A Few Things I Have Learned From Failed Deals

I am  a big fan of deal postmortems–the time you take to assess what went right, what went wrong and how you would do things differently if you had to do it all over again. With each done deal, volumes can be gleaned as educational and helpful in how you would proceed if you had the opportunity for round #2. Of all the “done deal” postmortems, I have perhaps learned the most from the deals that failed to cross the finish line. Deal failure is certainly not the aim of any intermediary, but anyone who has been in the business long enough is lying if they tell you all the deals in which they have been engaged have nailed the intended outcome. Anyone who has been in the industry long enough has the occasional failure. The hope is that not only do the percentage of failed deals decrease, but that expert deal-facilitators are able to spot deal-crushing issues before they spiral out of control. In the spirit of both transparency and enlightenment, here are some items I have learned from failed transactions.

Sellers: Your business is not worth what you think

In my experience, the biggest gap between buyers and sellers occurs on the part of the seller, who thinks his/her business is worth more than the market will bear. This idea is much more prevalent on a deal in the lower middle-market where buyers are often banking on the company sale to over-fund retirement. Once you get above the EBITDA size thresholds, seller’s tend to become more reasonable in how they value their businesses. There are a number of reasons for this including wants vs. needs, seller sophistication, treating comparable outliers appropriately and following the advice of valuation and transaction professionals.

If I perform a simple rough tally on failed deals, the percentage where seller valuation expectations was the big hurdle, would likely hit above 80%. Put differently, most deals fail–or never start–because the seller or issuer is not reasonable in expectations on value.

For sell-side M&A, seller’s often have a value in their mind that equates to their baseline on what they would be willing to receive were the business to sell today. Whether that reverse-engineered number is reasonable or not is typically irrelevant and thus a deal stopper. The deal is often dead before it begins (regardless of the type of offering being run). For instance, a potential pre-profit issuer with only $5M in sales may say, “we want to raise $10M and in exchange we are willing to give up 10% of our business.” For the layperson, this is a $100M valuation on a pre-profit company that is doing only $5M in sales. Even with an astronomical growth rate, most investors will not even get up in the morning unless they can receive >20% of the company’s equity. This is an example of a DOA deal. It is one that most competent and ethical investment bankers will refuse to represent.

In the words of Warren Buffet, “price is what you pay, value is what you get.” Sellers that get greedy and/or unrealistic on value are typically the biggest deal killers, especially if you dip down into the lower middle-market.

Buyers: the Rational Pricing Theory holds true in the middle market

Middle and lower middle-market M&A is currently a seller’s market and I expect it will remain so for some time. Gone are the days that buyers could simply acquire company assets for less than depreciated book value. Today’s market includes cheap and abundant capital (which creates high demand for deals), a fairly steady number of company sellers and a large number of financial and strategic buyers. As a prominent private equity buyer put to me recently, “we always pay at least market value for good deals. It’s not even an option anymore.” In other words, the Rational Pricing Theory also applies to middle-market M&A.

The trouble–and potential for deal failure–occurs when a buyer comes in, offers a more than fair price in a letter of intent, but then extracts any premium out (and then some) through an highly over-burdensome due diligence process. These types of buyers are sometimes referred to as “grinders” as they “grind” down value post-LOI. They use the exclusivity position for due diligence as leverage to eek out every last dime from the seller using their prowess in due diligence. Most of this is done through lack of appropriate net working capital disclosures, which we have previously discussed.

Again, most of the over-negotiated deals come as the business sizes dip down into the lower mid-market. Hence the reason the most legit buyers and seller intermediaries have their own limits on the size and type of businesses in which they will work.

Death is Inevitable

It is a known fact, that the majority of business sellers are looking to retire. Some of them are getting on in years and still have a large portion of their net worth tied to their business–which assets are almost always illiquid. A couple of years ago we worked a deal with a company seller who ran an extremely successful and profitable business. He was in his mid-70’s and “logic” told him it was time to sell. After running a typical broad-auction on the business with multiple strategic buyers at the table, a letter of intent was mutually executed by both parties with an agreed-upon sales multiple that was 2x above market. The seller was extremely pleased with the process. However, in the 11th hour of due diligence, something happened in the seller’s brain that caused a complete deal implosion. He reasoned:

  • I may be 74, but I’m healthy and both of my parents lived into their 90’s. I expect to do the same.
  • This business runs without me. I have a competent CEO in place who has managed the business for years. He can continue to run the company until I meet my demise.
  • My after-tax payout will fail to provide the same returns the business continues to produce year-over-year.

Unfortunately, this seller not only rejected a fantastic valuation, but he had burned a bridge with the most strategic buyer in the market who had a strong reason to pay a premium for the business.

