Inexperience Can Ruin Deals
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Author's Comments: Some years ago I was invited by an intermediary to act as his advisor inasmuch as his normal practice was a strategic advisor. What happened at the first meeting with the business owner, the intermediary and me was horrifying. Further, I was put in the compromising position of not challenging or embarrassing the intermediary in front of his client.
The following story gives the problems inexperienced deal makers can encounter when becoming engaged by a seller.
BACKGROUND
The 65 year old owner of Tip Top Lumber Company (TTL) decided to retire and sell his business... a five store retail chain with $30 million of annual revenues. Their customers were almost exclusively contractors and the store locations were a combination of urban and suburban in key real estate locations. The company owned some locations and leased the other locations from the owners' own entity. The business was nicely profitable in spite of the obvious gorillas in the area, i.e., Home Depot and Lowe's.
IMMEDIATE PROBLEMS
Over the initial meeting between the owner, the intermediary and myself, the following items quickly became red flags.
- Confidentiality: The owner had not planned to bring the comptroller into his confidence by implementing a "stay" agreement. With all the ensuing financial updates and analysis, it would be impossible to expect the selling process to be achieved through due diligence without informing the financial offers of the imminent company sale.
Furthermore, the potential buyers would be the other lumber yards within 20 mile radius of the client... all which would express interest in acquiring their quasi-competitor if for no other reason than simply curiosity. Having these potential buyers sign a non-disclosure would be easy, but there would be no assurance that there would not be a leak. The only way to run an auction type process with the least likelihood of a confidentiality breach would be to run the process as quickly as possible, i.e., send out the Offering Memorandums altogether, indications of interest within 10 days, etc.
The owner intended to talk to interested acquirers one at a time, thus prolonging the process and negating the competitive nature of an auction... as well as increasing the likelihood of a confidentiality leak. Problem: Confidentiality matters had not been carefully and thoroughly addressed. - Offering Memorandum: The intermediary presented a draft that was woefully incomplete, lacking substance, sizzle and excitement. Without charging a substantial retainer such as $30,000 upfront, naturally the intermediary will try to cut corners. Inasmuch as this lumber yard hard five locations, each one had to show an individual store analysis and a complete analysis of the real estate for the five locations. Even a $30,000 retainer would be too low in order to incorporate a document which a potential buyer must use to make his initial offer before a site visit. It would be necessary to have current real estate appraisals on all five properties including purchase price or rental comparisons. Problem: The importance of compiling a comprehensive Offering Memorandum was not realized nor appreciated.
- Transaction Attorney: When I asked if the seller had retained a real professional for this transaction, the answer was "no". In fact, the seller was intending to use "someone" from his accounting firm to handle the transaction. The analogy here is one might as well use the fifth string quarterback for the most important game in the college's history. Using an inexperienced transaction attorney is the best way to "screw-up" a deal. In this case, the transaction value was around $15 million, or the seller's entire net worth. Problem: Disregard for assembling the best most professional transaction team to handle the sale of the company.
- Financial: The statements were not audited which was particularly upsetting since inventory and receivables represented about 85% of the assets. Secondly, a million dollars of cash had been withdrawn by the owner, but not reflected by the owner. There was no reconstructed EBITDA. There were no projections, no industry ratios, and no reserve for contingencies, etc. Problem: An unprofessional and sparse presentation of financials will result in either bids lower than justified or no bid by certain buyers.
- Lawsuit: The company was being sued on an asbestos case used in products they sold, i.e., sheet rock, insulation, etc. Previously, the company had lost a similar case. I wanted to put this matter front and center and even mention it in the Executive Summary with a valuation on the Fair Value of the liability addressed in the Memorandum. The owner wanted to bury this disclosure with some sort of asterisk. Problem: Once the seller shies away from material disclosures, the buyers become concerned with what else is being covered up.
OBSERVATIONS
Unfortunately, many business owners do not appreciate either the complexities of doing a deal or appreciate the benefits of hiring a first-class intermediary to conduct the sale process. In this case, if the business sold for $15 million, it would be very reasonable to pay $1 million in closing costs (maybe more) such as $500,000 for the intermediary, $250,000 for the attorney, and $250,000 for appraisers, audits, etc., The effort up front is well worth the reward at the back-end. Watch out for inexperienced dealmakers, they can ruin deals.
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