M&A Surprises and Misconceptions About Selling a Business

Cristian Anastasiu

For most of our clients, selling their business is a once-in-a-lifetime event.

It comes as no surprise that over the years, business owners develop a certain expectation about the merger and acquisition process, whether by talking to friends who sold their business, listening to M&A advisers, participating in peer groups, participating in webinars or reading related literature. Time and again, while advising clients on the sale of their business, we experience their surprise when those expectations aren’t met, and they come to discover their misconceptions.

The M&A Lowdown

We recently surveyed IT business owners who sold their business in the last 20 years. Among the questions we asked: What was the biggest surprise you experienced during the process of selling your business? What was your biggest misconception? What would you have done differently, knowing what you know now? Their answers validated what we have experienced leading our clients through the M&A process.

The following is a compilation of the answers we received, with additional insights from our own experience working with clients over 20 years.

Surprises Regarding the Buyer

Sellers are often surprised to learn how different each type of buyer is in their approach, be it strategic, financial, goals, transaction structures, etc. See also “Differences between a Strategic and a Financial Buyer.”

Most sellers do not know the buyer at the beginning of the M&A process. In more than 95% of our transactions, the company that ended up acquiring our client’s company was not known to our client at the beginning of the process. For any lower middle market IT services company, there could be dozens, if not hundreds, of potential buyers.

Many business owners are surprised to learn that buyers look at their business differently than they do as owners and operators; sellers do not always understand the buyer’s motivation in acquiring their business; the reason a company is a good fit for a buyer is in some cases not obvious to the seller and the buyer might not be inclined to share it.

Surprises Regarding the Valuation

A common misconception among business owners selling their business is the belief that they, the seller, get to keep the working capital at closing. But unless explicitly negotiated otherwise, an offer for a business assumes that the business will be delivered with sufficient working capital at closing — see also “M&A and Working Capital.”

It’s generally known and expected that buyers try to either avoid acquiring or discount the value of a company they’re looking to acquire that has a high customer concentration. While this is certainly true for private equity buyers, who are focused and driven by the financial aspects of a business, some strategic buyers are, under certain circumstances, prepared to pay a premium for a company deriving a significant portion of its revenue from one customer. This is especially true if that customer is, for example, a Fortune 100 enterprise. This would be a sign that the acquired company can handle large customers, they have a strong relationship, and opportunities exist for the buyer to cross sell. Some buyers see customer concentration as a strength and opportunity, which comes as a pleasant surprise for many sellers.

The concept of “adjustments” to EBITDA or “owner addbacks” is generally understood, but when it comes to determining the specifics, many business owners have surprises. Probably the most common misconception is around “owner compensation.” Generally, buyers adjust the current owner compensation to reflect a market replacement salary for someone with the qualification and skill set to replace the owner, even if the owner continues with the business and is open to receiving a lower salary post-closing with the goal of increasing the adjustments and, as a result, the EBITDA and the valuation of the company.

Surprises Regarding the M&A Process

Many business owners find out that the M&A process is more complex than imagined; due diligence can be very time consuming. What is not intuitive to sellers is that a robust due diligence process is also in the seller’s best interest and will later protect them, because it uncovers any potential discrepancies and unintended misrepresentations which are more difficult to resolve later.

However, due diligence is a two-way street and sellers should be prepared to conduct some buyer due diligence as needed and appropriate. Ask the buyer about prior successes and failures, lessons learned, referrals, etc.

Sellers have told us that they underestimated the value of the CIM (confidential information memorandum) and company financials or that they initially had a different opinion regarding those documents’ structures and roles. Qualified, motivated and active buyers review hundreds if not thousands of CIMs every year. Having well-prepared documents signals to potential buyers not only a certain level of motivation and interest on the part of a seller, but also organizes and presents the information in a way that is meaningful to buyers and can result in higher valuations.

Surprises Regarding the Role and Value of the M&A Adviser

Some business owners initially believe that they can save money if they’re not working with an adviser but come to realize that an adviser can help them reduce legal, accounting and other fees. Advisers can help increase the proceeds by running a competitive M&A process and allowing the business owner to stay focused on …

… managing the business.

Some sellers believe that they can start the M&A process by themselves and later bring in an adviser. The reality is that one can’t parachute an adviser into the middle of the deal, because each deal has its own history and cadence, and the participants must be involved from the beginning.

Sellers who didn’t use an adviser shared that they mostly missed having someone on their side helping them to not second-guess every decision. Advisers bring the required experience and skill set needed to effectively stage the disclosure of information to a potential buyer at the appropriate points of the transaction process.

In addition, an adviser can conduct a “limited” and very targeted M&A process while maintaining confidentiality and keeping to a minimum the number of potential competitors receiving information.

Surprises Regarding the Role of the Seller

Selling a business is quite different from selling a service or a product, which our clients are experts in and have done successfully over many years. Business owners realize, eventually, that some of their selling skills and instincts from their “day job” don’t fully translate or apply when selling their business.

Some sellers tend to oversell when meeting with buyers. For example, some business owners are trying to find a buyer’s “pain point,” a common sales technique, but many experienced buyers are reserved about sharing their strategy, goals and motivation. Sophisticated and experienced buyers don’t like to be “sold to” and become suspicious that the seller is overcompensating or not disclosing a certain fact or facts.

Telling a potential buyer “I am not ready to sell but I always listen to offers” or “I would sell for the right price” doesn’t entice the buyer to make a better offer or motivate them to engage with a seller. Quality buyers are mindful of their reputation on the market, cognizant of the effort and money it takes to complete the M&A process and prefer to engage only with motivated sellers.

The importance of chemistry and culture is sometimes underestimated, or early red flags are ignored or not recognized as such; company culture plays a key role not only in the integration and success of a transaction but even in being able to close a deal in the first place. There are means and metrics to help the parties accelerate the mutual discovery and find out if there is a cultural fit early in the process. See also: “M&A and Corporate Culture.”

… And One More Thing About M&As

When reading M&A-related literature or in conversations with people who follow M&A, including business owners, one can come away with the conclusion that most M&A deals fail. This isn’t the case, especially in the lower middle market. By and large, M&A transactions in the lower middle market are more successful than the common perception. Many of the articles reporting failed or unsuccessful M&A transactions are related to large deals, which have a higher probability of failing for a variety of reasons — clashing corporate cultures, high stakes, high valuation, politics, public scrutiny, etc. The reality is that it’s difficult to call a deal successful or unsuccessful without knowing what’s being measured and what the original goals were. Regardless, the old saying is true here that there must be 10 good deals (or good news about deals) to offset news about one bad deal.

Mergers and acquisitions is a dynamic environment. No two deals are alike, nor are any combination of a buyer and a seller. Learning how business owners were surprised, and their misconceptions entering the process, helps our clients and us as advisers better prepare for what is often a business owner’s once-in-a-lifetime journey.

Cristian Anastasiu, founder and managing director of Excendio Advisors, has participated in more than 80 transactions involving sellers with $5 million to $150 million revenue. His experience includes acquiring and integrating companies for Cisco, where he also was director of worldwide sales operations. You may follow him on LinkedIn.