Acquisitions do not get completed due to concerns originating from two general sources: From the seller’s point of view, the business owner can be disenchanted with the terms of the deal or—much more likely—its value. From the acquirer’s point of view, they might have buyer’s remorse between when the Letter of Intent (LOI) is signed and the deal closes if doubts are raised about the quality of the earnings and whether the sustainability of the earnings are realistic after the close.
Deal value too low
Let’s look at the seller first. Most sellers have a firm price in their minds for what they want for their business. They’ve often worked their whole lives to build up the business, and they want to be compensated for that work before they hand over the keys. Fair enough. (Complicating matters, there is often debt to retire, which eats into the amount the seller can extract in cash.) That said, just as when selling a house that you’ve remodeled and worked on yourself for years, the seller often has an inflated view of the value of the property which the acquirer may not share. The acquirer is not arriving at their number emotionally. They are using dispassionate comps and mathematical modeling to determine the offer price. The acquirer is not factoring in the times the seller may have worked over the Christmas holiday, or missed the kid’s ball games, or didn’t take vacations.
This emotional component enters into the acquisition process especially when the seller first sees the opening bids. Some sellers take affront when the amount offered is substantially lower than what they had in mind. But the bid amount is something the seller shouldn’t take personally. The acquirer has a natural incentive to bid low (perhaps eventually adjusting upwards if persuaded). Moreover, as mentioned, the acquirer is not just pulling a figure out of thin air. They’re using third-party reports to determine their bid value, triangulating off known values paid for similar deals, calculating the value of future earnings, and estimating how likely the company is to grow. They may have boards to answer to, and they are highly unlikely to pay a premium just because they have the money to do so. In fact, generally, the richer the buyer, the less they will pay.
That said, sellers will sometimes just “walk the deal,” and leave what may be an accurate estimate of the company’s value on the table. Fair enough. It’s their company; they’re entitled to do with it as they please.
A second situation arises when the bid amount is acceptable by the seller, but then the acquirer lays out terms that are unacceptable. Generally, this takes the form of earn outs (one-year or multi-year) that require the seller to assume too much of the acquirer’s risk. Terms can be too onerous, e.g. revenue goals set at too aggressive levels, or there’s loss of control over marketing budgets and hiring. Here too the seller may look over the terms, and simply say there is too much put at risk, and “walk the deal.”
It’s about earnings
Among the acquirer’s concerns, earnings are paramount. Let’s say an acquirer submits a LOI, and the value and terms are acceptable. What the acquirer will watch for between the signing of the LOI and the closing of the deal is whether the earnings hit the targets put forth by the seller, and whether the earnings can be sustained after the close.
In the prospectus, called an Informational Memorandum, or IM, the seller will set revenue and earnings projections that they promise to hit during the due diligence process, which can last months. If there is slippage on those numbers, and forecasts are missed, the acquirer will look very harshly on that, and—depending on the severity of the miss—potentially reprice the deal, inevitably lowering the amount they are willing to pay.
Moreover, during the due diligence process, the acquirer might determine that something is amiss in the company’s ability to sustain its earnings. For example, let’s say the seller loses key sales people when they hear of the sale of the company, or key customers leave for a competitor. Here too, the acquirer may request a repricing, or even leave the deal entirely. To avoid this situation, make sure the Informational Memorandum is as accurate and realistic as possible, and that you have the team firmly in place that will remain after the closing.