As always, the week after Halloween is a weird time in the Crude Observations world as I try to wrap my head around how I am ever going to prepare for a full on blitz of Christmas blogs (we are mere weeks away from the Advent Calendar and Top Movie list!) while juggling an actual work and family life. Sometimes I like to mix in a bit of travel just for fun – and I did just that this year – in fact I took the red eye after Halloween to Toronto. How much fun is that? Not very to be perfectly honest. Not like the Friday before when I skipped the blog to go see freaking U2 in Las Vegas at the Sphere!
In the meantime, I was being forced to deal with a whole bunch of institutional bureaucracy and technocratic nonsense that I don’t have time to get into… Ah, who am I kidding. I have all the time in the world!
I am talking of course about the electrical permit for my hot tub. Which I applied for 3 years ago, almost to the day, and which permit has yet to be approved.
Why is that you ask? Well if you ask me, it’s because I have neither spent enough money nor have I managed to secure the yard and my family and friends from the risk of imminent death by electrocution my hot tub represents.
The saga of course began when we purchased the hot tub. THREE YEARS AGO. At the time we hired a master electrician to do the proper electrical install. He did an awesome job. He managed to get the hot tub on our overtaxed boxes by rearranging all the relevant wires and drilling a hole in our house to service the tub.
He of course checked all the rest. Plugs, wires, fixtures. All good! Enter… the inspector. Check box. Check box. Check box… wait. That overhead power line is 8.3 ft from the tub. It needs to be 9. Move it.
What?
Fine. Call Enmax. Pay $100’s to move the service over by 30 ft. And run a conduit along the entire length of our house across our beautiful Hardie. Fine. It’s fixed. We’re good right?
In comes the inspector. Nope. We need GCFI outlets for the porch light, which is 12 ft in the air relative to the tub but still a hazard.
Also, the cable and phone lines need to be moved. Current don’t you know.
$1200 later, the cable line has been moved and run along the length of our house and our beautiful Hardie.
The phone line? They wouldn’t move it cheap so we cut it. Bye Telus!
Return of the inspector.
Hey – your electricity meter is 9 ft away from the hot tub. It’s supposed to 9.1. You need a barrier.
Seriously? You didn’t see that before? Nope. You need a barrier. But it’s seven feet in the air. Water can’t defeat physics and travel up. Nope. You need a barrier. What about the lid that opens on that side – isn’t that a barrier? Nope. You need a barrier. Can we put a plexiglass boc around the meter? Nope. You need a barrier.
Defeated, I try and find someone to build a barrier. All too busy.
Fine. I go to Home Depot and order the barrier materials – fence posts, lattice, spike footings… Wait. Need to know where my gas line is. Good lord – what if it runs under the hot tub?
All this for a barrier to avoid a 0.000000001% risk of electrical arcing.
Bureaucracy and the laws of minimalism wrecking what should been an easy close.
Which of course leads me to my annual discussion of all the things that can jump up and wreck a deal. Expected or unexpected!
I am referring of course to some of the deal-breakers – old and new – that we encounter on a regular basis as we try to execute engagements in the humdrum world that is buy and sell-side M&A.
So what is a “deal-breaker” anyway?
Well, broadly, there are things one should and shouldn’t do during a deal and the ones you shouldn’t do can quickly become catalyzing events that send everyone scurrying away from a transaction, leaving only the lawyers any richer.
So… a “deal-breaker” is any one of the literally thousands of ways that a deal can fall apart, which in all reality isn’t all that surprising in an environment that is inherently fraught with tension and emotion as well as a bunch of money and who it belongs to.
That said, and to keep things on point, I am going to concentrate on the larger and more predictable deal breakers (killers?) as they are the ones that might actually be avoidable and avoid commenting on all the Act of God /Biden/Smith/Oil Price/ESG/Trudeau/Russia/OPEC issues that often pop up and have caused my own deals to see the back side of a slamming door.
Working Capital
Can we all just agree that working capital is the 100% guaranteed deal killer? I mean let’s face it, no one knows what it is or how to calculate it, why it’s important or not, why an owner can’t keep it, why a going concern business might need it.
Simply put, working capital is the hot potato in pretty much every transaction. Look at a standard Letter of Intent clause on working capital: “a normal level of working capital will be left in the business with a target to be determined prior to Closing”. Easy-peasy, right? Wrong!
