Business acquisitions are never quick processes. As we discussed in our previous blog exploring what a buyer’s ideal ‘shopping list’ looks like, buying a business requires a major investment of both time and capital. While identifying the right acquisition target is an important first step, successfully completing a transaction requires careful planning, detailed analysis and a clear understanding of the risks and opportunities involved. People want to be sure they are making a sound decision and not putting a considerable amount of capital at risk.
That’s why the due diligence process is such an important part of any business sale or acquisition. It provides buyers with the opportunity to gain a deeper understanding of the business, validate the information presented and identify any potential risks or opportunities before committing to the transaction.
While due diligence cannot remove all uncertainty from a deal, it helps buyers make informed decisions by ensuring they have the information needed to assess whether the acquisition aligns with their objectives and whether the terms of the transaction appropriately reflect the value and risks involved.
Inevitably, there are times when something crops up that makes a buyer think twice and perhaps even walk away from the deal. In truth, it’s rarely just one thing. When negotiations collapse irrevocably, there is usually a combination of factors at play.
That said, some issues are more likely to raise concerns for prospective buyers more than others and potentially delay or derail a transaction. Here we highlight three common ‘red flags’ that sellers should actively seek to avoid when preparing their business for sale and ensuring the transaction progresses smoothly.
Financial red flags
For business owners, there’s no hiding from the importance of their robust financial records when it comes to negotiating a sale. Buyers expect transparent, accurate, well-organised and detailed financial information. Inaccurate, inconsistent or just plain messy records are very likely to set alarm bells ringing leading to undermine confidence, raise concerns during due diligence and at times jeopardise the transaction altogether.
One common red flag is a lack of alignment between different sources. If management accounts tell one story, tax returns tell another, and internal reports tell a third, a buyer will naturally want to know which version is true and what the real story of how the business is performing is.
The same goes for sloppy record keeping. Unrecorded cash, mixed personal and business expenses, unclear director drawings and poor reconciliations all sow uncertainty and doubt, even where there are reasonable explanations.
Another common issue is aggressive or poorly explained adjustments. A particular area of sensitivity here is EBITDA, or earnings before interest, tax, depreciation and amortisation. EBITDA is commonly used as a measure of trading performance. But it is also often subject to adjustments to remove one-off costs or unusual items, with the intention of giving a more “normalised” view of revenue. That can be perfectly legitimate. But it can also be a tactic employed to disguise weaknesses in working capital. Any buyer aware of this might view heavy or unexplained EBITDA adjustments very suspiciously indeed.
Tax issues can be equally damaging. Unpaid liabilities, vague or undocumented VAT treatment, payroll errors or uncertainty around the employment status of contractors can all create serious concern for buyers. No one wants to have HMRC on their case for historic problems they weren’t responsible for.
Legal and compliance red flags
Tax issues raise the alarm for more than just financial reasons. Poor tax treatment can also be a compliance concern. Like we say, no buyer wants to risk fines from HMRC a year or two after buying a business for historical breaches.
There are lots of other potential compliance-related and legal red flags that can derail a takeover. Disputes and litigation are among the most obvious. Everything from customer disputes, supplier disagreements, shareholder issues or unresolved employment matters represent risk to a would-be buyer.
The same goes for compliance breaches or even a lack of robust governance, particularly in regulated sectors. Missing licences, poor health and safety records, weak internal controls or gaps in sector-specific obligations all raise questions about how well the business has been managed.
Picking up on supplier disagreements, lax contractual practices are another thing sellers should be very wary of. You might have gotten by on a handshake or verbal agreement with suppliers, contractors or even landlords for many years. But for a buyer, all that tells them is that there is a lack of security in key operational areas.
One final area under this category that is growing ever more important is cybersecurity and data protection. Every business is a digital business these days. And with the average cyber attack costing £195,000 per business, digital security is now one of the biggest risk vectors for any business. As a seller, if you don’t have robust protections in place, you risk a would-be buyer deciding that you represent too high a risk.
Owner red flags
Sometimes the biggest obstacle to getting a business sale over the line is the current owner. This is rarely intentional, of course, but even those with genuine intentions to sell can inadvertently put a spanner in the works.
One way this manifests itself is sellers having unrealistic expectations about price and sales terms. Every seller naturally wants the best possible deal. But if the asking price is based on personal attachment rather than commercial evidence or market conditions, the process can quickly become difficult. Buyers expect a valuation to be based on objective measures of financial performance, growth prospects and risk profile.
Owner dependency is another common concern, especially in founder-led businesses. If the seller holds all the key customer relationships, makes every important decision and carries most of the operational knowledge, the buyer may ask a simple question: what happens when that person leaves?
Smoothing the path to a deal
Business owners cannot afford to approach a disposal pretending there are no weaknesses or attempting to hide them. The only productive approach is to acknowledge the issues that could deter prospective buyers and work to remedy them.
Financial practices can be improved and records cleaned up. Contracts can be reviewed and formalised. Tax, compliance and security risks can be remedied. Management structures can be strengthened.
One practical step we highly recommend to all business owners considering a sale is to undertake an exit-readiness review. This helps identify potential red flags early in the process before a buyer uncovers them during due diligence All these red flags can be addressed in advance to allow you to present a strong and compelling acquisition opportunity. The result is; greater buyer confidence, a smoother sale process, and a higher valuation for exiting shareholders.
Our Corporate Finance specialists can take you through this process and then help you plan what you need to fix before you even start looking for a buyer. Contact us today to find out more.
