Common Pitfalls to Avoid When Selling Your Business

Trial and error can be a great way to learn, especially when making errors. The more painful the error, the stronger the lesson sticks.

Since most business owners get one, maybe two opportunities to sell a business in their lifetime, trial and error isn’t an option. Instead, it’s best to learn from the mistakes and experiences of others.

My work in business valuation has given me the unique privilege of seeing hundreds of M&A deals up close, often including the aftermath.

Here are some of my top takeaways to share with owners who are thinking about selling their business.

Level the Playing Field

Unlike most sellers, most buyers have done this many times. That is because the most likely buyers are active serial-acquirers such as large public companies and private equity buyers. These buyers are staffed with M&A professionals who have spent decades in the M&A world.

These buyers round out their teams with M&A attorneys from leading corporate law firms and, often, investment bankers, who have also done hundreds of deals over their careers.

Against this army of talent, sellers need to surround themselves with equally high-powered advisors.

Good advisors more than pay for themselves by helping sellers achieve their goals through a good deal. At a minimum, sellers should have a corporate attorney and CPA who are both steeped in M&A.

For many business owners, their existing attorney or CPA won’t have that experience. That doesn’t mean replacing them, but it does mean supplementing them with specialists from within the same firm or from another firm. This can feel awkward, but good professionals play well together, and there will still be important roles for your existing attorney and CPA.

“For Sale by Owner” is Not the Way to Sell a Business

In addition to the right legal and tax advisors, there is the role of the corporate financial advisor. Sometimes this is an investment banker or business broker. Often it can start with a valuation expert.

In cases where the seller already knows they want to sell to an outside buyer, but does not have a clear buyer in mind, an investment banker or broker can be extremely helpful. (Note: the term “business broker” tends to be used with those who broker deals of smaller businesses, while “investment bankers” represent larger companies.)

Investment bankers and brokers are adept at running a structured process to market the company to a broad group of potential buyers while creating an environment that incentivizes buyers to put their best offers forward and move decisively down a strict timeline.

In many cases, the owner needs to understand what the exit options are before choosing a path. This is where a valuation expert is an invaluable resource. Since valuation experts are involved in a wide variety of ownership transitions, they are able to provide owners with a solid understanding of the options that are available, without bias for any particular transaction.

In cases where there is already an outside buyer lined up, or if the buyer is internal, family, or otherwise already known, a structured marketing process may be unnecessary. In these cases, a valuation expert can be an experienced guide to help the seller navigate the process and meet their financial goals.

Beware of the “Headline Price” and its Deceptive Cousin, the Multiple

Savvy buyers will often offer an eye-catching price, euphemistically referred to as the “Headline Price”, which is subject to numerous adjustments, holdbacks, and contingencies, which inevitably whittle down the actual cash the seller ends up receiving. (See the “Fine Print” section for more details.)

In using this strategy, buyers are banking on human nature, assuming that the seller’s ego will overshadow their pragmatism.

The M&A market is opaque, leaving business owners with few reliable data points to benchmark the value of their business. Often, the reference points an owner has come from anecdotes in casual conversation, the cliched “country club conversations” about multiples.

Multiples, that is, shorthand for sale price as a multiple of EBITDA are problematic because neither the sale price, nor the EBITDA figure are reliable, consistent metrics. We’ve already discussed the problems with the “Headline Price”, and a quick internet search will reveal why Charlie Munger called EBITDA “BS earnings”.

Ultimately, neither the “Headline Price” nor the deal multiple matter if the seller is able to achieve the kind of after-tax cash proceeds that satisfy their goals, and they can feel good about the new home for their company and employees.

Read the Fine Print

A lot of factors can contribute to the difference between the “Headline Price” and the cash a seller can put in the bank. Some, like taxes, are unavoidable, others can be important negotiating points independent of price.

The tax structure of a deal is one of the biggest, most common factors. Most buyers prefer an asset sale because it is favorable to the buyer from both a liability and tax standpoint. This is usually a zero-sum game in which the benefits enjoyed by the buyer come at the expense of the seller.

Purchase price adjustments are another area ripe for unwelcome surprises for the seller. Most purchase agreements will have provisions that adjust the purchase price after close for a variety of contingencies. Often a portion of sale proceeds are held in escrow to satisfy potential adjustments.

One of the largest potential adjustments is around working capital. Any significant deviation from normal levels of working capital can cause either a cash drain or a windfall for the buyer. Because most companies aren’t able to update their accounting daily, the exact amounts of working capital balances as of closing won’t be known until some time after the deal closes.

Cunning buyers will set working capital targets artificially high in order to guarantee a post-closing purchase price reduction. This can often be obscured by how working capital is defined and calculated in the purchase agreement.

Contingent consideration, such as an earn out, is another major area for potential seller disappointment. Unless the seller will be involved in the business post-sale, or there is a high degree of trust with the buyers, the calculation of earnouts can be problematic due to vague definitions and varying accounting practices. Often, earn outs can be used to take advantage of an overly-optimistic seller.

These are just a few of the most common and significant M&A issues. There can be countless others, depending on the dynamics and nuances of the company and the deal. The best way to protect against unwanted surprises is to level the playing field with experienced advisors and begin planning years ahead of any potential deal.

How Adamy Can Help

Our experts are an important part of your advisory team to help level the playing field. We’ve navigated thousands of deals, so we know the hidden pitfalls and how to help you avoid them.

We are often the first step in the path toward a successful exit, helping owners understand their options and guiding them toward the path that best fits their goals.

Next, we help owners gain a clear, realistic understanding of the value of their business, and we work to identify and close any gaps between that value and their goals.

Finally, we work with the rest of the owner’s advisory team to execute the right ownership transaction that best fits their goals.