These are words no one wants to hear but unfortunately, deals blow up all the time. Within the Lab, we often say buying businesses isn’t for the faint of heart. Acquisitions are not a simple process.
I think the level of excitement that comes with finally getting an LOI signed and standing at the beginning of the due diligence period can be one of the most sought-after moments. So much work typically goes into the search, evaluation, and LOI negotiation process that finally crossing the threshold of a signed deal, feels monumental.
It’s the first moment that the idea that you’re going to be buying a business becomes a reality.
That being said, just because an LOI gets submitted, doesn’t mean it will get signed. Along the same lines, just because an LOI get signed, doesn’t mean the deal will close.
I’ll never forget the time that I was trying to acquire a business and ultimately lost the deal because the broker representing the deal decided they were going to buy the business instead.
While I don’t have the exact figure, I can tell you that deals fall apart frequently for a myriad of reasons far too robust to cover in a single article.
However, those reasons can all boil down to these four basic drivers:
(1) Seller (2) Buyer (3) Financier (4) Broker
Let’s dive into these a bit.
Seller Let’s talk about the two different types of deals you may find during your search: (1) on-market and (2) off-market. On-market means the deal is represented by a broker, advisor, investment banker. An off-market deal is not represented by anyone and likely was identified by an interested buyer approaching them. The number one reason off-market deals fall apart is because of the seller.
In this situation, typically the seller decides they don’t want to sell. They may change their mind for a myriad of reasons. Sometimes it’s the fact that selling your business is an emotional journey and an owner/founder’s identity is wrapped up in the business making it difficult to sell.
The number one reason for a seller backing out, on or off-market, is because they’re simply growing too fast. Many times, this reason is driven from the realization, often based on valuation information gained through the selling process, that future earnings would provide a higher payoff than cash at closing. These scenarios can be based on a few things such as a strong sales cycle during the acquisition period or even winning some outstanding proposals that bring in substantial revenue in the next 12 months.
It’s important to keep in mind that the seller frequently is not receiving the full purchase price in cash at close. Let’s say that I’m selling my company where I’m currently making a million a year for a 3.5 multiple which equates to a purchase price of $3.5 million.
If I’m earning a million this year but have doubled income every year, in the next 12 months, I’m expecting to make $2 million. I realize that I don’t want to sell for 3.5 million because if I just hold onto the business for another 18 months, I can make that and then go out and sell it for even more money.
Another scenario that has happened to a business I had on the market and recently happened to a Lab member, suddenly while under contract, the business got a new order or a prospective order that increased the business value significantly.
Depending on whether the order has been finalized, the potential for such significant growth may be enough to cause the seller to stall until the high-ticket sale closes or ultimately may kill the deal.
Buyer There are really two main reasons why a buyer backs out of a deal: new information and cold feet.
New Information Once the LOI is executed, due diligence begins which is when the buyer will verify if what they were told is true. It’s then that things come into focus. Typically, assumptions are confirmed but there are some situations where new information is introduced.
In one instance, there was a trademark issue with the brand of the business. It was enough of a legal challenge that the buyer backed out because this was new information that came to light while conducting due diligence.
Cold Feet We’ve discussed how closing on a business in the end requires a blind leap of faith in yourself at the 11th hour. However, Jason, Yelowitz at QuietLight refers to something similar, the 11th hour freakout. This is a pretty standard experience for all buyers. It’s the last-minute realization that they’re about to take a big risk. They may start questioning, “Should I be buying this?” and a good broker will be able to identify whether this is a real problem or a level of comfort issue.
The other reason for cold feet is the comfort of their paycheck. It’s important not to underestimate the comfort of a nice fat paycheck. Most of the people acquiring businesses are in a situation where they’re able to make a great living, not taking any risks, not taking a leap of faith. There’s great discomfort in stepping out of that stability and security.
Financier Financing a deal comes in many forms from traditional loans, SBA loans, investors, search funds, self-funded searches.
Securing investors is one of the most challenging endeavors likely because it’s a bit of a chicken and egg situation where you need a deal to attract investors but you need investors to access a deal. As a result, failing to raise the required capital is one of the primary ways the financing will kill a deal.
On the other hand, if the deal is being financed by a bank. While unusual, there’s a handful of reasons why a lender might kill the deal.
The first is that it’s simply just doesn’t pass committee meaning that a buyer was sold on the fact that they were the right bank at the beginning. However, there’s a long delay in going in front of the approval committee. If that’s the case, the buyer would likely already be pursuing the deal. This could be due to something in your buyer package they’re not comfortable with or possibly something about the business or possibly a 3rd party valuation will cause challenges.
Often the valuation won’t necessarily end the deal rather force a renegotiation of purchase price which can cause everyone to reconsider the terms.
The biggest reason the financier would pull out would be significant adverse change. If there is a material event outside of normal business operations between the LOI and closing period such as revenue dropping 15% in a 90-day period, it points to risk. This gives the financier and buyer an opportunity to back out.
Broker It often comes up in Acquisition Lab that not all brokers are created equal. We talk a lot about how the private capital markets are unregulated. There are zero licenses that you need, except in certain states a real estate license, to be a broker. That’s it.
Because brokers are hired by the sellers, at the end of the day, most will say that they represent the seller. As a result, they want to get the best price for the seller and keep control as much as they can. However, if you’re the buyer, it’s your money, which means you ultimately end up with all the control in a deal. You’re the one that decides if you will close or not.
As a result, brokers often try to keep control as much as possible. This can look a bit different in every scenario. It could be, “Hey, we don’t do non-binding letters of intent” or “we won’t give you enough information to make a good decision”. It’s an awkward position to be put into but it happens all the time.
They might have preferred suppliers that they insist you use. It’s absolutely possible that they’ve worked with that lender frequently and know they can get a deal done. However, if they’re very insistent on it or even require it, they’re likely in a kickback situation with those providers. As a result, they’re unwilling to work with buyers unwilling to comply and ultimately kill the deal. There have been situations where a broker has taken a fairly extreme approach of pushing a preferred provider which ultimately led the buyer feeling pressured and getting reticent about the transaction ultimately killing the deal.
If you plan on buying a business in the next 12 months, please consider applying to the Acquisition Lab. We have a vetted group of buyers and a do-it-with-you buy-side advisory service. Please feel free to apply and get world-class education, support from our team of advisors, and a suite of tools and a vetted community to help you succeed in that first acquisition or in implementing a grow-through-acquisition process.