Over the life of the blog, much has been posted about Deal Killers, those pesky things to avoid when you’re selling your company. John Hammett wrote a great series of blog posts several years ago that still stands the test of time. I thought it was a good idea to revisit this series of posts…
5 Deal Killers to Avoid When Selling Your Company
By John Hammett
Company value is a function of the buyer’s expectation of future cash flow, factored for the buyer’s perceived risk of not achieving that cash flow. There are many factors that will affect the buyers’ perceived risk. These include things like whether the company’s industry has good growth prospects, whether the company’s products are proprietary or commodity, and how capital intensive the business is. The buyer’s understanding of the effects of these factors is typically negotiated as a higher or lower valuation.
However, there are five factors that are so significant that they don’t affect price: they affect the fundamental ability to sell your company and complete a deal. For this reason, these are considered Deal Killers. If a company has one or more of these attributes, it will be difficult to find any buyer. Any buyer will very likely discount the value to accommodate the risk that these Deal Killers bring.
Over the course of my next five blog posts, I will be discussing the five most significant Deal Killers, along with recommended antidotes to diminish the effect of these situations on the deal.
Deal Killer #1:
NO MANAGEMENT DEPTH. This Deal Killer is the most common, the easiest to resolve, and the one that sellers resist the most. Nothing will kill a deal faster than the buyer’s perception that the keys to the company’s success are locked inside one individual.
The value of a company to a buyer is not in the physical assets but in the relationships a company’s management has with customers, vendors, and employees and the knowledge the management team has about the company’s processes and technologies. The more this knowledge and these relationships are wrapped up in one individual, the more risky is the business.
The buyer must be confident that that the company will have the same strategic leadership, the same customer relationships, and the same knowledge of operations of the company after they buy it. The buyer needs to know that if the seller retires, quits, or dies, there is a management team beneath him that will provide continuity of leadership.
ANTIDOTES. If the owner wants to retire at the time of a sale, the best strategy is to have an experienced #2 executive already in place to take over the leadership of the company when it is sold. This is the most significant value-builder an owner can do in preparation for a sale because it makes it easy for the buyer to rely on the past performance as an indicator of expected future results. Owners who hesitate to hire a second-in-command because of the added expense should consider the following: when the company is presented for sale with a strong #2 executive in place, the entire owner’s compensation is “added back” to the historical earnings for valuation purposes. In addition, the value multiple will be greater for a company with continuity of leadership going forward. So, the expense of the hired executive is more than offset by the add-back of the owner’s compensation, and that increase in earnings is leveraged by a higher value multiple. Having a clear management successor in place will give the seller a big boost in value.
If there is not the time or commitment to bring on a successor leader, the seller should at least begin immediately to transfer strategic knowledge and customer and vendor relationships down into the organization. Focus on transitioning the most critical knowledge and relationships first.
Buyers usually perceive the greatest risk to be risk of decreased revenue. To reduce the effect of this Deal Killer, the company must transition the customer relationships to management below the owner and to institutionalize the pricing/quoting process that may reside in the owner’s head. If the company is technology-driven, the company must begin building depth of knowledge in the technology, the products, and the processes that come from that technology.
In a few situations, companies without management depth can be sold to strategic buyers that can consolidate the company operations under an existing management team. Or the company could be sold to an individual buyer who has the ability to assume the leadership role from the seller.