Whilst those in M&A readily talk about their successes, the reality is that not every business gets sold.

The reasons are many and varied, and they hold the key to what owners should do if they find themselves still on the shelf after a year or so of being on the market.

Although there may not necessarily be anything wrong, usually reasons can be found in one or more of the following areas:

1. Is something wrong with the business?
2. Is something wrong with the price?
3. Is something wrong with the way it is being marketed?
4. Is something peculiar about the industry the business is in?
5. Is it still too early to expect a result?

To help owners analyse their situation, here are some possible areas to explore under each of the above headings and suggestions as to what can be done about it.

Only 20% of all of the businesses listed for sale ever sell*

90% of all of the people who begin the search to buy a business never complete a transaction*

These US small business sales benchmarks* would apply equally to the Australian small business market, and to a slightly lesser extent, to larger businesses.

The reasons for these atrocious statistics are many, but include the industry’s over-reliance on passive web-based marketing and the under-utilisation of targeted B2B marketing.

It is for these reasons that we have invested heavily over more than 21 years and over $5M in our M&A database, so we can actively target strategic buyers for each business. This allows us to achieve for our clients the best possible success rates, well above industry averages and substantially better than 80% of all clients taken to market.

In fact we won’t take on the responsibility of selling a client’s business unless we can identify and target substantial numbers of strategic buyers for that business (how to do that is explained below).

What could possibly go wrong in M&A?

Imagine if every single action you ever undertook in M&A resulted in immediate and positive outcomes.

Without the right tools, M&A can be a massively wasteful process for everyone involved. Even at its most efficient, with the right tools and a successful outcome, the M&A process may be only 10% efficient and 90% waste. At its worst, 100% of all activities could be wasted if there is no resultant deal done.

Imagine if every business for sale was investigated by only one buyer. The perfect match! No wasted effort, no dry gullies, no unproductive marketing. Just ‘tap and go’ with ‘The Buyer’.

Yet even with the perfect process, the product you are selling (the business itself) is imperfect and things can be wrong or go wrong, leading to a potentially wasteful process with an unhappy ending.

No matter how good the M&A Advisor and processes are, if the client’s business performance goes down, everyone goes down with the ship!

Putting business performance aside, the list of potential waste generators in an M&A process is practically limitless. Here are some examples of the pitfalls and how to avoid them:

Buyers may:

• Investigate hundreds of businesses without buying any of them.
• Target businesses priced beyond their financial capacity.
• Not take the time to find out their financial capacity before starting to investigate businesses.
• Not know what they are looking for or how to find it.

Solutions for Buyers:

• Decide on their target market profile and confirm their financial capacity BEFORE starting to look for a business. If you don’t have your own agenda, you’ll end up being carried along by those that do.
• Instead of wasting time sifting through opportunities randomly, engage in a systematic search of ALL businesses matching the target profile, rather than limiting only to those that are currently on the market. More than half of all business owners will sell if approached by or on behalf of genuine purchasers. This is because most businesses where the owners are willing to sell are not actually on the market and owners are attracted by the thought that a genuine buyer will allow them to short-circuit the potentially wasteful open M&A process.

Owners may:

• Engage M&A advisors who have no processes, knowledge or marketing capability.
• Try the DIY approach and end up in a mess.
• Not take the time to prepare properly, and therefore not optimise their financial outcome.
• Engage the wrong accountants or lawyers, disrupting or sabotaging the sale.
• Not obtain quality tax advice and end up paying more tax than necessary.
• Not be fully committed to the sale and pull out at the last minute.
• Not be properly briefed on how extensive the process will be, including due diligence.
• Not have adequate records, financial integrity or formalise commercial arrangements.
• Set too high a price and miss out on selling to those who could afford it, if it were priced realistically.

Solutions for Owners:

• Research and engage the right advisors, performing their own due diligence on who to engage to assist them.
• Ask a trusted advisor.
• Perform a google search of the prospective advisory firm’s [NAME] + [ACCC] (for Aus only). Some high profile business brokerages will show up as being renowned marketeers through that very simple check.
• Apply criteria such as these: https://divestmergeacquire.com/partner/#member-firm.