It is extremely difficult to admit that all good things must eventually end. And seller’s remorse, regardless of how good a deal the seller may receive, can be an extremely real threat to getting a deal done. Volumes could be spoken regarding the risk/return trade-off of a deal involving an aged seller that has trouble letting go. In my experience, the aged seller is often in the way of potential business growth. It is likely too morbid to say, but all company owners eventually need a transition plan.

To assume is to make an ___ out of u and me

Lack of explicitly outlined objectives, at any time during the capital process, means assumptions rule. Undefined assumptions, particularly when the reside in the mind of the seller or issuer, can be extremely dangerous to the process. Getting assumptions, desires and deal specifics on the table early and revisiting frequently helps to grease the skids between issuer and investor.

Here is a simple “for instance” example that may help paint a picture. We were representing a client that had a specific and somewhat non-standard expectation about his employment contract during the transition and post-transaction involvement. In his mind, his desires were typical, standard and–for him–non-negotiable. When he brought them up during due diligence and purchase & sale agreement negotiations, they came somewhat out of left field. He also failed to discuss them with us prior to discussing them with the buyer. Although we had spent hours discussing with this client his desires and requests for the business going forward, he had failed to divulge some of these seemingly small details. In addition, we had failed to dig deep enough to extract these issues until they emerged as near deal-killers.

Fortunately for all involved, the points were ancillary to some of the bigger issues and the deal finally progressed to a close. The story still illustrates the point that all desires and expectations should be voiced, explicit, written and discussed early and often with all stakeholders. It is always best to err on the side of candid communication.

Timing, timing, timing

Timing on macro, time to market, speed in market and speed in due diligence all have an impact on the performance of any deal. As the saying goes, “time kills all good deals.” Regardless of the revenue and EBITDA of a particular company, deals can get stale. If a deal is not quickly and efficiently brought to market and the various potential suitors brought to the table quickly, then deals can lose their luster rather quickly. A potential investor may see a teaser on an opportunity, but if proper and quick follow-ups are not made and this same buyer sees information on the same deal several months later, they may begin asking themselves, “why has this deal not yet progressed passed the marketing stage? Have others vetted this deal only to find skeletons in the closet?” There is a natural tendency to second-guess the viability of a deal when they know that several hundred other sponsors have likely seen it and it remains in-market.

Buyers certainly need their time to perform ample checks and rechecks on what is typically a significant investment, but experience has taught that timing is most important on the part of the seller. Issuers who are slow or non-responsive to general information and due diligence requests will find buyers quickly read between the lines thinking the lack of promptness is a result of incompetence, subterfuge or worse. When issuers are the bottleneck on a deal, the potential for deal implosion skyrockets.

Unchecked Emotion

Emotion can be a powerful negotiating tool that can pull a deal in the direction you desire. It can also be likened to gasoline on an already-consuming fire. If not kept in check, emotion can cause deal implosion. This is one of the more difficult hurdles for most entrepreneurs. When any of the other issues start to make the deal a bit more difficult and less smooth than they had anticipated, negative emotion easily surfaces. Here are two principles on emotion that are key when it comes to deal-making:

  1. Deals are never easy. Every deal takes on a mind and a direction all its own. It is up to the investment banker to aptly guide the deal as to where it should go, but pivots and changes in deal structure and offering are not uncommon. Patience is needed as deal-making is a very fluid process.
  2. The intermediary is there to take the arrows. Part of the job of an intermediary is to take the shots from both buyers and sellers. When emotions become a part of a deal–which is more typical of individual business sellers–the investment banker is there to be a sounding board for both buyers and sellers. This is not my personal favorite position, but it is necessary to provide a buffer between the transaction parties.

Other waves of emotion, including thoughts parallel to seller’s remorse (spoken of above) are not uncommon. In order to move to a successful sale, the desire, need or drive toward an exit should outweigh any emotion inherent in the investment banking process.

Demographic Considerations

While rare, demographics can play a role in the dynamics of a deal. For instance, during the sale of a software consulting company the seller executed a letter of intent with a strategic buyer who, in his own words, had a higher perceived social/economic status than the seller. This was brought about by cultural, race and country-of-origin differences between buyer and seller. While it is sad this still exists in modern America, it does. This created a completely unwanted and unexpected dynamic to the deal. The buyer routinely looked for ways to create difficultly in the deal, including speaking to employees about transition, badmouthing the sellers and causing grief to all parties involved in hopes to get a better price at close. The deal ultimately closed, but the sellers and the business itself sustained some major blows in the process.

This example is likely a bit rare, but could likely play itself out in other ways and should be given consideration when a issuer or seller is assessing and weighing apples-to-apples comparisons among various buyers.

“It Ain’t Over ‘Till it’s Over”

Yogi Berra said it best. Every deal takes on a life of its own and an investor on fire could find one aspect they do not like and long-sought deal could be quickly doused. The potential pitfalls and challenges that occur from engagement to deal closure are many and varied. Until mutual signatures are on all the closing documents and cash has changed hands, literally anything can and does occur. The key is to be flexible, adaptive, creative and extremely active throughout the process. No one wants the next deal to end in the proverbial deal graveyard.


