Why Do Deals Fall Apart? - A Private Equity Perspective (Part 2)
Not all deals come together. In part 2 of this series, we provide the perspective of four more private equiteers on the reasons why most deals fail.
Here is our second installment of "Why Do Deals Fall Apart?" Some of our friends from the private equity world provide sage advice for business owners looking to sell their companies.
The Congruity Group
"As investors and acquirers of mid-market businesses, we evaluate nearly 200 proposals annually; however, less than 2% of these proposals conclude with a successful transaction. In order to efficiently filter through for the very best opportunities, there are essentials that we look for and the absence of these essentials will kill a transaction:
1. What you say turns out to be true: Make the assumption that a buyer will do their homework. We will ask endless questions; they are not personal so don’t take them that way. Ensure your presentation numbers match your actual financials. Establishing confidence early in the process will produce trust, reduce perceived buyer risk and increase value for the vendor. The converse is also true.
2. Explain your challenges before we find them on our own: We understand all businesses face challenges; understanding them will allow us to get comfortable with that business. Without comfort, we need to discount for risk. Walking us through trials and tribulations actually builds trust and credibility. A deeper understanding of the business risks allows us to mitigate them moving forward.
3. Are you a willing seller? We will want to get clear indication of price very early in the process. Ensure you want to sell. Understand the implications that selling the business will have on you and your family. Ensure your price expectation matches that of the market. Clear up any internal shareholder or family issues prior to going to the market."
Paul Poscente, Co-founder and Managing Director of The Congruity Group
Banyan Capital Partners
"I can’t say why most deals fall apart, but one common denominator among the deals that I have seen fall apart is the passage of time. Sometimes it’s hard to tell whether the passage of excessive time is symptomatic of something else in the deal going wrong or whether poor time management is the cause, but, regardless, the passage of excessive time always seems to be present when a deal dies.
Like natural erosion, it wears on all aspects of the deal and it will uncover those aspects of the deal prone to weakness. It creates additional opportunity for new, competing buyers to emerge for the seller and it brings forth new opportunities for the buyer. Time causes counterparties to call into question each other’s good faith. Eventually it uncovers latent due diligence problems and it always wears on the energy of the deal participants, which ultimately leads to fatigue."
Michael Martin, Managing Director of Banyan Capital Partners
32 Degrees Capital
"In my experience, the breakdown of 'trust' is a major contributor to deal failure. This generally occurs during the Stock Purchase Agreement negotiations and results from the risk allocation process. Risk allocation is the process of determining which side, the seller or the buyer, will assume deal related risks. Common deal related risks include unknown expenses like potential litigation, warranty claims, unexpected capital expenditures or future taxes. No buyer wants to assume risks they can't see and no seller wants to assume risks they are unaware of. Therefore, balancing risk and conversely trying to maximize return always becomes a focal point of negotiations and often contention. If the risk allocation process takes too long and creates too much animosity, the combination of second guessing the decision to buy or sell and deal fatigue set in. As deal fatigue sets in, the seller or buyer begins to ask themselves 'What am I missing? Should I trust the other side? or Why is the other side asking for this, don't they trust me?' As trust breaks down, invariably each side begins to question the integrity of the other and then ultimately question why they are doing the deal. If these issues can't be resolved then the deal falls apart. Contrary to common belief, not every seller or buyer is in it just for the money. Most people want to feel like they negotiated a hard, but fair deal and that all involved won."
Art Robinson, Partner at 32 Degrees Capital
"Deals fall apart for many reasons. Sometimes the reasons are unforeseeable, but many times the situation can be avoided. One of the more common 'avoidable’ reasons that deals fall apart is because the facts, as they emerge, don’t match the original expectations of the buyer. For a deal to fall apart, it means there had to be a deal - a point in time when both parties agreed to the basic terms of a transaction. At that point in time, the buyer had in his or her mind a set of beliefs about the business he or she was hoping to acquire or invest in. And chances are, up until that point in time, the vendor had provided a limited amount of information because he or she wanted to know if there was going to be a meeting of the minds around the terms of a deal before providing detailed information. The probability the deal will close is highly correlated to whether the facts and concepts the buyer learns in due diligence match his or her initial beliefs.
When the deal is struck, both parties presumably want it to close. For the deal not to close as a result of the due diligence means that the buyer’s understanding of the target business, after a thorough process, did not live up to the perception of what he or she expected to find. Perhaps the buyer was not sufficiently familiar with the industry when the deal was struck, and once he or she got into the details, the risks around the business proved to be more than he or she originally assumed. Perhaps the vendor marketed the business with summary materials that conveyed the business as having (or lacking) certain attributes that did not prove to be in diligence.
Vendors will always want to portray their business in the best possible light. Buyers will often want to delay devoting scarce resources to diligence until they know that there is a deal to be done. Finding the right balance of pre-deal education/diligence to ensure that the set of beliefs held by the buyer is accurate and able to be confirmed during due diligence, is critical to increasing the odds that a deal is completed successfully. The responsibility for striking that balance rests with all parties: vendors, buyers and especially advisors."
Michael Hollend, Partner at TorQuest Partners