Chapter 20

Ten Major M&A Errors and How to Avoid Them

In This Chapter

Avoiding faulty assumptions about M&A

Knowing when to tell others of the deal

As with many industries, the mergers and acquisitions business is full of errant opinions. People who have never done a deal before can’t possibly know what to expect, and as a result, many people harbor false impressions and incorrect assumptions about M&A. Here are ten of those common errors.

Assuming the Deal Is Done after the LOI Stage

The letter of intent (LOI — see Chapter 13) is a key document because it defines the basics of the deal and essentially becomes the foundation of the purchase agreement. Sellers and Buyers alike often make the mistake of thinking a signed LOI means all the work is done.

The LOI isn’t the final deal. In fact, the LOI simply ushers in a host of work called due diligence and contract writing. The heavy lifting of M&A doesn’t begin until after the LOI is signed.

Being Unprepared for Due Diligence

In my experience, perhaps the number one mistake Sellers make is being unready for the crush of materials they have to provide for due diligence. A Buyer (rightfully, I should add) expects to gain access to the due diligence materials the moment the LOI is signed. Sellers, perhaps thinking the deal is done after the LOI is signed (see the preceding section), often don’t share that same sense of urgency.

Sellers, plan ahead. You should start compiling the due diligence materials the moment you start marketing the company. This way, the moment the LOI is signed, you can provide the Buyer access to the due diligence materials. Check out the appendix for a detailed list of possible due diligence requirements.

Asking for a High Valuation with No Rationale

Many first-time deal-makers make the mistake of thinking, “If I ask for a crazy price, I’ll get it.” This notion is often compounded by the Seller’s own biased, sentimental opinion of his company’s worth. Although I’m a big fan of compelling valuations when I’m selling a company, I’ve never been able to get a compelling valuation without providing the Buyer with the rationale for the valuation.

Buyers have to leap over financial hurdles in order to do deals. They don’t have unlimited piles of cash and aren’t looking to overspend when making acquisitions. Sellers need to provide Buyers with a rationale for a high valuation. Head to Chapter 12 for more on figuring out a company’s true value.

Figuring Buyers Won’t Discover Problems in the Financials

Sellers, sticking your head in the sand and hoping the Buyer doesn’t discover discrepancies or problems with the books isn’t a realistic approach. Buyers hire accountants and auditors to pore through a Seller’s financials, and those folks will discover problems. Worse for Seller, Buyer is then in control of how to use that information to her own benefit. As Seller, you’re far better off to own up to problems in the financials and share that information with Buyer. This enables you to control the situation and frame the argument.

Underestimating the Other Side’s Sophistication

This miscalculation pops up with surprising regularity, typically with Buyers (and specifically, Buyers from large cities). Underestimating the other side’s sophistication and abilities is almost always a recipe for problems. Never take for granted your superiority over the other side; you’re bound to be unpleasantly surprised.

Be especially wary of those who purposely portray themselves as backwoods rubes. Odds are, they’re simply playing you and lulling you into a false sense of superiority.

Failing to Understand Who Really Has the Power

During an M&A process, power oscillates between Buyer and Seller. A huge error by novice deal-makers is to miscalculate their power. Failing to understand the amount of power you have simply increases the odds you’ll misread the situation and make a wrong move.

Misplaying a strong hand is bad, but misplaying a weak hand is worse. If you’re in a weak position with no other options, you may have to take the deal being offered. In that case, you’re not in a position to dictate terms.

Withholding Material Information

Material information is any bit of information such as a lawsuit, an environmental problem, the loss of a large client, and so on, that has a substantial impact on the company. Failure to disclose material information means Seller is acting in bad faith and is effectively deceiving Buyer through the omission of important data. If you offer to pay $300,000 for a home and subsequently discover the house is missing the furnace and half the windows are broken, you’re probably going to rethink the offer price. You may even walk away from the deal. The same goes when buying a company.

Seller is obligated to inform Buyer of all material events.

Blabbing about the Deal Before It Closes

Depending on the terms of the LOI, informing outsiders about the deal may be a breach of confidentiality. If one or both of the companies is public, disclosure of this insider information may be considered illegal, especially if someone uses it to buy or sell stock. But it’s easily avoidable — just keep your mouth shut.

Even if the Buyer and Seller are private companies, improperly disclosing deal discussions may harm one or both of the companies. The Seller is most susceptible to consequences: Employees may jump if they think they’ll lose their jobs post-sale, and competitors can use the information to steal customers from the Seller.

Calling the Seller’s Employeeswithout Permission

Unfortunately, Buyers have been known to pick up the phone and call a Seller’s employees prior to the deal closing. Sometimes, Buyer even lets slip that he’s buying the company and that the employees will soon have a new boss.

Although the cause of this behavior is usually not malicious (in their excitement about doing a deal, would-be Buyers jump the gun and start calling employees as if they’ve already closed the deal), this conduct is still wholly unacceptable and really just poor form. Tipping off an unsuspecting employee about a deal can cause untold havoc in Seller’s business, much like breaking confidentiality can (see the preceding section). Buyers should always follow the chain of command and only speak with those people who know about the deal and to whom the Seller explicitly agrees you can contact. Make sure you go through the proper channels.

Contacting a Seller’s Customers or Vendors without Authorization

Another huge no-no for Buyers! Customers are the most important relationship for a Seller, and a Buyer who carelessly contacts a customer and informs her about the pending deal may cause that customer to find a new vendor. This kind of breach can quickly scuttle the deal, as well as harm the Seller.

In most cases, this breach is caused by an overzealous Buyer trying to conduct due diligence. Although determining the strength of the relationship with customers is important, this situation is delicate, and Buyers should tread carefully.

Buyers should refrain from contacting Seller’s vendors without permission for the same reasons.