For every acquisition that reaches the closing table, many more never make it to a signed Letter of Intent (LOI). While disagreements over price often receive the blame, valuation is rarely the sole reason a transaction fails. More often, deals unravel because one or both parties discover issues that could have been addressed months before the company was marketed.
In lower middle market transactions, the most successful deals are rarely those without problems. Rather, successful deals are ones where management anticipated potential obstacles and addressed them before negotiations began.
Here are five of the most common reasons transactions fail before an LOI is signed.
1. Sellers Have Unrealistic Expectations About Value
Business owners understandably view their companies through the lens of years, or decades, of hard work. Buyers, however, evaluate businesses based on future cash flow, risk, growth opportunities and market conditions.
A seller who believes the company is worth significantly more than the market will support often loses credibility early in the process. Sophisticated buyers may simply move on rather than invest substantial time pursuing a transaction with little chance of success.
Owners considering a sale should seek an objective valuation or market assessment before beginning discussions. Aligning expectations early creates a stronger foundation for negotiations.
2. Financial Reporting Does Not Inspire Confidence
Many privately held companies operate successfully with financial reporting that is sufficient for day-to-day management but inadequate for an acquisition process.
Buyers do not necessarily require reviewed financials or need financial statements prepared perfectly in accordance with GAAP; however, Buyers expect financial information that is organized, consistent and capable of supporting management’s representations. Missing documentation, unexplained adjustments or inconsistent reporting often raises questions that extend beyond the numbers themselves.
If a buyer begins questioning the accuracy of the financial statements, that skepticism frequently extends to other aspects of the business.
Investing time in preparing reliable financial information before approaching the market often increases buyer confidence and allows management to spend less time explaining historical records.
3. Material Business Risks Are Discovered Too Late
Even before formal legal diligence begins, experienced buyers evaluate risk. Common concerns include:
- Significant customer concentration
- Dependence on one or two key employees
- Expiring customer contracts
- Pending litigation
- Intellectual property ownership issues
- Regulatory compliance concerns
- Cybersecurity weaknesses
None of these issues necessarily prevents a transaction. The problem is discovering them unexpectedly.
When sellers identify and address risks in advance, or at least prepare thoughtful explanations, they maintain credibility and reduce the likelihood that negotiations will stall.
4. Sellers Are Not Operationally Ready for a Transaction
Selling a company is demanding. Owners who attempt to manage a transaction while continuing to operate the business often underestimate the amount of time required.
Preparing due diligence materials after buyers begin asking questions creates unnecessary delays. Buyers may interpret slow responses as evidence that management lacks organization or is attempting to conceal information.
Well-prepared sellers typically establish a secure data room before marketing the company and assemble key corporate records, contracts, financial statements, employment agreements and organizational documents in advance.
Deals typically proceed more smoothly when owners bring in key employees to assist with diligence and management of the transaction.
Preparation allows management to remain focused on operating the business while demonstrating professionalism throughout the process.
5. The Wrong Buyers, or Advisors, Are at the Table
Not every interested buyer is capable of completing a transaction.
Some strategic buyers are merely gathering market intelligence. Some financial buyers lack committed capital. Others simply do not have experience completing acquisitions in the lower middle market.
Similarly, assembling the right advisory team matters. Sellers should enlist accountants, lawyers, and other advisors who are experienced in M&A transactions to help guide them through the transaction process from start to finish.
Choosing experienced advisors early often helps prevent avoidable problems before they become deal-breaking obstacles.
Seller Readiness Checklist
Before beginning discussions with potential buyers, consider whether your company can answer “yes” to the following questions:
- Are our financial statements complete, accurate and readily available?
- Are our major customer and supplier contracts current and assignable?
- Are our corporate records and ownership documents organized?
- Have we identified any pending litigation, regulatory or compliance issues?
- Do key employees have appropriate employment, confidentiality and restrictive covenant agreements?
- Do we understand how a buyer is likely to value our business?
- Have we assembled an experienced team of legal, accounting and financial advisors?
Addressing these questions before entering the market will not eliminate every challenge, but it will significantly improve the likelihood that serious buyers remain engaged through the LOI stage and beyond.
Contact
Considering a sale or preparing to enter the market? Contact KJK Partner Alex Jones (AEJ@kjk.com) to discuss further.