Getting to the closing table
When it comes to mergers and acquisitions activity, closing a deal takes overcoming huge statistical odds. Most studies agree that more than 85% of all M&A transactions fail to close, meaning that if you are looking to buy or sell a business, you can expect to close fewer than two out of every hundred LOIs that are accepted. If you are a seller, and only have one business that you are looking to exit, that calculus is even more formidable. So, how can you improve your odds of success and rise above this quagmire?
The key to success lies in how you present and review the salient facts about the business position, the requirements of an appropriate buyer, and the owner’s ability to successfully transition out. It is within the formal due diligence process that these factors are put under a microscope, and thus it is within the due diligence phase of transactions that they typically fall apart. In this article we will uncover the five most common due diligence mistakes, and identify ways to avoid making them.
There is a cliched refrain within the investment banking industry that “time kills all deals.” This phrase has earned its cliché status because of the underlying truth in the sentiment. The longer it takes to get to the closing table once an LOI is signed, the more opportunity there is for something to go sideways. As much as investors truly want to put their money to work on a business, their fundamental paradigm is trying to find a reason to say no to a deal. This is how they hedge against failed investments. The more time an investor has to scrutinize an operation, the higher the likelihood that they will talk themselves out of the transaction.
Time also opens the door for an outside threat to cause trouble. For instance, my team was in due diligence on a company that manufactured roofing trusses for the home construction industry. When the economy headed toward an inflationary recession, the banks started changing their acceptable risk profile and interest rates began shooting up. This changed everything about the transaction metrics and required that we get extra creative in formulating a structure that took care of everyone. We were able to get this particular transaction closed, but a huge number of other transactions did not close.
What everyone involved in an M&A process needs to recognize is that the due diligence process requires the preparation and review of literally thousands of documents. If your deal team begins collecting these files when the LOI is executed and they receive a formal request list from the buyer, two things will happen: the process will grind to a halt right when everyone needs to build momentum and the deal team will not be able to adequately review the files it is handing over. This is where mistakes get made, and information can be misconstrued or disclosed out of sequence.
Our recommendation and our process require that the collection of information for due diligence begin at the execution of the engagement agreement. This allows everyone adequate time to collect and fully review all of the information that will be disclosed, and to categorize it appropriately. What’s more, by having these files gathered and categorized, the team is ready to flip a switch and open up the data room so that the buyer team can hit the ground running when the LOI is executed.
Nothing is more detrimental to the due diligence process than a material adverse finding. Anything negative about the business that is discovered during diligence will cause the entire transaction to change. At best, the seller will have to defer a larger portion of the overall business value. The business value could be lowered on account of this new information, or the buyers could simply walk away from the transaction. We have a phrase “go ugly early” to describe how we identify and disclose in our Confidential Information Memorandum (CIM) any salient information that may be negative. By getting out in front of the issues and provide solutions. Any buyer that issues an LOI will contemplate these issues in their value calculations and will not be able to cite them as material adverse findings.
It is estimated that more than 70% of all failed deals can be attributed to owner sabotage. Letting go of a business that the owner has not only poured their heart and soul into for decades, but also that was the principle factor against which they identified themselves is a deeply emotional process. Without doing the work of establishing a meaningful plan for life after ownership and emotionally separating themselves from the organization, there will be a point during due diligence where the idea becomes too much to handle. Owner sabotage can take many forms, ranging from attempting to re-trade the business value to speaking negatively about the buyers to the staff and include everything in between. The deal team cannot avoid the difficult owner conversations, and should have a well-established transition plan before beginning the sale process. Buyers should seek an understanding of what this plan is before executing an LOI.
Many business owners are afraid to talk with their staff about their exit plans, and this almost always causes unnecessary complications during due diligence. People are by and large averse to change and the unknown. The more that a deal team can facilitate understanding about what a change will likely look like with respect to their job security and day to day work expectations, the less risk there is that the staff will cause problems. The loss of a key employee or several members of a team can certainly be considered a material adverse incident, and can cause all kinds of problems for the transaction. Having open conversations with the team about any M&A plans can limit this from happening, and open up more productive buyer introductions when the timing is appropriate for them to happen.
I have personally witnessed transactions fall apart because legal counsel and accountants for the same team disagree on salient points of the definitive purchase agreement. Confusion within the advisory team at this critical stage of the game can be expensive and can derail a transaction. It is essential that the transaction advisor brings the entire advisory deal team together from day one to ensure that everyone’s perspectives and concerns can be aired, and reasonable solutions can be worked through. This will ensure that the entire deal team is in lockstep when negotiating with their counterparts on the other side of the table.
It is possible to beat the odds and close transactions consistently and to everyone’s benefit. All it takes is a strong plan, diligent execution, and an understanding of the factors that cause deals to fall apart. More attention and time needs to be dedicated to your due diligence process than any other element of the deal process. It should be the first thing you embark upon once the engagement agreement is executed, and will be the last thing you close out when the ink is on the paper. Keep this in mind and you will be ahead of the pack.