You could drive a truck through this statement and no amount of cajoling various accountants and lawyers is going to get a Vendor or a Buyer a straight answer. Here’s the basic dichotomy – buyers want as much working capital as possible, because they know it takes cash to run a business and they don’t want to have to invest it back in, and vendors think it should be zero, because the working capital in a business represents their “profit” for the year and not a permanent investment and asset of the business to offset the timing difference between when cash goes out and cash is collected. Normalized working capital is a going concern asset. EXCESS working capital on the other hand should belong to the shareholders. In a going concern purchase, the price is a capitalized amount tied subsequent years’ profits and the buyer makes an assumption that they will receive sufficient assets (including working capital) to run the business cash flows they are buying without further investment – otherwise they have overpaid!
But remember, the flip side of this is that the Vendor believes the working capital is theirs so if they leave some behind, they have been underpaid.
It happens in every deal. Without fail. Don’t even get me started on what happens if you have a business that in reality doesn’t need working capital (it’s a unicorn, but it exists!)
At any rate, I’ve seen $50 million deals fall apart over $50,000 in working capital.
Is there a solution for this? Preparation. Explanation. Calculation. Figure it out early and often. Talk about it with the vendor at every opportunity.
Letting Issues Fester
Another way for deals to blow up is let issues develop and fester without addressing them. This is true on both sides of the deal. It may be related to performance of the business or it may be something as simple as someone acting in an off-putting manner or otherwise putting a nose out of joint. Any transaction is fraught with emotion and many different personalities. Juggling all of that is difficult and regular open communication is required to identify issues as they happen and not a month into drafting a purchase agreement.
Not understanding the deal
This happens way more often than you would think.
Private company deals can be complex with lots of moving parts including working capital, earn-outs, vendor notes, equity rolls, management contracts, non-competes – you name it. Surrounding this are a team of advisors and experts all throwing their two cents at a business owner who has probably not transacted in this manner before and may not ever again. Mix a little emotion into it and you have a recipe for disaster. Take the time to read and understand the details of the deal in the silence of your own home at your own time.
Thinking a Letter of Intent is the finish line
Wrong! A Letter of Intent (LOI) is a great achievement, but this is nowhere near a closed deal. You’re probably only 50% of the way there. But too many owners take their eye off the ball at this stage and start acting as if the money is in the bank. They start sizing up vacation homes in exotic destinations. Then the business performance suffers and before they know it, they have hidden the underperformance for a while, the issue has festered and the buyer is looking to renegotiate a deal the vendor didn’t really understand in the first place. Your business is of interest to a buyer because you run it well and have created value. Until the money is in the bank, run it the way you normally would.
Time
Second to working capital, the passage of time is one of the main deal-killers. People develop what we call deal fatigue. The inability to move at a proper pace to close or to set deadlines and expectations allows doubt to creep in, makes people think they should renegotiate and, predictably, reduces the likelihood of closing significantly. Once an LOI is signed, anything more than 90 days for due diligence to Closing is a recipe for disaster. Keep your eye on the prize and the leash short.
Giving People Who Don’t Have an Equity Interest a Veto
We see this a lot in transactions where an owner is exiting the business and there is a second tier of management that the buyer wants to retain through management contract or service agreement typically way overloaded with lunatic terms and a non-compete that would make anyone’s head spin. But they make it a condition of the deal. And then wait until a week before closing to drop it into people’s laps. Seems fine right? No. Because if everything has been agreed and this is the last piece? You’ve given that individual a defacto veto over your deal. It never ceases to amaze me how often this happens. Look, I’m all for empowering second tier management, and getting key people under contract, but don’t do it at the last minute when everyone is freaking out, he or she has probably never seen a management contract before let alone a non-compete and will require his own legal representation – even a fake lawyer like me would recognize the position of power you have put that individual in. Suddenly your $50 million payday depends on the guy you hired to run your shop signing an agreement that he probably doesn’t understand and it all may fall apart over an extra week of holiday. Great.
Advice? Pay your people generously, treat them with respect. Tell the buyer that if they do the same thing, all will be well. But don’t give people who don’t have an equity interest a defacto veto over whether you can sell your business.
Assuming Third Parties will act sensibly and in your interests
One of the bigger roadblocks to getting deals done in a timely fashion that can grow into deal killers is dealing with outside third parties. I’m not talking here about your core deal team (advisor, lawyer). No, I’m talking about the army of mid-management service providers you need to wade through that have zero economic incentive to assist you aside from a paycheque.
For example, most deals are done on a debt free basis so you need payouts for any loans and to arrange for the security against your assets to be released so the buyer can leverage them with their bank. Your account manager may care, but do you think the manager in the bowels of some risk department in Toronto who has to do the entry cares or shares the urgency of having this done concurrent with closing? Absolutely not.
