Deal Breakers – What to Avoid When Selling Your Business

Canadian Capital Magazine

By Mark Groulx – AIM Group Canada Ltd.

The vast majority of companies with earnings of $1 million or more should be sellable. Yet sometimes seemingly good companies do not make it to closing. A veteran business broker reveals some surefire ways a transaction can fall apart.

Lack of a Management Team

Some entrepreneurs pride themselves on the fact their companies can’t run without them. They keep the major customer contacts and supplier relationships to themselves. The operational logistics and other key aspects of the business aren’t documented. As a result, the primary source of the firm’s success walks out the door as soon as a cheque is delivered to the vendor. Having a management team that’s capable of continuing the business uninterrupted will improve the sale prospects.

Shabby Record Keeping

Due diligence can uncover a multitude of shortcomings in a company’s record keeping. These might include out of date customer contracts and regulatory reporting, vague and incomplete marketing or production information, or inaccurate inventory tracking. Without accurate and complete records, purchasers are uncertain of what they are buying and will be reluctant to close the deal.

Misrepresentation of Facts

The optimist in some people can lead them to put a positive spin on information at the expense of accuracy. The first time a buyer discovers something factually incorrect their suspicions start. If more inaccuracies are revealed, things get worse. Even if the exaggerations don’t add up to much, many buyers will walk away for fear there is a larger surprise hidden in the shadows.

Unaddressed Weaknesses

Confront a strategic weakness head on—you’ll be well regarded if you do. (For example, you don’t have an HR manager but realize you have a bunch of HR headaches that you have yet to deal with.) While you may not have had the time, people or cash to make that happen, a new owner may be able to bring fresh resources to the table and turn what was a problem into an opportunity.

Litigation

If your company is being sued or you are suing another entity, and either of these lawsuits could have a material impact on your business, there isn’t much chance you will be able to sell until everything’s sorted.

Environmental Red Flags

If there is the risk of environmental contamination on your business property, the chance of selling is greatly decreased. You must proceed with environmental testing and, if necessary, remediation before a deal can get done. For minor cleanup issues a Phase 1 audit and the disclosure of the problem is probably enough, but many deals have not closed due to these concerns.

Personal Expense

Normalizations is the term used to reference expenses that won’t occur under new ownership. It’s often a euphemism for personal expenses put through a business to minimize taxes, such as salaried spouses and children who provide little or no services to the company. Normalizations can come in many forms. I once asked an owner of a consumer products business what the marine equipment item was on the income statement. Turns out it was expenses related to his 36-foot yacht he used for corporate entertaining. I’m not sure that would have passed muster with Revenue Canada as an eligible business expense.

If you are planning to sell your company in the next year or two, minimize normalizations on the income statement and stop running personal expenses through your business. This will increase the value and the price you’ll eventually sell it for, since your earnings will be higher and most valuations are based on a multiple of some variation of earnings. It will also reduce the number of embarrassing conversations about dubious accounting practices.

Deal Fatigue

This often occurs when a vendor is uncertain of their decision to sell. When a prospective purchaser asks for information and it comes back late or incomplete, the buyer gets discouraged. The condition can also be sparked when a seller makes unreasonable demands. The most painful negotiators bring up the same points repeatedly. Eventually the prospective buyer will walk. Don’t enter into a sale process if you are uncertain about your willingness to complete a deal. You end up souring the marketplace for when you really do want to sell.

Tax Problems

If you owe outstanding tax claims or are in the midst of negotiating a tax matter with Revenue Canada, you might be able to provide an indemnification for the claim if it’s not a material amount. But if it is significant, the prospective purchasers might prefer to wait until the matter is settled.

Due Diligence

At the due diligence phase a buyer will want to review your material contracts. If your customer contracts or real estate leases are expiring, they will have concerns about the sustainability of the business. Additionally, if you have retiring senior managers or disgruntled staff shopping resumés, this will not sit well with a prospective purchaser; and depending on the employees involved, it could be the end of your negotiations.

The best deals are those where the transition to new ownership is almost seamless. Your goal should be to deliver the continuation of a going concern with a minimum of interruption.