M&A Advisors may:

• Try and take short cuts and fail to market the business adequately. This article compares the various ways to market businesses: https://divestmergeacquire.com/sale-process/how-to-market-and-sell-strategic-businesses/
• Not properly qualify or advise clients, to ensure their expectations are realistic.
• Not check whether the owner has received proper tax advice and know the after tax outcome for a given price.
• Not prepare a comprehensive Information Memorandum so buyers can properly assess the opportunity.
• Invest/waste copious amounts of time manually researching possible targets.
• Target the wrong markets or not target any markets at all!
• Source and interact with a large number of responses and expressions of interest from buyers before finding one or more willing to proceed.
• Not properly qualify buyers for financial capacity and/or suitability to operate the business.
• Invest copious time and money and not sell the business.

Solutions for M&A Advisors:

• Be on top of your game. Be part of a professional organisation or network with proven systems, processes, documentation, training, resources etc., such as our own  M&A advisory network: https://divestmergeacquire.com/partner/#member-firm
• Properly market opportunities to identify and target the right buyers.

Everyone may invest time and money on the process, to find:

• There is some legislative, legal or commercial reason why the business is unsaleable.
• The business performance has taken a dive and is now not attractive to either buy or sell.
• One or more key employees or customers leaves at the 11th hour, or potentially worse for the buyer if it happens just after the transaction.

The list of what can go wrong in M&A is endless.

Having the right M&A team, advice, processes and resources are essential to optimising outcomes….and beating those odds!

*References: 

1. “Industry Statistics Every Buyer Should Know”, by Richard Parker, published in BizBuySell in alliance with Wall Street Journal

2. “The Business Reference Guide”, by Tom West 

3. “How to Plan and Sell a Business”, Jim Stauder

How to structure business sale transactions to create bonus value for all parties

This model delivers spectacular outcomes when a business is sold.

Reduced risk, easier negotiation, smoother transition, optional team involvement, higher overall price and long-term value, enhanced growth and stronger teams …this model ticks all these boxes and more!

With the right approach and mechanisms and a little effort, tailoring up an optimal structure can deliver spectacular outcomes to all stakeholders where business owners are retiring.

Here are some basic elements and benefits:

Reducing risk

A Vendor can often retain a share of their business (eg 20%) for free. This is because of the added overall business value due to the reduced risk from the Purchaser’s perspective.

The amount or proportion retained should be high enough to mean something to both Purchaser and Vendor, but not so large as to be unduly risky to the Vendor, who is relinquishing absolute control to a relative outsider.

The Vendor can hold the ‘bonus’ 20% of the business as a shareholder without additional liability provided they do not become directors or officers.

This can be immensely comforting to the Purchaser, as the Vendor’s mid-term objectives are aligned with their own and that the Vendor will be available to assist at critical times.

This has been covered in more detail in a previous Divest Merge Acquire article: https://divestmergeacquire.com/articles//how-to-retain-20-equity-in-your-business-for-free/

Easier ‘Sell’ and smoother transition

A key risk in any transaction is the potential disruption caused by a change in ownership. Employees may become spooked and customers and suppliers may reassess their positions. If handled poorly, the perceived uncertainty can wreak havoc on a business and wreck the sale.

By retaining an interest in the business, Vendors can make the transaction an easier ‘sell’ to customers and employees. As the incumbent owner is retaining a share, they are effectively “bringing in an investor to take the business forward”. The clear message to customers and staff becomes “I’m not going anywhere for the time being, so it is business as usual apart from some positive changes.”

How and when you communicate the sale to your staff is also a key factor in reducing uncertainty. If poorly handled, key staff may jump ship, destroying business value for both the Purchaser and Vendor and possibly even sabotaging the sale.

Recommended approaches are outlined in Divest Merge Acquire’s article: http://divestmergeacquire.com/articles/who-do-you-tell-when-youre-going-to-sell/

Easier negotiation – Positions Purchaser and Vendor on the same side

If the Vendor is retaining a stake in the business, negotiations become instantly easier the moment the Purchaser realises they are negotiating with their future business partner. Why would you want to screw the last drop out of the deal when there is enough upside for everyone and you want the Vendor and their team to have a happy and lasting relationship with you? The parties become more flexible during the negotiation if they are proposing to become business partners for a period of time.