Similarly, many contracts have change of control provisions which require you to go cap in hand to ask for permission to sell your business. This can be clients (who may see this as an opportune time to renegotiate pricing or key terms (deal killer!), landlords (hello rental increase!), key suppliers or, on occasion, the dude who rents you your photocopier. Figure out these consents in advance and have a plan or they could derail your deal. Other third parties with influence on your deal? Appraisers, environmental consultants, tax advisors, accountants tasked with doing Quality of Earnings reports, your insurance agent. There’s a lot – get the lay of the land early.
Not Hiring Good Advisors
Look, this is totally self-serving and probably breaks 2,104 Canadian and US email anti-solicitation rules, but I won’t tell anyone if you won’t… Right?
Anyway, the lesson is that you can never underestimate the value of your advisory team.
From lawyers to accountants to tax experts to whatever, each of these professionals performs critical tasks that helps to get a deal done.
Sitting in the middle of this is your friendly M&A advisor, your consigliore, the connection between the buyer and the vendor. The Quarterback of the team. The only party to the deal whose economic interests are perfectly aligned with yours – we work on contingency so if you don’t get paid, we don’t. Closing matters to us.
I don’t do due diligence work, but I can coordinate it. I don’t draft legal agreements, but I can sure read them, understand them and in some cases explain them to you in a different way than your legal counsel. The M&A advisor is the backchannel to the other side, the person you go to when the deal gets sticky and the sh** is about to hit the fan. If you get a revenue or profit miss, your advisor gets to tell the other side and shelter you from the inevitable blowback while at the same time finding a solution that will move things forward.
I’m not a therapist, but I play one at work quite often. Remember, deals are emotional. People get paid to sh** on your business and it can get f-ing annoying. Your advisor is there to be a shoulder to lean on, the heavy to deliver your feedback, a provider of perspective and, let us not forget, the defender of your working capital claims.
Take a Step Back
While this may sound counter-intuitive given the suggestion that a vendor needs to understand the deal in order to help it succeed, the reality is that the vendor should attempt to minimize their direct day to day involvement in the minutiae of closing.
Remember all those experts? You’re paying them so let them do their job.
A vendor who inserts themselves too aggressively into the point-by-point discussion loses the ability to be the voice of reason and becomes part of the conflict instead of the solution.
Whenever possible, let the advisors absorb the body blows and be the bad guy – we are more than happy to be thrown under a bus if the deal gets done to a client’s satisfaction.
One thing that vendors often forget in the heat of the moment is that they will be working with a buyer post close – starting that relationship off on the wrong foot can be a disaster, especially where there is an earn-out or rolled equity involved.
There is nothing more useful to me in a negotiation than being able to coach my vendor through a direct conversation with the senior execs of the buyer – reminding each of the business rationale for the deal and making them realize that Section 4, paragraph(t), subsection (iii) really doesn’t matter that much.
Final Comment
Show the F Up!
Seriously.
All this discussion reminded me of something that happened earlier in my career when I was selling a business with multiple shareholders. So here we are, at the end of some months of fractious negotiation, all the issues solved and there is a boardroom table with all the closing docs laid out for my selling shareholders to sign. It’s a beautiful thing, it’s after lunch, the buyer has signed – I’m already cashing my completion fee…
Except…
I’m missing a shareholder. And the deal has to be signed by 3 PM or something to authorize funds which is the true close – the clock is ticking.
What. The. Actual…
Call the Buyer to extend Closing? Nope, zero flexibility – he apparently hates my client at this point.
Sign and close or the deal is done I’m told. I make some calls – no answer. Aaarghh! Suddenly I have an inspiration – this guy is known to have the odd pop so I tell the rest of the shareholders to stay put or risk painful death and rip out of the office into downtown Calgary and start going in and out of pubs.
Sure enough, stop #3, there he is, putting away a few pints celebrating his successful deal that HASN’T CLOSED, AND WON’T CLOSE unless he makes his way up to my boardroom. After some cajoling, and a paid tab, I’m ready to go but buddy had just ordered a fresh pint and didn’t want it to go to waste, the cats were at risk of de-herding, so at great personal risk and using some of the more useful skills I picked up in university, I picked up and chugged his pint, said it was time to go and forcibly walked my client out of the bar, across the street, up the waiting elevator to the boardroom to sign the documents that would ultimately fund his retirement and future beer purchases.
Conclusion
Are there any final nuggets to be drawn from this? I don’t know. Every deal is unique. There is no way going into a transaction to pinpoint what issue or factor is going to be the one that can trip you up, so there is no universally appropriate answer. The best advice is to be prepared, have people on your side who can anticipate and mitigate concerns and stay focused on the why you are doing this, because there was always an end goal.
Know what the deal breaker concerns are and have a strategy for each of them.
Always be closing.
