The 7 Deadly M&A Sins

Over the years, we have advised hundreds of media entrepreneurs on selling their companies. During this time, we have identified seven common mistakes that plague the sales process, all of which, with planning and forethought, can be avoided. Review this list of common mistakes before you sell your company.

1. Not understanding how your company will be valued by potential buyers.

A client had created a proprietary technology for online video streaming and he believed that his company was worth $50 million. He’d arrived at that amount based on a recent sale of a technology company in the video space, as well as on his calculation of all the potential revenue streams that the technology could generate. Although the technology company he used for comparison was similar to his company, the sale had occurred over two years ago. Since that time the evolving video landscape had changed significantly, so that transaction was no longer a valid benchmark for his company’s current market value. In addition, there was no single buyer who would be able to leverage all of the revenue streams that his technology could enable; rather, a buyer would have to choose one and invest in it, a much riskier, and, in this case, lower return proposition.

We advised our client to choose only the most likely revenue streams and those that a single buyer would be able to leverage when estimating his company’s value. This process allowed our client to present a more realistic growth scenario for his company but also helped hone in on the ideal strategic prospects to approach. We also shared recent transaction multiples with our client that were more relevant to his pending sale than the deal he was citing from two years ago. Entrepreneurs need to think like buyers, and stay as current as possible in order to properly estimate how their companies will be valued.

2. Assuming you know who the buyer of your business will be.

A client had been reluctant to sell his marketing services business for years because he assumed that his direct competitors were his most likely buyers. He worried that the process of shopping his company around would reveal too many of his trade secrets to his competitors, thus undermining his business going forward. In researching his market, we discovered that there were a number of other equally good buyers who were not direct competitors. We marketed his company to buyers outside his direct competitive space and completed the sale to one looking to aggressively expand into an adjacent market sector.

3. Not presenting the acquisition opportunity to potential buyers in the best possible light.

A client had been running her magazine business in a way that made sense for her as an entrepreneur: she provided free printing services for her nephew’s sign business and she had her uncle on the company payroll even though he provided few services to her.

Our client ran her company to minimize the taxes she would owe, but in presenting to prospective buyers she needed to make some changes. Buyers value potential acquisitions based on the earnings they will generate post-acquisition, at which time the free printing and unwarranted salary for her uncle would no longer apply. It was in our client’s best interest to present the company as if these changes were already made, so with our help, she presented a Pro Forma EBITDA to prospective buyers that was $250,000 higher than the EBITDA she had initially calculated; the buyer based  its price on the Pro Forma EBITDA and paid an additional $1.75 million (7x the additional EBITDA of $250,000) for her company as a result.

4. Undervaluing the importance of the founder to the business.

We were hired by a lead generation entrepreneur who was 100% focused on earnings. She had chosen a remote office location based on its low cost and rather than recruit an expensive management team from the nearby cities, the entrepreneur hired her husband as CFO and COO.

While she was maximizing her company’s EBITDA, we were concerned that buyers would be wary of paying a premium price for her company Because the entrepreneur and her husband wanted to retire immediately following the sale, the buyers’ main concern would be that without them the client relationships were unlikely to transfer to the new owners. We realized that there was a not a team in place who could take over for the CEO after the transaction. Strategic buyers would want the company to continue operating independently post-acquisition and financial buyers would view the transaction as too risky if they had to recruit, hire and train an entirely new management team.

Accordingly, we advised our client and her husband to remain with the company for two years after the sale during which time they could transition their relationships to the management team that would eventually replace them.  As a result, our client was able to instill confidence in buyers that the company was on solid footing regardless of the CEO’s long-term plan to retire. She was paid 50% of the purchase price at the closing of the sale and received the remaining 50% at the end of her two-year tenure.

5. Creating financial projections that are overly conservative or overly aggressive.

A digital media entrepreneur understood that his business would be valued based on the earnings he projected. Initially, he was tempted to pitch an extremely aggressive upcoming year in terms of earnings, devising projections that showed his business ramping up quickly from a new product.

When we delved into the assumptions underlying his projections we determined that they were overly optimistic. A sales process takes an average of six months to complete, and over that time the seller must report his results to the buyer. Missing your projections during the course of a sale has detrimental consequences because buyers lose confidence in your financial projections. Meeting or exceeding your projections, on the other hand, creates a positive view of the business and its future prospects. It is much better if a seller slightly outperforms reasonable expectations than if he slightly underperforms overly optimistic ones.

Our client revised his projections and achieved them during the next six months, resulting in a successful sale that might have otherwise stalled if he had underperformed.

Note that a transaction with an earn-out requires the seller to achieve certain levels of financial performance. Buyers will typically use the seller’s financial projections to set these milestones, so if the projections are too optimistic the seller may also be limiting his future sales proceeds.

6. Having incomplete documentation about your company.

We were retained by a market research firm that had shown spectacular growth over the previous five years: it doubled its earnings every year while maintaining strong margins. We knew this company would attract wide interest from both strategic and financial investors.

As we requested the information we would need to prepare the offering memorandum we discovered that our client had insufficient data for us to construct the story behind this tremendous success. The metrics we required had only scantily been tracked. Instead, the company relied on the CEO’s sense of what was going on. We encouraged the CEO to delay his sale for 30 days, and take the time to reconstruct the needed metrics.  Once this was completed, prospective buyers had much greater confidence in the company which was reflected in multiple strong offers.

7. Not hiring experienced advisors soon enough.

Two years ago, the CEO of a healthcare promotion business was approached by a group of investors with an offer to buy out her company. Though unsolicited, the offer was for more than she thought her company was worth, so she responded with enthusiasm. When it came time to negotiate deal terms, though, she realized she needed expert advice and hired DeSilva + Phillips.

When negotiations stalled over unrealistic terms from the investor group, we recommended, based on our knowledge of the buyer universe, that the CEO allow us to explore interest from other buyers.

In short order, we obtained an offer from another buyer that was nearly 1.5x the valuation of the initial offer from the investor group. Had the CEO not brought in experienced advisors, she might have sold her company for 1/3 less than it was worth. Experienced advisors not only help a seller with negotiations, but they also know who the potential buyers are – and that can translate directly into greater sales proceeds.

Note that hiring an experienced investment bank like DeSilva + Phillips is only one piece of the solution. In order to maximize the value you receive for your company it is also extremely important to hire experienced accountants and lawyers, specifically trained in media transactions. We recommend consulting with an M&A accountant as early as possible, as much can be done to contribute to your deal value with proactive planning. For example, structuring your company as a Subchapter S may limit the type of transaction some buyers are able to utilize, whereas choosing a C Corporation may require you to pay income taxes on the proceeds from your sale, effectively cutting your take-home dollars nearly in half. There also may be ways to gift portions of your company or otherwise integrate the upcoming sale with your own personal financial planning.

Experienced advisors will not only react to your questions but also may come up with creative solutions beyond what you had previously considered possible- a benefit that will exponentially pay off when it comes time to tally your proceeds after your deal closes.

Conclusion

You’ve poured your heart and soul into your company – and you only have one opportunity to sell it. Avoiding some basic pitfalls including the seven above (as well as others) will materially impact the amount you are able to realize from your sale as well as the likelihood that the deal will close.