It goes without saying that a business’ revenue and profit trends, as well as forecasts, play a large role in an owner’s ability to maximize value. Even when revenues and profits remain flat buyers and banks take comfort that the business has a steady and repeatable model. Conversely, when revenues and profits show some softness it can mean more than just a lower valuation; this scenario has the potential to derail a potential sale.
The trend of the primary indicator (revenue and profits) is a signal to the market about the businesses resiliency and ability to generate predictable results. Buyers will pay a premium for predictability and banks covet those lending opportunities. When these indicators show weakness it causes all parties in a transaction to evaluate the acquisition from a different lens. The diligence process is different in these situations with potential buyers and bankers scrutinizing the business much more closely.
Deeper scrutiny is sometimes the least of the issues in these circumstances. Our firm recently represented a large Chicago marketing agency for sale and as their M&A advisor we had to help the client navigate a declining revenue and profit situation in the middle of selling their business. When we first began the marketing phase of this engagement the company was coming off a very strong year and all major indicators looked positive. Within a quarter, the business started to show some weakness and by the time buyers were circling with offers the profits showed a thirty-percent year-over-year decline.
This led to increased scrutiny and a litany of questions from the prospective buyers and the banks, ie; what caused the decline, could this happen at any time, could it have been prevented, how did the company forecast performance, was the business going to recover. The narrative quickly shifts from how to hold value to is the business still saleable and financeable.
In this case, we were able to keep a small number of buyers interested in the business, however, the banks were no longer willing to finance this business. When banks decline to finance a business acquisition that leaves the buyer and seller with fewer options. Typically, buyers will need to come to the closing table with more equity and sellers will need to assume more risk with larger seller notes and/or earn-outs. The liquidity event that was planned for is no longer a reality.
In this instance, the sellers of this Chicago firm were at retirement age and they did not have the desire to spend another 2 to 5 years stabilizing the business before attempting another sale. The parties reached agreement on a reduced price that did not include bank financing. Clearly not the outcome the buyer or seller had hoped for in this acquisition.
This scenario is exactly why M&A advisors along with other professional advisors urge their clients to sell their businesses while in the midst of improving performance and not when it reaches a pinnacle. We understand this is a hard thing to predict which is why getting external perspectives can be invaluable to planning an exit or succession plan for the owner.