The Dangers of Optimism: Deal Killers

Mon, 12/07/2015 - 05:53


In this series, we promised a description of the most common “Deal Killers” in third-party sales. Today, we deliver on that promise. For advisors who are not M&A professionals, don't assume you can overlook this topic. Exit Planning Advisors and their Advisor Teams are responsible for helping owners set goals that allow them to determine whether a third-party offer is “good” or “bad,” educating them about the sale process, and preparing their companies for sale. Last week, we outlined the specific steps advisors take with an owner to accomplish those three tasks. In this article, we describe the effects of the most common Deal Killers. 

Deal Killer Defined

A Deal Killer is a condition that, if undetected and unresolved before a third-party sale, will kill the transaction. The purpose of pre-sale planning is to maximize sale profits; achieve the owner's other, perhaps “softer,” goals; and neutralize these Deal Killers.

The First Three Deal Killers

There are a number of Deal Killers that, once the sale process begins, live up to their name: They can and will destroy the ability to sell company.  Let’s start with the most common, and avoidable, Deal Killers.

  1. Owners’ belief that they can sell their businesses for enough money today to satisfy their financial independence needs and wants.
  2. The failure to reconcile the owner’s need for value with the market’s perspective of value before going to market.
  3. The owner’s exclusive focus on top-line sale price.

As you can see, the first three are variations on a theme and a result of owners being individuals who view a glass as half-full. After all, as Harvard professor Howard Stevenson noted, entrepreneurs started their businesses “without regard to resources currently controlled.” Optimism is likely a necessary quality in starting a business without adequate capital.

In the context of a business exit, however, optimism can result in owners consistently and often dramatically overvaluing their businesses. The most common complaint we hear from private equity representatives is that owners of successful businesses overvalue their companies and insist on asking prices that are unobtainable. In doing so, they waste time, money, and effort. In entering the market with an unrealistic asking price and subsequently withdrawing from the market, owners do significant harm to any future effort to sell the business.

In our last article, we argued that once advisors have helped an owner calculate the amount of money necessary to achieve financial independence, “It is vital that owners know, before going to market, what the market considers the business to be worth.” Advisors who are not investment bankers or business brokers must recruit and work with those members of the Advisor Team to assign an accurate valuation.

Don’t be surprised when the owner’s expectations do not match the expert’s estimation of the likely sale price range. As we saw with the example of James in the first article in this series, owners and advisors must factor into the likely sale price deductions of taxes, debt, transaction fees, and other costs to help owners avoid Deal Killer #3.

Helping  (or, more likely, prodding) owners to seek an expert’s estimate of sales price replaces optimism with reality in determining an attainable sale price. If the expert confirms the owner’s opinion, then the advisor has provided a data-based opinion at no cost. More often, however, the professional’s realistic estimate does not support owners’ optimistic estimate. This addresses and solves two problems created by hyper-optimism. The first problem we described earlier: going to market before the business is ready. The second is not devoting time and effort to creating a company with sufficient transferable value to meet their financial and other goals.

We find that owners who jump into the sale process blinded by sale-price optimism (or without consideration of the reductions to sale price) spend considerable time, money, and energy only to find their glass half empty, if not shattered altogether. The advisor's job is to incorporate an understanding of marketplace reality into an owner’s pre-sale planning. Successful exits can require years of value-building efforts, but owners who think their businesses are worth far more than buyers do don't know that. It is critical to the ultimate success of an owner's exit that they realistically assess likely sale price years before their planned departure dates.

Who Can Slay Deal Killers?

All advisors to business owners have the potential to neutralize these three Killers, whether or not they are an M&A Advisor. All BEI-trained Exit Planning Advisors appreciate the intricacies of Exit Planning well enough to understand the need to recruit a best-in-class Advisor Team that includes M&A Advisors. In assembling their teams, they provide their clients access to vetted business brokers and investment bankers who can determine a likely sale range for a business—usually at no cost—before an owner goes to market. This is an invaluable value-added service for owners.

In our next article we will de-fang Deal Killer #4: The failure to preserve a company’s most valuable asset. In the meantime, if you haven’t created a relationship with a business broker and investment banker who understands Exit Planning and their role in it, do yourself a favor. Go to the Identifying "Real" Exit Planning Advisors page to view a list of the characteristics that these advisors must have to play a role on an Advisor Team.