THIS WEEK IN BROKEN DEALS

Here’s what’s in store for this week:

• Announcement: Reply to this email to get a free copy of our new ebook, The 10 Commandments of a Sellable Business

• Best Link: The State of Private Equity in 2024 with Charts & Data

• The Graveyard: Did you know that about 13% of all deals fail because of management transition issues? This week we go deep on how to avoid the deal graveyard by transitioning smarter.

• Work With Us: We just opened up a new program for small growing M&A Advisors and Brokers to get Wall Street level analyst help with their deals on a success-fee basis. Book a call with us below to learn more.

ANNOUNCEMENT

Join the waitlist for our new ebook, The 10 Commandments of a Sellable Business!

This ebook contains the main principles we’ve uncovered analyzing hundreds of broken deals. If you’d like to receive a free copy, simply reply “Commandments” to this email and you’ll be added to the list when we launch. 

In this new ebook, we’ll describe the 10 things you must avoid to close more deals, including:

• Why focusing on price is often a mistake and how to use it to your advantage to speed your deal to a closing

• How to manage your team through closing so your sales stay strong

• The mindset every selller must have to guarantee a successful exit (and why avoiding it can cost you millions)

• And more…

Reply now to this email with the word “Commandments” and we’ll put you on the priority list to receive a copy as soon as it launches.

BEST LINKS

Matt’s Favorites

• The secret to becoming a great manufacturing business (Twitter)

• A great reminder that you have to commit (Twitter)

Finance & Capital

• The Taxonomy of Moats, aka “How to get an unfair advantage” (Twitter)

• The State of Private Equity in 2024 with Charts & Data (Twitter)

Salability

• How to figure out if the SMB you want to buy is over-reliant on the Selling Owner (Twitter)

• Why deals aren’t always as simple as you’d think (LinkedIn)

THE GRAVEYARD

The little know consideration that kills 13% of deals: Management Transition

Introduction

In the sprawling, often bewildering universe of mergers and acquisitions, one might assume that the secret to a successful deal is hidden away in some arcane financial algorithm or perhaps guarded by a particularly stern accountant in a distant skyscraper. But no, the truth is far simpler and, dare I say, more mundane: it’s all about removing obstacles to your goal. Yes, much like clearing away the existential debris that clutters one’s mind during a bout of Greek poetry.

This enlightening approach was popularized by a rather clever chap named Eliyahu Goldratt in his modestly titled book, The Goal. It’s become something of a holy text for the best operations experts across the world, who use its wisdom to fine-tune company performance.

Now, this is especially important when navigating the treacherous minefield known as the Lower Middle Market. Here, only 2 or 3 out of every 10 deals listed for sale actually manage to close. If we were running a casino with those odds (20-30%), we’d either be maniacally obsessed with improving them or swiftly out of business. 

The Real Problem

Oddly enough, improving these odds isn’t something that gets discussed much in M&A circles. People seem to wander around blithely, as if the closing of deals were some sort of divine lottery instead of a rather serious and solvable problem. 

Enter The Broken Deal Newsletter, the only publication bold enough to apply this new, superior paradigm of operations thinking directly to deals. 

Our mission? 

To help you eliminate the obstacles that dampen your “lady luck” of closing, much like your trusted casino odds manager. 

As the wise and notably succinct Charlie Munger once said, “All I want to know is where I’m going to die so I never go there.” A philosophy that seems particularly prudent when you consider that our research indicates 10-15% of deals fail due to management transition issues. Yes, a significant portion of deal fatalities could be avoided if only more attention were paid to the thorny matter of who does what after the ink has dried and the previous owner has absconded to a beach somewhere.

With that context, let me tell you a story about a friend of mine, whose deal was spectacularly undone by a seller who believed that six weeks was an entirely sufficient period for a complete transition of a business it took decades to build… when in reality, it would take months, if not longer.

The 6-Week Disaster

A friend of mine, after 18 grueling months of searching for the right business to buy, was ready to throw in the towel. He was exhausted from combing through offers that didn’t fit his needs or required a cross-country move. But then, out of the blue, he got a call from a banking contact who had something promising.

The deal was perfect on paper: a niche B2B sales company, a sector where my friend had plenty of expertise. It was only a short drive from his home, where his family was already deeply rooted in the community. And the owner? He was motivated, friendly, and offering a reasonable price. Everything was lining up.

But there was one problem. A big one.

When it came time to negotiate the transition services agreement, the owner—who had been running the business for over 20 years—made a shocking proposal: he wanted to be out in just six weeks after the sale. My friend was floored. Six weeks? To learn a business that had no clear systems, no written processes, and had been run almost entirely based on the owner’s intimate, undocumented knowledge?

If you’ve ever taken over a company as CEO, you can probably feel the panic in my friend’s chest at that moment. Six weeks was simply insane.

