This is the second article in our series on buyer warning signals. In Part 1, we discussed five key warning signals that might tip off a would-be buyer that a deal could be problematic or more effort than it is worth. To be clear, we are talking about signs the buyer may detect about the seller or company that have the potential to cause the transaction to go south at some point during the sale process. In this article, we will discuss four more warning signals that buyers may pick up on, and their potential effects on the transaction.
Warning Signal #6: The owner does not have a clear objective for pursuing the sale of their company. Owners who are serious about selling their company have a specific reason for embarking on the sale process. Perhaps the owner is ready to retire, spend more time with their family, or pursue other interests. Or maybe the owner is seeking a liquidity event. Or they need to make an investment in the business to take it to the next level, and they are at an age in which they do not want to take on the risk of doing so. Or they are in ill health. These, among others, are all valid reasons for owners to sell their company. However, if the owner cannot provide a reason to sell that the buyer can validate, the buyer will, with good cause, be skeptical about whether or not the owner intends to follow through on the sale.
Warning Signal #7: The owner just wants to explore what the market will pay for their company. As a follow-on to not having a clear objective for a sale, the owner may simply want to conduct a “litmus test” of the market to learn how would-be buyers might value their company. They may have no intention of selling in the near term. As such, the owner may orchestrate a valuation exercise without having undertaken the necessary preparation, i.e., not confirming that their financial statements are in accordance with GAAP, not having a sell-side quality of earnings (“QoE”) prepared, not having a net proceeds analysis prepared, and/or not preparing a management discussion and analysis (“MD&A”), etc. The lack of preparation should be a signal that the owner is seeking a “free” valuation from the market. All of this so-called “activity” typically results in wasted time and opportunity cost for prospective buyers. However, the owner’s motives are to achieve their own ends — finding out what their company is worth, without any intention of following through on the sale. This can result in angry and spurned buyer candidates — not a formula for a successful transaction should the owner decide to sell their company in the future. Buyers’ memories are long, and they are less likely to look at a deal from a seller who has burned them before.
Warning Signal #8: The seller’s advisors are unsophisticated. When the seller’s business advisors do not have a track record for advising on transactions that are representative of the contemplated transaction, this can be a huge red flag. This can manifest itself in several ways including a non-market approach to providing company information and/or requiring transaction terms that are clearly not market. As a result, it may be or become obvious to the buyer that the seller and/or their advisors are not knowledgeable about how to conduct a sale process. This leads to the conclusion that pursuing the transaction could be needlessly over-complicated and/or may never reach closure due to the company’s advisors.
Warning Signal #9: The buyer senses something is wrong based on their experience or intuition. Seasoned buyers who have closed many transactions are not easily fooled and can typically tell when something about the deal does not quite pass the “smell test.” The buyer may not always be able to put their finger on exactly what is bugging them about the seller, the company, or the situation as presented, but they have seen enough transactions to spot the warning signals and know when something is wrong or when something makes them uncomfortable about the seller or the subject company. Buyers who trust their instincts will quickly back away from the transaction. As we mentioned last time, a buyer’s evaluation of a company is often subjective. Therefore, one buyer’s warning signal may be another buyer’s blessing in disguise. However, while none of these red flags makes a company unsalable, it is important for owners to be aware of them, as they will most definitely negatively impact the sale price and deal terms. Owners who find themselves routinely falling short of their expectations to sell their company may consider not selling, finding a buyer who (hopefully!) looks past the warning signals, or more closely aligning their expectations with the reality of their company.
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