Once an LOI is negotiated and executed and the initial euphoria of a “deal” has worn off a bit, the hard work really begins. I would like to start with some facts. An easy Google search will reveal that anywhere between 50% to 90% of deals die between LOI and closing. Well those are sobering numbers. At Redcap, we are pleased to say that our batting average is a bit better than that – we estimate that we have closed about 80% of the deals we sign, but its still not 100% – why is that?
While deals can die for any number of reasons, there are a few key pressure points that we often see that become problematic. A good advisor will help you navigate these (whether it be on the buy or sell side) by getting in front of them early (pre-LOI ideally) and managing them along the way.
A few that we would highlight:
- Negotiating the Definitive Docs: Along with hiring the right advisor, we also recommend a strong vetting of counsel, one that is experienced with M&A docs and that is “generally commercial”. One of the biggest mistakes that we see by entrepreneurs is their preference to use their “local guy” for all their law needs. This generally works fine for incorporating companies, wills and estate planning, maybe working on a small real-estate purchase or a lease and we don’t want to diminish the importance of trusting your counsel, but when an inexperienced generalist is up against a more experienced M&A lawyer, the resulting documentation goes one of two ways. The inexperienced lawyer doesn’t know the relevant precedents, so they either spend a lot of billable time trying to negotiate with the other side off-market terms which wastes both time and good will, or they cave on important legal concepts that ultimately leaves their clients in a less than favourable position in terms of representations and warranties or indemnities. The best lawyers that we interact with have a strong understanding of M&A precedents, but also have a strong commercial sense of where the risks in the business lie and how to appropriately “paper them” in the documentation. Without having strong, appropriate counsel, we see clients that get confused and frustrated because risks are being overblown or misrepresented and that “the other side is trying to screw them” on some concept and they or their counsel take a hardline on a term that is frankly unreasonable. We work hard to present the “other side” of the argument so that our clients see both sides which is important in any negotiation and weigh the risks with the ultimate reward of closing the deal.
- Due diligence over-reach: Buying a business can be a complex and lengthy process but depending on the deal structure and size of the business, can generally be completed in 2-3 months by an experienced and well-organized counterparty. However, inexperienced buyers who take a few weeks to “get organized” right out of the gate and then are not sure how to conduct proper diligence can derail a process. We see this occurring two typical ways – First either a company never gets organized and their due diligence is very superficial until a few weeks before a deal deadline at which time it is a scramble by all parties to meet their bare minimum requirements (and leaves the sell side wondering how serious a buyer really is). Or, and more common with Private Equity, the information requests and questions never stop and continue to get more and more into the minutia of a business. This can lead to deal fatigue and frustration as seller struggles to understand why so much emphasis is being put on $2,000 of annual donations (true story). To manage this, we typically have in our agreements an exclusivity period and specific timeline milestones built into our agreements so that all parties are focused on the material diligence items, timelines and implications of missing them. One item to note is that in larger deals, there may or may not be the need for additional outside parties to assist with diligence (e.g. a Quality of Earnings conducted by an 3rd party accounting firm or a Phase 1 Report by an environmental consulting firm) – sometimes as we saw during the fall of 2021, these reports can take a significant amount of time and effort to complete, so we work these types of reports into our schedule and documentation.
- Due diligence findings: Another item that often derails a deal (and sometimes quite quickly) is when something material (like a client contract being terminated, a tax issue or any number of other things) wasn’t disclosed pre-LOI which changes value premise and thus the buyer requests a change to deal terms. When representing a sell side client, we spend a lot of time upfront working with clients reviewing, critiquing (as a buyer should) and packaging up as much reasonable information upfront. We often say to sellers – treat us like your Priest or Therapist and tell us the good, bad and the ugly about your company upfront so that we can appropriately disclose and position it to buyers. Buyers who do proper due diligence will find problematic items if they exist, so better to be upfront and address it upfront rather than it turn into a deal breaker closer to closing when emotions are already elevated. Finding new information is all part of a diligence process, but if something material was hidden from buyers (either maliciously or not), it breaks some of the trust and goodwill established and leaves buyers wondering “what else may be missing or hidden”; which means they will spend even more time looking through and being critical of the business. If something material is found and a purchase price adjustment is requested (justifiable or not), that often causes friction in the broader discussions and can lead to a deal falling apart.
- Personality misalignment: If two parties don’t particularly like each other (perhaps they are current competitors), this dynamic can be worked through if the sale is for 100% of the company and the vendor is walking away – intermediaries like Advisors and Lawyers can step in the middle. However, if the deal is contingent on an earn-out or is just a partial sale and the parties are going to be working together post closing – sometimes that marriage just isn’t meant to be. In our processes, we generally try to have all parties meet a couple of times pre-LOI just to get a sense of “fit” going in (which is made more difficult during the COVID Pandemic), but we have seen a few “off the cuff” comments completely derail a process. In fact, in the early days of Redcap&Truss, we actually advised a sell-side client to walk away from a deal as we could see the friction developing as the buyer began explaining all the changes they were going to make to the business (that would have impacted the short term profitability of the business and potentially the earn-out consideration our client was going to receive). After a few discussions, it was clear that both parties had different ideas and the fit just wasn’t there. (Thankfully – we were able to find that seller a more suitable buyer a few years later, so it worked out for our client in the end).
- External influences: Sometimes there are just things that are outside of anyone’s control. The COVID Pandemic, an unexpected illness or death of an owner or key employee, or a key client being acquired or going into bankruptcy are all examples of reasons why we have seen deals collapse. The environment changes, the operating business changes and ultimately the value premise changes.
Ultimately deals are very hard to complete and the stars sometimes really need to align to make it all work. Anyone who tells you that doing deals is “easy” is either inexperienced or lying – when you hear that, we suggest you politely smile, turn and run, and give us a call!