Top 10 Reasons Lower-Middle Market Deals Fail

And critical ways to fix the issues

I’m sure you see headlines. “Business Owners sells their business for millions of dollars!” Time for me to cash out. The part that doesn’t reach the headlines is 90% of businesses fail to exit and most that do exit, often see reduced valuations. Why?

We are going through the top 10 reasons why businesses fail to sell. Stay tuned to the end for a bonus reason!

1. Key man risk

   • Kay man risk is the number one reason why businesses fail to exit or why valuations are severely ratcheted down

   • What is Key man risk? When either the owner or someone critical to the business is detrimental (aka a “bottleneck”) to the business running. If the person is removed, the business cannot operate and the business fails

   • Examples include being the only knowledgebase of critical information, being the only one who knows how to complete critical tasks, and being the only person who communicates with top clients

   • Owners frequently confuse control of the business with needing to be the bottleneck. Control is understanding your business, how it runs, and the market you are in. Being the bottleneck withing your business actually demonstrates lack of control. It shows that you do not know how to control your business and it cannot operate independent of you

   • The more intrenched you become, the less a future owner can see themselves running your business. This translates to failed sales

   • How to Fix:

     • Hire a General Manager or CEO as your replacement

     • Document your critical processes

     • Build your critial tasks into your employees objectives

     • Delegate your tasks

     • Spend less time in the office

2. Disorganized Financials

   • Why are disorganized financials a problem? First, you have no idea how much money you are actually making because either you don’t have a P&L or the P&L is inaccurate. Second, when it’s time to sell, it will be a scramble to get organized

   • Other issues with inaccurate financials include, not paying the correct amount in taxes, not understanding how revenue is attributed, not understanding gross margin, no ability to forecast (good or bad), lack of planning

   • Read our blog post: What Private Equity Looks For in Your Financial Reporting

   • How to Fix:

     • Hire a great bookkeeper to build consistently and ensure there is a monthly financial close

     • Build a plan to bridge, with your Accountant, from your current state to the desired state

     • Document the General Ledger so everyone understands your financial categorization

     • Spend, at minimum, one time a month reviewing financials with your bookkeep to ensure consistency

     • Start budgeting and forecasting

3. TOO MANY ADD BACKS!

   • SDE (Seller’s Discretionary Earnings) is a Marketing term that has started to gain traction in the last decade. SDE’s definition is EBITDA + Add Backs

   • Why? If a business’ EBITDA / profit isn’t strong enough on its own, Investment Bankers and Brokers must think of creative ways of making a business look more attritive to buyers. So, they start to add expenses back to EBITDA as profit. The most frequent add back is Owner’s salary, but we’ve seen crazy add backs like marketing and travel expenses

   • We promise, you will not fool buyers by adding back expenses into EBITDA to increase profit. Smart Buyers will remove the add backs every time. In fact, it’s probably the first thing they do when reviewing a business’s CIM

   • Add backs lead to initial distrust with Buyers and will always reduce your expected valuation

   • How to Fix:

     • Review point number two above and ensure your financials are accurate

     • Build solid profit first and don’t build a business based on add backs

     • Be honest with buyers

4. Inaccurate Sales Reporting

   • You must understand sale attribution. What is sales attribution? It’s just a fancy way of saying where your sales come from

   • Not understanding the value of your sales negatively impacts valuation because it becomes very difficult for a buyer to understand how your business model works

   • Lack of clarity equals lack of valuation

   • How to Fix:

     • Build an attribution map

     • Document your sales strategy of the attribution map

     • Explain category or client growth in their segments

     • Discuss strengths and weaknesses of the attribution map

5. Lack of process documentation

   • When a buyer purchases your company, they need a manual on how to operate it

   • Not all businesses in your industry are run the same way

   • If buyers can’t understand what’s going on, you are conveying disorganization in your business

   • How to Fix:

     • Start with building simple Standard Operating Procedures (SOPs) for the most critical process of your business

     • Not only does documenting processes help you with Buyers, but it allows you to see what’s working and not working in your business now

6. Lack of scalable processes

   • What is a scalable process? It’s a process that can easily be taught and ramped up when sales increase

   • So, what’s a non-scalable process? It’s a process that’s reliant on one or a few people knowing how to do it and can’t easily be taught. Or a process that is very manual

   • Why do lack of scalable processes kill deals? Sophisticated Buyers want businesses that work and, when they invest capital into the business the just purchased, they want processes that can ramp up. Most Buyers do not want fixer-uppers

   • Examples of lack of scalable processes include only one person in your organization able to perform a critical task and the whole business is reliant on this person. Or when a simple task, that can be aided by technology, takes ages to complete because every step is completed by a person. Or, when too many people are required to make a decision

   • How to Fix:

     • Cross train on critical tasks

     • Utilize technology

     • Build succession planning

     • Outsource

7. Majority of Sales generated by one Sales Representative

   • Having one dominant Sales Rep, in many cases, can even be worse than a Key Man issues

   • Why? Because the Sales Rep has leverage over you and your entire business knowing that if they leave, it’s possible revenue will fall flat.

   • Owners are always very hesitant to address the issue because of the leverage the Sales Rep has over the business. What makes the situation more complicated is that the Sales Rep’s compensation is tied to their Sales Performance and if you shift sales from them, their compensation reduces. It’s a terrible position to be in

   • Why is one dominant Sales Rep a deal killer? This FREAKS Buyers out! Imagine a Buyer’s feelings here. They buy the business and the key sales rep leaves. Game over!

   • How to Fix:

     • It has to be addressed and is, of course, complicated

     • Approaches that work:

     • Moving the Sales Rep into a leadership role of Managing other Sales Reps

     • Slowly add additional sales reps over time

     • Terminate the Sales Rep, knowing your brand will take an initial dip, but will recover in the long term. While this approach can seem scary at first, there is plenty of documented cases where this works, provided you plan ahead

8. No legal documentation

   • Your business should be like a mullet. Business on top and party in the back. Seriously, be as creative as you want around sales and go to market, but your backend of your business must be on the straight and narrow. And, this is most meaningful with legal

   • Not having agreements in place, losing them, or not keeping them up to date shows disorganization and buyers can sniff it from a mile away

   • Not having legal documentation is a deal killer because it literally means your business cannot transact

   • How to Fix:

     • Start early. Build a folder of all your documents

     • Hire a good Attorney who can keep you organized

9. Too much customer / vendor concentration

   • Similar to Key Man, take out a client or vendor and the business crumbles

   • No buyer is going to want to touch customer or vendor concentration. Also, banks won’t finance an acquisition with concentration issues

   • How to Fix:

     • Build customer and vendor diversity

     • Spend more time with clients that purchase less from you

     • Increase your marketing efforts

     • Add product lines

     • You must have a strategy around client and vendor diversity

10. No budgeting process

    • While this one may not kill a deal, not having a budgeting process will definitely reduce your valuation. Private Equity firms, who you want to buy you, are going to expect that you have a budget process. They want to know that your business understands how to plan for the year ahead. And, as import, how to review how your business is doing against the budget

    • What great about a budget is, at a minimum, it forces you to think about targeted growth

    • How to Fix:

      • Start with a simple budget. If you are in the middle of the year, build a plan for the second half of the year

      • Go one step further and make a plan of the initiative you are going to take to meet or exceed the budget

11. Bonus: Your business partners not prepared to exit

    • Not having alignment with your business partners on an exit will positively kill your exit

    • When you show buyers that you are disorganized as an ownership team, it makes them uncomfortable. And again, disorganization leads to reduction in exit values