Vendor’s future role is rewarding and builds value

In many instances, retaining an ongoing interest in the business enables the Vendor to enjoy a phase out period and transition from ‘process to projects’, by being freed up from the day to day routine and admin etc, and being able to add value by undertaking training, business development and exploring other growth opportunities by using their extensive knowledge and perspective in the most valuable and rewarding ways.

Many former owners find this among their most rewarding times in their careers, as they get to do all the things they enjoy most, impart as much knowledge as possible and play a key role in seeing their business grow towards the future.

Contrast this to the difficulty some Vendors have when they continue to work in their old business but no longer have the status of ‘owner’ and instead are merely part timers or consultants. Retaining some ownership makes the transition much more palatable and allows them to retain some of their former status as owners.

Potential for more financial upside for the Vendor

The Vendor has the opportunity to continue to add value and share in the further success of the business. Depending on the Purchaser and their growth ambitions, the final settlement transaction can be far more lucrative than the Vendor would have ever been able to achieve if the sale had not been staged.

Including key managers provides further benefits

The Vendor equity retention model laid out above can easily be expanded to accommodate key managers.

Scenarios that have proved successful include where the Purchaser and Vendor each allocate (gift) a small % of their shares to willing key managers. The key managers may also have the ability to invest their own funds. In most instances, their shares have a special category without voting rights.

Divest Merge Acquire has previously covered some of the scenarios that can be built in to accommodate key managers: https://divestmergeacquire.com/other/how-to-help-your-team-to-think-and-act-like-owners/

The benefits of this are substantial and can make (and have made) the difference between a transaction proceeding or not.

Not only do the key employees have greater commitment and ‘buy in’ to the business transition and the future, but they are far less likely to leave, which reduces a substantial risk of them becoming competitors. It also brings them into the transaction as receiving consideration, thereby making any restraint built into their employment contracts far more likely to be enforceable.

If equity is not an option, a more watered down approach could involve employee retentions. Such retentions serve to keep key employees with the business for agreed periods, but with a significantly reduced ability to align employee objectives with those of the Business Owners. For more information on employee retentions, refer to https://divestmergeacquire.com/sale-preparation/keeping-key-staff-when-selling-a-business/

Retaining a share of the business vs a pure earn-outstructure

Retaining a share of the business for a period of time is generally superior to the simpler and more traditional approach involving only an earn-out. Under a pure earn-out structure, a portion of the sale price is contingent on future performance outcomes being met. The intention of an earn-out is primarily to transfer some or all of the risk to the Vendor. But there can be serious downsides and very few positives. The outcomes are usually no longer under the control of the Vendor, especially when control of the business has transferred to the Purchaser even before the earn-out period commences.

Earn-outs can also promote friction between Vendors and Purchasers, where Vendors are focussed on fixed short-term criteria and Purchasers are more concerned with long-term sustainability and growth. They also tend to limit the Purchaser’s ability to inject capital or make other changes during the earn-out period, as there is an element of custodianship and Vendor resistance to take into account.

Structure the arrangement for further investment and eventual exit of the Vendor’s remaining equity interest

In situations where both parties have agreed the Vendor should retain an equity interest, it is important to establish defined strategies and options for both parties in agreed timeframes.

The Shareholders agreement (SHA) should set out how to handle future transactions. Key considerations include:

Initial Transaction element

Purchaser initially acquires up to 80% of the business based on an agreed Enterprise Value (normally calculated according to a multiple of earnings (EBIT multiple).

Provide for further Capital Injections

Make provision for Vendor to either match the Purchaser’s capital injections or allow their % shareholding to dilute.

Prepare for exit by either party – Sunset provisions to resolve future outcomes

i.       Drag along and tag along rights (“drag and tag”)

If the purchaser wants to sell while the vendor still holds a share, then the vendor can tag along, or can be dragged along to sell.

 ii.      Call Option after an agreed period

The purchaser can exercise a call Option to acquire the remaining shares at any time or within an agreed period, with the price set according to a pre-agreed multiple of earnings (EBIT).

