Recently I wrote about how the private equity firm Riverside Company closed on only 15 of the 4,228 acquisitions it considered last year. That means there were a lot of deals that fell apart.
Why such a high failure rate?
I turned to Perry Miele, the chairman of Toronto-based Beringer Capital, for his opinion. Miele makes his living buying, selling and occasionally investing in companies in the marketing, communications and media industry.
Missing your numbers
'The number one reason deals fall apart is missing your numbers leading up to closing day,' he says.
Miele shared the story of a client who was keen to fetch top dollar for his company. The founder and CEO put together an ambitious set of growth projections for the year, forecasting his company would generate $2 million in pre-tax profit on $7 million in revenue.
Beringer shopped the company to a number of buyers. Given its recent growth and profitability, Miele had several interested companies make attractive offers. The CEO agreed to one offer and entered a 90-day period of due diligence during which the acquiring company had exclusivity to investigate the CEO's claims without other companies making bids.
As it turns out, the CEO was well behind on his numbers and was actually on track to deliver just $1.3 million of profit on roughly $6 million in revenue. Surprisingly, the acquirer was still interested but adjusted down its offer price to reflect 35 percent less profit than was promised in the CEO's forecast.
The seller had already become attached to the higher offer and was insulted at the last-minute discount. He walked away. By that point, the other bidders were long gone. And so the deal died.
What is Miele's advice to sellers? 'Leave yourself a cushion when doing your forecasts for the year you are planning to sell. The only surprises a buyer should have when they dig into your numbers are pleasant ones.'
Gross margin erosion
Next up in deal killers: shrinking margins.
'Top-line revenue growth is often the price of admission in selling a company,' says Miele.
But in Miele's view, it is not acceptable to grow at any cost. You need to grow sales while simultaneously maintaining or growing your profit margin.
Miele shared a story of a client of his running a successful company generating $2.4 million in pre-tax profit on $12 million in sales.
The company generated lots of initial interest when Beringer put it on the market, but one thing in the financials stopped each buyer short of making an offer: the company had been buying new business. Despite growing revenue at an annual rate of 5 percent per year, its profit was stuck.
The prior year, the company had generated $11.5 million in sales and $2.4 million in profit. In fact, despite growing sales each year, the company's profit was frozen at around $2.4 million for six straight years.
Potential buyers saw the profit margin erosion and walked away, reasoning that the industry had become too competitive to grow and the company had not differentiated itself to the point of having any pricing power.
Perry's advice? Make sure your top line is growing but also ensure your profit margin holds up in the process.
John Warrillow is a writer, speaker and angel investor in a number of start-up companies. He writes a blog about building a sellable company at http://www.BuiltToSell.com/blog. You can also follow him on Twitter at @JohnWarrillow.