“Red Flags” in the Sunset
Unlike that poetic title of an old-time standard song, Red Sails in the Sunset, red flags are not a pretty sight. They can cause a deal to crater. Sellers have to learn to recognize situations indicating there might be a problem in their attempt to sell their business. Very, very seldom does a white knight in shining armor riding a white horse gallop up, write a large check and take over the business – no questions asked. And, if he did, it probably should raise the red flag – because that only happens in fairy tales. Now, if the check clears – then fairy tales can come true.
Sellers need to step back and examine every element of the transaction to make sure something isn’t happening that might sink the deal. For example, if a company appears interested in your business, and you can’t get through to the CEO, President, or, even the CFO, there most likely is a problem. Perhaps the interest level is not what you have been led to believe. A seller does not want to waste time on buyers that really aren’t buyers. In the example cited, the red flag should certainly be raised.
A red flag should be raised if an individual buyer shows a great deal of interest in the company, but has no experience in acquisitions and has no prior experience in the same industry. Even if this buyer appears very interested, the chances are that as the deal progresses, he or she will be tentative, cautious and will probably have a problem overcoming any of the business’s shortcomings. Retaining an intermediary generally eliminates this problem, since every buyer is screened and only those that are really qualified are even introduced to the business.
Both of the above examples are early-stage red flags. Sellers have to be focused so they don’t waste their time on buyers that are undesirable. If a buyer appears to be weak, does not have a good reason to need the deal, or is otherwise unqualified, the red flag should be raised because the chances of a successful transaction are diminished. The seller might seriously consider moving on to other prospects.
Red flags do not necessarily mean the end of the deal or that it should be aborted immediately. It simply means that the seller should pay close attention to what is happening. Sellers should keep their antenna up during the entire transaction. Problems can develop right up to closing. Here is an example of a middle-stage red flag: The seller has received a term sheet from a prospective buyer and is then denied access to the buyer’s financial statements in order to verify their ability to make the acquisition. As a reminder, a term sheet is a written range of value for the purchase price plus an indication of how the transaction would be structured. It is normally prepared by the would-be purchaser and presented to the seller and is non-binding. A buyer who is not willing to divulge financial information about his or her company, or, himself, in the case of an individual, may have something to hide. Due diligence on the buyer is equally as important as due diligence on the business.
If a proposed deal has entered the final stages, it doesn’t mean that there won’t be any red flags, or any additional ones, if there have been some along the way. If there have been several red flags, perhaps the transaction shouldn’t have gone on any further. It is these latter stages where the red flags become more serious. However, at this point, it makes sense to try to work through them since problems or issues early-on apparently have been resolved.
One red flag at this juncture might be an apparent loss of momentum. This might mean a problem at the buyer’s end. Don’t let it linger. As mentioned earlier, at this juncture all stops should be pulled out to try to overcome any problems. If a seller, or a buyer, for that matter, suspects a problem, there might very well be one. Ignoring it will not rectify the situation. When a red flag is recognized, it is best that it be confronted head-on. It is only by acting proactively that red flags in the deal can become red sails in the sunset – a harbinger of smooth sailing ahead.
The Confidentiality Myth
When it comes time to sell the company, a seller’s prime concern is one of confidentiality. Owners are afraid that “if the word gets out” they will lose employees, customers and suppliers. Not to downplay confidentiality, but these incidents seldom happen if the process is properly managed. There is always the chance that a “leak” will occur, but when handled correctly, serious damage is unlikely. Nevertheless, a seller should still be very careful about maintaining confidentiality since avoiding problems is always better than dealing with them. Here are some suggestions:
- Understand that there is a “Catch 22” involved. The seller wants the highest price and the best deal, and this usually means contacting numerous potential buyers. Obviously, the more prospective buyers that are contacted, the greater the opportunity for a breach of confidentiality to occur. Business intermediaries understand that buyers have to be contacted, but they also realize the importance of confidentiality and have the procedures in place to reduce the risk of a breach. Another alternative is to work with just a few buyers. This, however, does reduce the chances of obtaining the best price.