He brought this concern to the seller, thinking the gravity of the situation would be understood. The seller’s response? “I’m tired. It’s your problem now.”

Well, here’s the harsh truth: it WAS their problem.

Without a realistic transition plan, my friend had to walk away from the deal. Fast forward a few months, and the business remains unsold, and the owner is no closer to his escape plan. That same tired business owner is still tired, still managing the daily operations. And perhaps worst of all, there’s a lot less cash in his pocket than he could have had.

The Reality of Transition

There’s a lesson to be learned here: you can rarely negotiate away reality.

In the world of M&A, you have to give buyers the tools they need to succeed. Buyers may enter a deal full of excitement, but as closing nears, reality sets in and deals break down. If the new owner isn’t given the bare minimum amount of training or support to keep the business running smoothly, the chances of the deal collapsing rise dramatically.

Let’s get into the math of how valuable removing this obstacle can be for a Seller.  To do this, we need to use basic probability calculations like the ones used in industries that must think clearly about probability in order to stay in business, industries like Casinos and Insurance.

We know that out of every 100 deals, about 13 fall apart due to issues with management transition (i.e. 13%). This means that simply removing these kinds of issues from a transaction can increase your chances of closing a deal by 15%.

Assuming we did everything else right, a competent casino odds manager would report that your chances of closing were 87%.

This means that on a $5 million enterprise value deal, the adjusted deal value to be $4,350,000 ($5,000,000 x 87%).

Why is this important?

It means that the “Deal Obstacle Tax” of a weak management transition plan is $650,000 on a $5,000,000 deal. 

Now, here’s where the rubber meets the road for sellers. 

M&A professionals are accustomed to their clients fighting over $10,000 contract terms during a negotiation. But these negotiations are often inconsequential compared to the enormous cost of not closing the deal. In other words, In the lower middle market, optimizing for Salability is empirically more valuable than optimizing for Exit Value. 

Tools: How to craft better management transitions

We’ve shown you an example of how weak management transition planning can break a deal and the most rational way to view the math. 

So how do you ensure your deal doesn’t get tripped up by management transition issues? 

There are three components of management transition planning:

1. Documentation of the Job – How clearly is the job and its activities defined?

2. Understanding Job Importance – How important are each of the Job Activities to the business’s success?

3. Understanding Job Complexity / Difficulty of Handing Off – How hard is it to train someone else on the Job Activity?

By breaking down these elements, management transition agreements can be crafted more precisely to account for the importance of specific job activities and the level of difficulty handing off specific activities.  This is the laser targeted approach to negotiating the transition and allows “white space” for Buyers and Sellers to find a relatively happy medium. 

For Sellers, we recommend the following documents be put in place prior to marketing their business for sale:

1. An accurate job description

2. A more detailed list of all duties being performed

3. SOPs for the hardest-to-hand off duties

4. SOPs for the most important duties to the success of the business

5. A written plan to transition in a new manager

For buyers, we recommend the following process for Due Diligence:

1. Work with Seller to develop a written job description

2. Request a detailed list of all duties being performed by the Seller and cross reference the list with key employees throughout the closing process

3. Create a visual process map of the workflow of the Seller

4. Collect all standard documents for the Seller’s work such as spreadsheets, meeting agendas, contact people, and get example of completed work for each

5. Review all documentation and rank all job activities from hardest to easiest to hand off

6. Identify the Key Success Factors (KSFs) of the business through interviews with the seller, key employees, and other stakeholders and identify which job activities are tied to KSFs. 

7. Craft your management comp agreements to cover all relevant job activities and include:

   1. A short term, intensive training period to cover the easiest to hand off Job Activities and

   2. A long term consulting agreement to cover hard to delegate, high importance management activities

By doing this, you’ll eliminate much of the management transition risk that causes deals to break down and find more common ground. 

Closing Thoughts

We’ve shown you:

• A real life example of how deals break down from poor management transition thinking, 

• How management transition is a major deal breaker, causing about 15% of all broken deals and 

• Exactly how to manage the transition process to you can increase the number of deals you close

Management transition is a key part of every deal and is often overlooked. Now you’re armed with the resources to handle it. As a result, you’ll close more deals, earn more money, and earn more credibility in M&A process.

Best of luck!

THAT’S A WRAP

Before you go: Here are 2 ways we can help

Is your deal stuck? We may be able to help. Get a free 30-minute deal assessment here — LINK TO SCHEDULE ASSESSMENT CALL

Are you an M&A Advisor or Broker looking for Wall Street-level financial analysis support for your CIMs and client financial info? If so, we offer a success fee-based program to help you close more deals with less overhead. To learn more, schedule a call here — LINK TO LEARN ABOUT SUCCESS-BASED FINANCIAL ANALYSIS