What can keep the transaction from closing?
After you have made the decision to sell your business and you have an agreement with a buyer, what can keep the transaction from closing? An understanding of the review and approval process of the buyer will help understand what might happen and can potentially save you from making costly mistakes that can de-rail your deal.
A buyer (in our example a private equity group) will conduct a significant amount of due diligence on your company before it provides a Letter of Intent outlining the major terms of the agreed acquisition. This means that they have analyzed your industry, looked at your business in detail, met the management team and reviewed the financial statements that you have provided.
Schematically, the process looks like this:
The Letter of Intent is a major step in the process. Not only does it set forth the deal terms, but once it has been executed, the LOI is the point at which the buyer will incur real costs as they move towards closing. These costs include legal fees for documentation and agreements, possibly intellectual property reviews, etc., background checks and financial due diligence. The financial due diligence involves the hiring of an accounting firm to provide a “Quality of Earnings Report (QofE)”, which is a thorough audit of your company’s financials. When the outside professions are hired is when the buyer incurs real costs. These fees often total $400,000 – $500,000 or more and if the deal does not close, the buyer is stuck with the tab.
Feedback from various private equity groups shows that they will walk away from a deal if the QofE report is materially different from the numbers that have been presented through the process. This appears to be one of the major reasons that a deal will not close. The lesson for a seller is to ensure that the financial information that is provided is accurate and that the adjustments to EBITDA are reasonable and substantiated.
When moving your business down the path to a sale, keep the following points in mind:
- Make sure your financials will stand the QofE test.
- No Surprises. If the buyer uncovers information in their due diligence exam that you have not divulged, it can be a deal breaker. Even if it doesn’t kill the deal, it will give them undue leverage in this part of the process.
- Make sure your performance forecasts can be met during the sales process. If the performance of the business begins to erode before the buyer’s eyes, previously negotiated terms may be adjusted, and not in your favor.
Of course there are other reasons why a deal will may not close after it has cleared other hurdles in the due diligence process. Years ago I was working a deal and at the final stage the buyer began to have real concerns about the cultural dynamic among the management teams. It was discovered late in the game that the seller’s brother, the president of the company who was to stay on to operate the business, had been convicted of a felony. Of course the buyer refused to close and sued for its due diligence costs incurred – roughly $150,000.
Posted by David Sinyard.