If the business has gone well, then the price will be higher, but in theory the Purchaser should have the capacity to complete the acquisition due to the profit earned over the period.

iii.    Put Option

The Vendor can exercise their Put Option after an agreed period, eg 3 years, requiring the Purchaser to buy their remaining shares according to the pre-agreed formula.

The exercise price is based on agreed multiple of EBIT.

Documentation

Many, but not all, lawyers can handle this. We are happy to recommend those who are familiar with this structure.

Conclusion

With a little effort, the right tools and advisors on board, it is very easy to achieve a smooth business transition, a higher quality outcome and provide ongoing benefits to all stakeholders.

It is no wonder that, after this model is explained to the parties, it is widely accepted and welcomed by Purchasers and intending Vendors alike.

When selling a business, a primary concern of both the seller and buyer is how to retain key staff. Losing key staff can be catastrophic for any business, and is likely to cripple a sale process. So how do you ensure they stick around?

Employees handle uncertainty regarding their futures in different and sometimes unpredictable ways. Some leave prematurely, often to less satisfying roles with other organisations.

Despite the inevitable uncertainties during the sale process, it is usually in their interest to stay with the business and the new owners. New owners are often larger firms offering broader services, new opportunities, growth plans, capital, promotional opportunities, scope for travel and diversity. The new owners are likely to be more dependent on key staff than the previous owners were, so they now have an opportunity to shine through. It makes sense to encourage key staff to remain committed during and after the sale.

Staff retention and integration is always high on the priorities for intending new owners, so key staff will need to be involved in the sale process and meet the intending new owners at some stage. For more information on this aspect, refer to Divest Merge Acquire’s article Who do you tell when you’re going to sell.

So how can you ensure staff retention during and after the sale?

One way to encourage key employees to stay during a sale process and afterwards with the new owners is to offer a retention bonus.

The aim of a retention bonus is to align the interests of each of the 3 key stakeholder groups and enhance value for all involved:

• Sellers – want to sell and exit. Having key staff in place makes the business more valuable and saleable, and also allows them to shorten their post-sale handover period;

• Buyers – want to retain knowledge and expertise, relationships with customers and suppliers, overall capacity, and have a smooth transition with minimal disruption to the business. Having the key employees incentivised to stay gives both the employees and the new owners encouragement to work together and manage through changes and any unsettling times.
• Employees – new ownership usually offers upside for key employees. They are in the spotlight and may become the ‘experts’ in the absence of exiting working owners. New owners usually herald new opportunities, growth plans and the removal of previous “handbrakes” on growth. The extensive opportunities can often be masked to employees by the inherent perceived uncertainties throughout the process, and additional encouragement may be needed to see the full picture. This is normally an exciting period for those who stay on.

Aligning the goals of all parties with a retention bonus

Any retention bonus should be transparent to all 3 parties and is generally financial in nature.

It is important to structure the bonus effectively.

There is no point paying it all out as soon as the sale occurs or staff may then leave. Such a structure aligns the interests of both employees and the sellers, but not the buyers – whose perceived risk would actually increase knowing employees will receive a lump sum immediately with no longer term incentive to stick around. Ignoring the interests of one or more parties is often be enough to jeopardise the sale, and would therefore be self-defeating.

The recommended structure of a retention bonus is to pay one component on settlement, and a second contingent component after an agreed period of time (eg. after 12 months), provided the staff member is still employed in the business.

The rationale for offering a retention bonus is also important. A cynical view would be that it is to bribe employees to stay and work to the agenda of both the seller and buyer. However a more positive view is to consider it as a ‘thank you’ for contributing to enhancing the value of the business over time, for participating in the sale process and agreeing to assist new owners settle in.

When preparing to offer a retention bonus, it is important to consider the tax structure of the deal and how to optimise this for both the payer and payee. Any payment is likely to be taxable income to the recipient, but if the company shares are sold, it may or may not be deductible to the seller. You should obtain advice from your accountant/tax specialist on how to best structure these retentions under your circumstances.