When selling a business, the best outcomes are created when the seller identifies an investor who not only has the confidence, ability, and resources to drive future growth, but also recognizes clear, predictable upside potential –justifying paying a premium for the opportunity. When that happens, we often see this result correspond with the market-clearing price (or best offer) from that particular interested party.
Value is also created by reducing risk—or perceived risk—which varies significantly among investors, often based on experience or expertise within an industry. But not all risk can be explained by familiarity with a business. Common challenges are found across businesses, many of which are predictable and can be mitigated, if not avoided, if addressed prior to marketing a business for sale.
Many refer to these challenges as “deal killers” because, when significant enough, they can result in the death of an otherwise healthy transaction. In certain cases, they are less severe. However, working with an M&A advisor prior to marketing your business to potentially interested parties is often the best way to identify deal killers and other risk factors to create a better outcome for the outgoing shareholders.
As an M&A advisor, we often catalogue the reasons for which buyers “pass” (or decline) an investment opportunity that we bring to market. Below are several of the common deal killers, or reasons for which interested buyers have passed on the opportunity to buy a business:
Size (Too Small/Too Large)
An initial filter that many buyer groups use to sort through opportunities is the size of the target business. This can be on either side, whether revenue, EBITDA (earnings before interest, taxes, depreciation, and amortization), or some other financial metric is too large or too small. Certain investors need to deploy a minimum level of capital in order to invest, while others are unable to meet the check size required to buy the business. For that reason, it is important to consider which potential buyers are the right fit for the opportunity, or whether now or later is the ideal time to market the company for sale.
Low Margins
In addition to looking for consistency, buyers also usually have a high preference for more profitable businesses. When looking at profitability, investors will evaluate gross profit margins, net income, EBITDA, Adjusted EBITDA, and industry-specific margins to evaluate their interest in an investment, often using benchmarks that fit their investment profiles. When the margins of the target company for sale are too low, many buyers will become less interested.
"Ramp"
Ironically, growing too rapidly can be a problem. Dramatic recent growth in revenue or EBITDA may indicate that a seller has taken advantage of some driving force that is unsustainable, which can generate fear in buyers when the graph charting the financial performance of the company for sale shows a major step up in profitability over the previous twelve months that may look unusual. Are the sellers exiting at a peak? Is the growth sustainable? What will it take to repeat or continue this trend, and is it likely that new investors can continue this, given any other inherent risks in the business? These are all concerns that may cause certain buyers to pass on the opportunity.
Not a Fit/No Angle/Not Competitive
Many financial buyers, in particular, often believe they may be outbid by a strategic buyer, or one whose operations align closely with the target company for sale. This is because strategic acquirers can often realize benefits from joining forces with a similar business through cost reduction (duplication of leadership, for example) or growth opportunities (like cross-selling). And this is sometimes the case. When financial buyers like private equity investors do not believe they have such an “angle,” they may pass on the assumption that their offer will be less competitive than others might be.
Not Enough Recurring (or Re-occurring) Revenue
Recurring revenue is king in business investment. Investors can be much more confident in paying higher prices when they believe the business being evaluated is earning revenue that recurs, or can be expected to repeat, on a regular basis. Revenue that can be counted on contractually, or with a long history, gives buyers confidence that there is less risk in the future of the business (that buyers are betting on). When the opposite is true and there is little to no recurring revenue (such as project-related work), buyers will become much less interested or pay significantly less for the earnings.
Too Much (or Not Enough) “Hair on It”
Interestingly, some buyers like business challenges that may have suppressed performance and specialize in turnaround situations; however, many more prefer to invest in companies without such issues, or “hair,” on the business. In most cases, this type of feedback is due to business or financial factors they believe they have uncovered during the process. When the business is not the right fit for them, based on business performance and operations, buyers will pass.
Geography
To simplify their evaluation process, investors often focus on specific geographies where they prefer to pursue opportunities, while avoiding areas where they do not. Sometimes, buyers look specifically within a state, region, or country, whereas others may be more agnostic, given the right target. Unfortunately, when businesses are headquartered or operate outside a preferred geography, buyers typically decline the opportunity to review or participate in the marketing process.
Timing (Not Right)
Timing a sale to align with buyers’ current priorities is often one of the more challenging preferences to navigate and predict. Without knowing or hearing from interested investors who invest in the industry, it is difficult to know which of them will have the greatest appetite for buying the company for sale at any given time. Even the right partner for a business owner will pass on an opportunity if the time is not right. M&A advisors like HORNE Capital often stay in touch with buyers in the industries they cover, which can benefit owners looking to sell.
Union/Non-Union
Whether employees are unionized or not is one of several examples of specific preferences that interested buyers hold that are sometimes dictated by current holdings or operations of the acquirer. For example, if a buyer is already invested in a non-union contractor business, then acquiring another contractor business to operate the businesses together can become additionally challenging to navigate. Many buyers will not entertain investing in both types of businesses. When evaluating prospective interested buyers, it is often important to understand which types of companies the business prefers, and equally important, which businesses it does not.
The above reasons are often nuanced, and the list is certainly not exhaustive.
When considering a sale, we recommend using an M&A advisor, like HORNE Capital, who can share expertise from conversations with interested parties. Avoiding deal killers is just one of the many conversations (value drivers, timeline, business or industry factors, etc.) that can be addressed months or years prior to initiating a sale process.
As an owner, you have spent years building your business and countless hours planning how to execute your business strategy. Equally important is the time needed to plan for executing a business exit or legacy strategy. Understanding which factors may prove to kill an otherwise successful transaction can be the difference between a good outcome and a great one.
