And how to mitigate pitfalls
This is the first in a two-part series from Calder Capital, a mergers and acquisitions firm that serves Michigan and Indiana.
Acquisitions can be a strategic move to bolster growth. The journey to a successful acquisition contains many potential pitfalls. Here, we delve into reasons why a deal may fail pre-close and advice to overcome them.
1. Unrealistic expectations
Pitfall: Lofty and unrealistic expectations can set the stage for disappointment. Both parties need to have a clear understanding of the value, benefits, challenges and intricacies of a deal transacting.
Advice: Regarding valuation, all prospective sellers should have a business valuation completed by a mergers and acquisitions professional. (Note: not a valuation-only firm, a firm that sells). Unrealistic expectations in terms of valuation are the top reason that businesses do not sell. During the transaction process, realistic goal-setting and open communication are crucial. Engaging professionals can be helpful to give insight into market standards, level-set expectations, and negotiate benefits and drawbacks for buyers and sellers.
2. Financial concerns
Pitfall: Quality (or lack thereof) of financial information is a top reason that business transactions fall apart. Sound financials and accurate valuation analysis are critical. If financials are shaky or full of errors, uncertainty and reluctance can permeate both parties involved.
Advice: Business owners must ensure organized and clean financials. Many owners of small businesses retain a good “gut” feeling about the financial condition of their company and, as a result, believe that spending money on a good CPA is a waste. This is absolutely not the case leading up to a transaction. As you begin to consider the eventual sale of your business, it is recommended to have timely monthly financials prepared by a CPA. Additionally, it is recommended that you get your tax return done as timely as possible. Buyers and lenders will rely significantly on your financials.
3. Deal fatigue
Pitfall: Communication lapses and delays between acquiring and target firms cause misunderstandings, erode trust and create confusion in negotiations. Prolonged processes can lead to deal fatigue, prompting parties to withdraw due to the desire for certainty.
Advice: Scheduled touch bases between all parties are highly effective in ensuring communication remains constant and open. Calder recommends a weekly conference call among stakeholders post-letter of intent to keep momentum toward closing.
4. Leadership changes
Pitfall: Changes in leadership in either company can disrupt the business, integration plans and threaten financial performance.
Advice: To mitigate the risk of key executive departures during a transaction, the buyer should talk frankly with the seller about their team and plans for the future.
5. Poor due diligence
Pitfall: Due diligence entails investigation and analysis of the target’s finances, operations, culture and legality. Neglecting this may yield pre-closing surprises tied to overlooked risks, liabilities or key concerns.
Advice to buyers: Engage teams with expertise in financial, legal, operational and cultural aspects to ensure a well-rounded assessment, enabling you to make informed decisions and navigate potential challenges effectively.
Advice to business owners: Due diligence may feel intrusive. Consider that you might have decades of experience with your company. Things that are innately understood and comfortable to you remain foreign to a prospective buyer. Buyers are often personally guaranteeing transactions and investing significantly from their personal savings. They need to make sure they know what they are buying.
6. Economic or market shifts
Pitfall: The external environment plays a significant role in the success of an acquisition. Economic downturns, industry disruptions or sudden market shifts can dramatically impact the viability of the deal.
Advice: Do not always assume that the stock market or public company headlines translate to the lower middle market. The private and public markets are disconnected. For example, despite higher interest rates, low inventory of sellers combined with strong cash reserves and demand from buyers have muted declines in valuation multiples in 2023. Most prospective sellers are unaware of this, and many will fail to act in time to take advantage of it. Work with a professional that has experience in adapting to unexpected changes. Be flexible and creative in deal terms, financing and deal timelines.
7. Lack of stakeholder buy-in
Pitfall: The opposition of key employees or stakeholders can create resistance and hinder the ability for an acquisition to take place.
Advice: Establish clear communication channels to address concerns, highlight the benefits and outline integration plans. While it is important to keep the transaction confidential from employees, key stakeholders should be brought into the loop before the transaction closing to have ample time to become acquainted with the buyer and expectations moving forward.
8. Regulatory hurdles
Pitfall: Acquisitions may require regulatory approvals from government agencies or industry bodies.
Advice: Conduct research or consider hiring professionals to navigate through the intricate web of regulations. It’s important both the buyer and seller clearly define permissions that need to be obtained for a deal to transact.
9. Cultural misalignment
Pitfall: Cultural misalignment in mergers and acquisitions transactions refers to a disconnect between the organizational cultures of the merging companies, encompassing differences in values, communication styles and workplace practices. This misalignment can lead to decreased employee morale, resistance to change and hindered integration efforts, threatening a transaction.
Advice: Business owners and acquirers should have ample time to meet and learn about each other and each other’s business practices and styles. Cultural due diligence should be a consideration for prospective buyers. Parties should work together to define a shared vision and create an integration plan to outline specific initiatives, activities and milestones that will promote alignment and reduce friction.
10. Legal obstacles
Pitfall: Pending litigations or unresolved legal issues can hinder progress and derail the deal altogether.
Advice: Collaborate with legal experts to devise strategies for resolving these issues, including renegotiation of contracts, IP protection mechanisms and indemnification clauses. In cases of pending litigations, engage in communication and explore alternative dispute resolution methods.
Acquiring another company is a complex endeavor that demands careful execution. Working with an experienced mergers and acquisitions business broker is vital to mitigating these potential pitfalls. By entrusting experienced professionals, business owners can be confident their deal will make it across the closing table.
