-aged partners tend to want to be income partners.
On the other hand, partners nearing retirement age will likely ask for their payout and leave. Until the selling partners figure out a deal structure that works for all the partners, they will never come to an agreement with a buyer. Selling partners should have a deal structure put together that satisfies all partners before entering the market to sell.
4. Governance Issues
If sellers desire to stay in the business after a merger or acquisition, conflict over leadership positions in the new organization can break down an otherwise healthy deal. For example, the managing partner of a $10 million dollar company is the same age as the managing partner of the $30 million dollar company buying his firm. The partner of the smaller firm expects a leadership position after the transaction, but all the positions are filled. The selling partner terminates the deal and begins looking for another one where he can have a leadership position after the acquisition.
Sellers who are planning to stay on in the business after the merger or acquisition should determine early in the negotiation process if the new firm will have a desirable position for them. Clear expectations in a new role with a new hierarchy is important not only for the seller but also the staff. Who will be their leadership under the new ownership? When both parties don’t discuss governance issues early on, a lot of time and money may be wasted as the process continues, only to be terminated.
5. Unprepared Financials
Sometimes a deal falls apart when a buyer seeks funding for a transaction and doesn’t have their finances in order. If the buyer attempts to secure funding without disclosing other debt like seller notes on another deal, the lender may not continue in the loan process. Bruce Warren, Vice President of Strategic Market Sales at Oak Street Funding said, “Buyers seeking funding should make sure they have their tax returns and complete up-to-date financial statements readily available when applying for a loan.”
During the underwriting analysis of a loan application, deal killers include too many unexplainable expenses, low margins, and higher-than-normal employee costs. These are red flags for a lender who may reject the loan application unless the applicant has a satisfactory explanation. To avoid surprises during the underwriting process, consider a financial audit before applying for funding.
Now that you’re aware of the five M&A deal killers, you can begin the journey to a successful deal. If you are looking to buy a business and need funding, you may assume the best option is a local banker in your community. However, by nature, bankers are more comfortable with collateral-based financing than providing capital to support a company’s future.
An alternate for companies like yours is a specialty lender that is accustomed to working with your industry. Such lenders understand how a business like yours operates and are familiar with the nature of your income streams so that they can approach the underwriting with realistic expectations and an appreciation for inherent risks. Consider Oak Street Funding, a specialty lender with experience in loans for mergers and acquisitions in your industry.
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Disclaimer: Please note, Oak Street Funding does not provide legal or tax advice. This blog is for informational purposes only. It is not a statement of fact or recommendation, does not constitute an offer for a loan, professional or legal or tax advice or legal opinion and should not be used as a substitute for obtaining valuation services or professional, legal or tax advice.