Nate Nead on LinkedinNate Nead on Twitter
Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
  • John L. Illes
    Posted at 18:48h, 22 February Reply

    All great observations and reasons that deals don’t happen. My suggestion is to always start the process sooner rather than later as time gives sellers some real world experience and, hopefully, attractive options.

  • David Lopez
    Posted at 19:46h, 22 February Reply

    Couldn’t agree more with article above. From personal experience, once an offer has been agreed to and the buyer is in due diligence, time is of the essence. If either party drags their feet, deal fatigue can kick in and cause people to loose focus and interest. That is why as an investment banker I try to have my sell-side client as ready as possible before going to market so we can quickly respond to any due diligence requests.

    • Nate Nead
      Posted at 21:33h, 24 February Reply

      Yes, I would include the need for pre-due diligence before an investment banker even engages with a client. If everything is out on the table at the outset, it helps avoid problems later that could and likely will arise. Better to have the intermediary find a deal blind-spot than the buyer during actual due diligence.

  • Jim hill
    Posted at 19:39h, 23 February Reply

    Well, I have done thousands of deals. Busted auctions are preemptive strikes to a seller who gets swept away and doesn’t run a process and then the buyer lowers the price as the seller is emotionally involved as is his management team. You should never go for preemptive strikes as sellers unless the buyer has a track record of not retrading. Process keeps people honest. Busted deals are when data rooms get dribbled in data and there is a huge liability at the eleventh hour and that stinks as a buyer. Also good investment bankers keep a strict schedule with the bidders – IOIs timing, mark up of the seller’s draft timing, no exclusivity if it is a desirable company and certainly of close. All investment bankers are not that disciplined. But they interact and just don’t show up at the closing dinner with a nice cube. They need to coordinate with the seller, his counsel, his accountant, the buyer and the buyer’s counsel and all investment bankers should insist that seller’s have a Quality of Earnings with an independent accounting firm because the buyer will do a Q of E and they will show holes in the financial statements. Time is never on the time of sellers – you project increased CAGR and EBITDA but often times you fall below and that constitutes retrading. Now investment banks can run five bidders with nonexclusivity but that costs a fortune and time as management has to negotiate with the five bidders, as does counsel, and it consumes their time to run the company. So you need, as a seller, to discuss that tactic with buyers as buyers typically spend over a million dollars and they might lose and some buyers just walk away. This is all complicated and I have done so many deals. Jim

    • Nate Nead
      Posted at 00:58h, 24 February Reply

      Thanks Jim. If we’re being transparent, what you’re describing is really the only role of investment bankers: they’re the cat-herders that bring the complex parties and their agreements together. As you have stated, it is an extremely complicated and convoluted process. Very rarely does a deal progress without issue. Having the right deal attorney in this is also critical as many of the 11th hour issues directly relate to agreements, etc.

      What you’ve written here seems to be “off the top of your head” but I’m sure if you were to brainstorm further, there are other big rocks that could be discussed as well as small nuances that come into play in each piece of the process.

      As always Jim, your inputs are extremely cogent and they contribute greatly to the discussion. Thanks again.

  • Andrew Ikeda
    Posted at 03:48h, 24 February Reply

    Very good observations. As an intermediary working with CRE investors and lenders, I can relate with all the hiccups that occur. Besides being upfront from the start and a stickler on due diligence, is there anything else a intermediary can do to keep the deal from going south?

    • Nate Nead
      Posted at 21:30h, 24 February Reply

      Thank you for your input Andrew. From my perspective, deals require daily diligence and pro-active thinking about what’s next, including are you following a deal process Gantt Chart.

      Daily contact with all stakeholders (sellers, buyers, other investment bankers, attorneys, etc.) is also helpful. There never is a silver bullet, but being proactive on a deal everyday until the purchase and sale agreement has been signed and the money changes hands is the most vital. The rest is typically a byproduct of being a decent deal problem solver and foreseeing issues before they occur.

      • Andrew Ikeda
        Posted at 18:00h, 25 February Reply

        You’re welcome, Nate, and thank you for your reply. I agree with being in contact with stakeholders daily, but I feel my challenge is to be a decent if not great problem solver. From my experience, it keeping all parties engaged takes finesse and skill. Thanks again.

  • Business Buyer Advocate ®
    Posted at 18:54h, 17 June Reply

    Good insight.
    But without one thing, which is not mentioned above, there are no done deals.
    Just one word differentiates successful business buyers from losers: http://partneroncall.com/just-one-word-differentiates-successful-business-buyers-from-losers/

  • Marcelo Scott
    Posted at 20:24h, 26 January Reply

    Very interesting article! How do you usually deal with a seller who has an unreasonable expectation of the value of his/her business?

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