Expect Negative Surprises When Acquiring a Business

Some aspiring entrepreneurs will get started by buying an existing small business and many business owners have growth plans that include buying up other businesses to add larger chunks of growth via acquisition (mergers and acquisitions or “M&A” growth as opposed to “organic” growth). And if you are a business owner, you will most likely at some point sell your business. So here’s a few tips to both sides of the transaction…

While it may not be statistically significant in terms of all the deals ever done, in my experience of negotiating with roughly 300 prospective sellers, signing approximately 75 letters of intent (LOIs), and acquiring about 20 companies, I can confidently state that there were always negative surprises — during due diligence and after closing — in 100% of the deals.

What I mean by “negative surprises” is that the companies were never as good as they were portrayed, their earnings were never as high as they were initially presented (usually verbally), the customer relationships were never as solid as they had appeared at first, the management team is never as good as they seemed, etc.

I recently had two deals under LOI and the same thing happened all over again. I found out that one of the companies that had represented earnings of $2.6 million in EBITDA (Earnings Before Interest, Taxes, and Depreciation) really only has $1.3 million in EBITDA. Of course the Seller was still expecting the same purchase price initially discussed when I thought the company had earnings of 2x the actual amount! And that’s another funny thing: the earnings shortfall has often been almost exactly half of what the sellers had bragged about upon our initial meeting. Or put another way, the seller’s expectation of the selling price, is almost always exactly double the market value.

I remember another prospective seller several years ago that looked me straight in the eye and boasted of his $1 million in earnings and no debt whatsoever. As I dug into the company’s trailing twelve months (TTM, also known as last twelve months or (LTM)) financials, it turns out that their earnings were only $550k and the company actually had $350k of debt on the Balance Sheet.

Let’s break down the impact of this negative surprise: The business was in a market that indicated it was worth 6 times EBITDA, so the initial discussions were $1m x 6 = $6m. However, with the new information, the business was worth less than half that: $0.55m of EBITDA x 6 = $3.3m – $0.35m of debt = $2.95m of equity value.

When I confronted the seller (in a nice way of course, not wanting to lose the deal, but trying to reshape it and re-price it based upon the new information) he acted in the typical fashion of blowing up at me, blaming me for taking too long on the due diligence, and demanding a quick close at the original price of $6 million. His response was to try to bludgeon me into submission rather than deal with the fact that his company was nowhere near the company he had made it out to be.

So, the anatomy of a deal often goes like this:

  1. Initial meeting with the prospective seller is all about the seller painting a glowing picture of the company and in their enthusiasm for the company and a potential cash-rich deal, the seller often exaggerates a few details such as revenue and earnings and they nearly always paint more vision than reality.
  2. The buyer gets excited about the company (it sounds like such a terrific company!) and positions the value of the company based upon what they have heard and they peg the timing of the closing based upon the seller’s promise to get the information right over to the buyer. They have officially entered the honeymoon period.
  3. The seller starts to pull the initial information together for the buyer, but is embarrassed to find a few significant shortfalls in what has been portrayed. It is easier to stall on getting the information to the buyer than it is to own up to the issue.
  4. The buyer prods the seller into action, wanting to keep the seller on track to close on time (after all, it is going to be such a good deal), but the seller goes silent for a while.
  5. The seller finally gets a bit edgy and comments that they has a business to run and can’t get all the information as quickly and as completely as the buyer wanted. The honeymoon period is not yet over, but the first big stress in a deal is almost always over the due diligence process itself.
  6. The buyer backs down a little and tries to reset expectations in terms of the closing date, because they still doesn’t have any information. But the seller, of course, is still expecting to sell the company by the end of the week and get a huge check to just walk away.
  7. The seller finally delivers some information to the buyer just to get them off their back for a while and holds their breath, knowing the information doesn’t live up to their initial discussion.
  8. The buyer gets handed the first big negative surprise and tries to figure out how to renegotiate the deal based on what was just found out. The honeymoon period is now officially over.

And on the process goes with its ups and downs and negative surprises until the deal is called off because of unmet expectations or the deal finally gets done, but with lots of tweaks, a lower price, and more contingencies. I wish it were different, but it has been an enduring pattern.

So…if you are a buyer, tighten your belt, increase your patience, and get ready for a bumpy ride with a low probability of closing the transaction – and expect those negative surprises.

And if you are a seller, please, please, just state the facts and quit trying to sell so hard. We know you love your company and we know it’s your baby. And we understand that your name is most likely on the door of the business. But honestly, it is only worth a multiple of earnings and the earnings are what the earnings are, no matter how hard you try to tell a buyer that’s it’s worth more. If it is worth more than the prevailing market multiple, then frankly, you should keep the business because you value it more than any buyer will.

Recommended Resources

Ask an Expert:


  • Venture Academy (especially the Finance and Accounting section that discusses how companies are valued and explains earnings multiples)

About Wade Myers

Wade has founded or co-founded, invested in, and been a director of over 25 companies and has completed 55 financing and M&A transactions. His previous work experience includes the Boston Consulting Group and Mobil Corporation. Wade also served as an Airborne Ranger in the US Army where he was a decorated veteran of the Gulf War. He is a Baker Scholar graduate of Harvard’s MBA program and is married with five children.

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