- Another way to avoid this breach is to try to keep a short timetable between going to market and a closing. The shorter the timetable, the less the chance for the word to get out. One way to keep a short timetable is to gather all of the information necessary for the buyer’s due diligence ahead of time. Create a place where all of this material can be consolidated. This can be as simple as a set of secured file drawers. Such documentation as: customer and vendor contracts, leases and real estate records, financial statements and supporting schedules (assets, receivables, payables), conditions of employment agreements, organization charts and pay schedules, summary of benefit programs, patents, etc. should be gathered. It is not unusual for due diligence examinations to look back 3 to 5 years, so there could be a lot of records.
- The above means that the seller has to get organized. Selling one’s business is fraught with paperwork. Set up some three-ring binders so all of the relevant paperwork and resulting documentation has a place. These binders should be kept in a secure location.
- The seller’s employees should be conditioned to having strange people (potential buyers) walk through the facility. One way to avoid suspicion is to arrange to have unrelated people, for example – customers, suppliers, advisors – tour the company facilities prior to placing the business on the market.
- If sellers have not prepared their employees for strangers walking through the facilities as suggested above, awkward situations can develop. A valued employee may question why tours are being conducted. The seller is then placed in the position of explaining what is happening or covering the question with a “smokescreen.” A seller could reply by saying that the strangers are possible investors in the company. If asked directly if the business is for sale, the seller could respond by saying that if General Electric wants to pay a bundle for it – anything is for sale. Once in the selling process, it is also important to minimize traffic by only allowing serious, qualified prospects to tour the operation.
- Keep in mind that confidentiality leaks can emanate from many sources. For example, an errant email ends up on someone else’s email. A fax gets sent to the wrong fax machine or UPS or FedEx deliveries go to the wrong people. Establish methods ahead of time on how to communicate with potential buyers or an intermediary.
- The key to handling confidentiality may be for the seller to retain a third party intermediary. They will insist that all potential buyers sign a confidentiality agreement. They will also be able to advise the seller on how to handle the “company tours” and can insure that only qualified buyers are shown the facilities.
- The “myth” is that confidentiality issues can make or break a deal, or cause serious damage to the seller’s business. The reality is that breaches seldom occur when an intermediary is involved, and if they do occur and are handled properly, there is little damage to the business or a potential transaction.
Do I need an attorney?
It may be advisable to have an attorney review the legal documents. It is important, however, that the attorney you hire is familiar with the business buying process and has the time available to handle the paperwork on a timely basis. If the attorney does not have experience in handling business sales, you may be paying for the attorney’s education. Most business brokers have lists of attorneys who are familiar with the business buying process. An experienced attorney can be of real assistance in making sure that all of the details are handled properly. Business brokers are not qualified to give legal advice.
However, keep in mind that many attorneys are not qualified to give business advice. Your attorney will be, and should be, looking after your interests; however, you need to remember that the seller’s interests must also be considered. If the attorney goes too far in trying to protect your interests, the seller’s attorney will instruct his or her client not to proceed. The transaction must be fair for all parties. The attorney works for you, and you must have a say in how everything is done.
If you know someone who has owned their own business for a period of time, he or she may also be a valuable resource in answering your questions about how small business really works.
You have to make the final decision; that “leap of faith” between looking and actually being in business for yourself is a decision that only you can make!
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Why should I go to a business broker?
A professional business broker can be helpful in many ways. They can provide you with a selection of different and, in many cases, unique businesses, including many that you would not be able to find on your own. Approximately 90 percent of those who buy businesses end up with something completely different from the business that they first inquired about. Business brokers can offer you a wide variety of businesses to look at and consider.
Business brokers are also an excellent source of information about small business and the business buying process. They are familiar with the market and can advise you about trends, pricing and what is happening locally. Your business broker will handle all of the details of the business sale and will do everything possible to guide you in the right direction, including, if necessary, consulting other professionals who may be able to assist you.
Your local professional business broker is the best person to talk to about your business needs and requirements.
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