I’ve always wanted to write a column about all of the reasons that deals die. It’s helpful for tire dealers to know what some of the pitfalls might be before they start their business exit planning. But since I’m only involved in so many transactions, it would only be one guy’s opinion.
So I was pleased when Axial recently published their “Dead Deal Report: Unpacking 2023’s Broken LOI’s” report.
Axial is a private deal network that covers the lower middle market in the United States and Canada. (Full disclosure, my firm FOCUS Investment Banking was just ranked No. 1 in Axial’s Top 25 Investment Banks for 2023 list.)
Axial’s definition of lower middle market is private companies with revenues between $2.5 million and $250 million. Most tire dealers and automotive businesses that that I run across fall within this range.
Axial investigated 47 transactions across a variety of industries — transportation deals were 11% of them — in which a Letter of Intent to purchase was signed by a buyer and seller, but for some reason, the deal did not close.
Since we find that private companies in the lower middle market have more similarities than differences, regardless of industry, there are things here that tire dealers can learn from.
It’s first interesting to see who the buyers in the lower middle market are. Thirty percent of the buyers were independent sponsors — think private equity that finds capital on a deal-by-deal basis — without a committed pool of money; 19% were strategic acquirers of various sorts; 19% were search funds — vehicles for aspiring entrepreneurs to find and buy a company; 17% were private equity funds with committed capital; 6% were family offices backed by a wealthy family; and 9% were individual investors bidding on the smallest deals.
The math is that 49% of the deals died for financial reasons and 51% died for non-financial reasons.
Nineteen percent of the deals died because the deal couldn’t get financed. With higher interest rates, the same cash flow of years past now supports a lower amount of balance sheet debt. That may kill a high-priced deal. Also buyers like to use mezzanine and senior bank debt. Sometimes these lenders choose to not invest in a certain industry — like oil and gas, for example — when oil prices are past peak. The equity check writer will walk away in these cases because they can’t make the return on equity that they seek without the debt.
Seventeen percent of deals died because the quality of earnings (QoE) report typically funded by the buyer came back with substantially lower EBITDA. There is a simple way to avoid this. Where it makes sense, we recommend that our clients get their own independent, sell-side QoE before going to market. This avoids surprises, helps firm up the valuation from a buyer, assists with working capital negotiations and leads to a smoother financial due diligence process.
Next, 12.8% of deals died because there was a valuation misalignment between a buyer and a seller. There are two numbers in most valuations: the multiple the buyer is willing to pay and the EBITDA. We try to pin down the multiple so that there is only the EBITDA variable left. But that variable is often a moving target and it’s only good when it has been heading upwards both in the last twelve months (LTM) and the next twelve months (NTM). I always recommend new sales incentives and profit bonuses to keep the numbers headed in the right direction.
At 17.1%, the largest non-financial reason for deals dying was that the “seller backed out.” Transactions can be emotionally draining and stressful. And in family-run businesses, multiple generations are often at odds on the best option. Due diligence also can frustrate sellers who don’t understand that buyers have fiduciary duties to their investors to carefully review investments. Sellers can take repeated requests and multiple ways the same questions are asked in the wrong way. We do a lot of handholding and talking sellers off of cliffs in our business.
Another 17% of deals died for non-financial reasons discovered in due diligence. Private companies are risky investments and buyers walk away if the perceived risk is too high. The best way to avoid this is to not lie. Be transparent about the challenges your business faces. It makes a buyer more comfortable with you and they’ll look for solutions to your issues instead of walking away.
The last category is the catch-all “other” at 17%. In the Axial report, this was anything from the buyer having too many deals going on at once and killing the least attractive one; the deal committee killing the deal when it was brought to them for final approval; or one of the acquisition partners backed out of the deal. All three have happened to me before. The only solution is to ask a lot of questions before picking the right buyer and doing some diligence on them.
