Why Deals Fall Apart — Loss of Momentum
Deals fall apart for many reasons – some reasonable, others unreasonable.
For example:
• The seller doesn’t have all his financials up to date.
• The seller doesn’t have his legal/environmental/administrative affairs up to date.
• The buyer can’t come up with the necessary financing.
• The well known “surprise” surfaces causing the deal to fall apart.
The list could go on and on and this subject has been covered many times. However, there are more hidden reasons that threaten to end a deal usually half to three-quarters of the way to closing. These hidden reasons silently lead to a lack of or loss of momentum.
This essentially means a lack of forward progress. No one notices at first. Even the advisors who are busy doing the necessary due diligence and paperwork don’t notice the waning or missing momentum. Even though a slow-down in momentum may not be noticeable at first, an experienced business intermediary will catch it.
Let’s say a buyer can’t get through to the seller. The buyer leaves repeated messages, but the calls are not returned. (The reverse can also happen, but for our example we’ll assume the seller is unresponsive.) The buyer then calls the intermediary. The intermediary assures the buyer that he or she will call the seller and have him or her get in touch. The intermediary calls the seller and receives the same response. Calls are not returned. Even if calls are returned the seller may fail to provide documents, financial information, etc.
To the experienced intermediary the “red flag” goes up. Something is wrong. If not resolved immediately, the deal will lose its momentum and things can fall apart quite rapidly. What is this hidden element that causes a loss of momentum? It is generally not price or anything concrete.
It often boils down to an emotional issue. The buyer or seller gets what we call “cold feet.” Often it is the seller who has decided that he really doesn’t want to sell and doesn’t know what to do. It may also be that the buyer has discovered something that is quite concerning and doesn’t know how to handle it. Maybe the chemistry between buyer and seller is just not there for one or the other of them. Whatever the reason, the reluctant party just tries to ignore the proceedings and lack of momentum occurs.
The sooner this loss of momentum is addressed, the better the chance for the deal to continue to closing. Because the root of the problem is often an emotional issue, it has to be faced directly. An advisor, the intermediary or someone close to the person should immediately make a personal visit. Another suggestion is to get the buyer and seller together for lunch or dinner, preferably the latter. Regardless of how it happens, the loss of momentum should be addressed if the sale has any chance of closing.
How’s Your Corporate Social Responsibility (CSR)?
Your first question may be, “Just what is Corporate Social Responsibility (CSR)?” We see CSR demonstrated in a variety of ways in areas such as:
THE COMMUNITY:
o Contributing to local community programs through financial support and personal involvement
THE ENVIRONMENT:
o Using packaging and containers that are environmentally-friendly
o Recycling
o Using low-emission and high mileage vehicles where possible
o Seeking more efficient manufacturing processes, etc.
THE MARKETPLACE:
o Utilizing responsible advertising, public relations and business conduct
o Exercising fair treatment of suppliers/vendors, contractors and shareholder
THE WORKPLACE:
o Implementing fair and equitable treatment of employees
o Upholding workplace safety, equal opportunity employment and labor standards
Actions such as these not only uphold today’s business standards, but they also pave the way for future generations. In years past, many of these elements were considered almost anti-business and some had to be enforced by governmental regulation.
Successful companies such as Tom’s of Maine (producer of natural personal care products) and Newman’s Own have practically been built on CSR. More and more companies – public and private – are following the elements of CSR. Google is a desired workplace because of the way they treat their employees: great benefits, great food in the employee cafeteria, exercise equipment – you name it, Google provides it.
Recognizing CSR in today’s business climate not only increases shareholder/investor interest, but also increases value. Socially-conscious companies are considered sound investments. They attract buyer interest and acquire higher selling prices when it comes time to sell. After all, most buyers want to find a business with the following attributes:
• Good relations with the local community
• Products and/or services that are meeting the current trends in the marketplace and are positioned to meet future trends
• Positive relations with employees and low-turn-over
• Excellent customer loyalty
• Good relationships with suppliers and vendors
• No “skeletons” in the company closet
In addition, good environmental practices reduce costs, create efficiencies and provide excellent public relations. Good employee relations make for happy workers, which translates to higher productivity and lower absenteeism. Good relationships with customers and suppliers eliminate, or greatly reduce, the possibility of legal entanglements.
All in all, Corporate Social Responsibility not only creates additional value and helps in creating a higher selling price when that time comes – it is also very good business for now and in the future.
Ownership Transition — Survey Results
Mass Mutual Life Insurance Company provided the following survey results based on family-owned businesses. Although the survey was conducted several years ago, the results are still quite revealing, and still applicable.
• Four out of five companies are still controlled by the founders.
• 30% of family-owned companies will change leadership within the next five years.
• 55% of companies fail to conduct regular valuations of the company.
• 55% of CEOs who are 61 or older have not chosen a successor.
• 13% of CEOs will never retire.
• 90% of businesses will continue as family owned.
• 85% of successor CEOs will be a family member.
• 20% of family owners have not completed any estate planning.
• 55% of family owners do not have a formal company valuation for estate tax estimates.
• 60% of businesses do not have a written strategic plan.
• 48% of companies rely on life insurance to cover estate taxes.
The above survey indicates that many family businesses are not optimizing their opportunities. Their insular approach to succession, leadership, planning, etc., indicates their vulnerability for the long term. These vulnerabilities suggest that many business owners should work with professional advisors to resolve these issues. A professional intermediary is an essential member of this advisor group.
An Update on Earnouts
New accounting rules may require that acquirers and acquiring companies report earnout agreements as liabilities.
Joel Johnson, president of Orchard Partners Inc., in his article, “Earnouts,” published by Valuation Strategies, states: “In a given year, 2% – 3% of announced mergers and acquisition agreements involve earnouts. These figures probably understate their prevalence. Earnouts tend to be a characteristic of smaller deals; and in many small deals, terms are not announced. Earnouts are rare when public companies are acquired and more common when ownership is concentrated among a few shareholders.”
This would mean, if implemented, that earnout agreements must have a value placed on them for accounting purposes. As Joel Johnson points out, “The higher the earnout, the greater the liability.”
Why the Earnout?
Johnson further states that earnouts are used for various reasons:
1. to bridge the pricing gap between the seller who places a heavy emphasis on the company’s projections, and the buyer who places most of the company’s value on its present and past performance.
2. to tie the acquisition payout to future performance.
3. to create a form of seller financing in that some of the buyer’s purchase price is delayed into the future. 4. to establish a form of escrow account in that the money is paid on condition of meeting certain thresholds.
5. to act as a type of employment agreement in that the CEO has to stick around in order to collect.
Remember: It Is Not Always the Price
The following are situations where the price was not the deciding issue in the successful sell of a business. The ultimate buyer may be the only one who really understands the situation. A business intermediary really understands the issues and can lead the buyer and seller to a successful resolution.
• One seller had 60 shareholders who needed to walk away from the deal. The losing buyer wanted all selling shareholders to be accountable for the “reps and warranties.” The winning buyer waived the reps and warranties at closing.
• A seller’s management team wanted some future upside in the deal. The losing buyer offered all cash and normal compensation. The winning buyer offered 80% cash, 20% stock plus 3-year earnout on revenues — including acquisitions.
• Time was of the essence. The losing buyer needed 30 day due diligence and negotiations plus a 60-day window to close the deal. The winning buyer offered to close within 40 days of the Letter of Intent and agreed to have limited due diligence.
