Selling your business is an emotional rollercoaster. It is a unique mixture of fear, uncertainty, excitement, arrogance and eventually relief. Knowing the appropriate time to feel each of these emotions comes from experience, and understanding what to expect may be helpful when you eventually sell your company.
Over the years I’ve realized that receiving your first letter of intent or “LOI” is a very confusing part of the business sale process. Experienced sellers (there are not many of these) realize there is about a 40 percent chance that a LOI will actually result in the sale of your company. In fact, the majority of LOIs never actually turn into a closed deal. There are many reasons for this, and how you approach, think about and react to your first letter of intent will dramatically impact your opportunity for a successful sale.
As evidence, let me present the most recent annual report from Riverside Company, one of the best mid-market buyout firms in the country.
As reported in their 2009 annual report, Riverside Company submitted 63 LOIs yet closed on just 15 of those transactions (23.8 percent):
- 4,228 Deals Considered
- 1,315 Companies Screened
- 347 Company Visits
- 63 LOIs Submitted
- 15 Deals Closed
They are very good buyers and know how to close deals, yet less than 24 percent of their LOIs resulted in a happy, wealthy seller. The tough economic climate of 2009 was a contributing factor, as was Riverside Company’s extreme discipline as a buyer. Regardless of the specific reasons, this example is instructive for any entrepreneur who is considering a company sale. There are a few important lessons to glean from this report about the process of selling your company.
Most acquiring companies, private equity firms or buyout firms have a network of professionals they rely on for deal flow; Riverside relies on them almost exclusively. In 2009 Riverside developed a complete screening memo for 1,315 companies and submitted a LOI to less than 5 percent of those companies. A professional introduction or “friend of the firm” is always the best way, and often the only way, to present your company if you want any serious consideration.
Selling your company is a humbling process. You’ll talk to dozens of buyers who are not interested, and many of those who are interested will tell you “your baby is ugly.” I often talk with CEOs or entrepreneurs who tell me they get calls about buying their business “all the time” as if that adds credibility or value to their company. The problem is that it sometimes leads to arrogance, which is always a problem when selling a company.
Again, if you consider the Riverside numbers, only 8 percent of the deals they considered created enough interest even to arrange a management meeting (that is, a visit to the company). Calls of interest are always gratifying, of course. The key is to stay humble or the process will do that for you.
Minimum Deal Size
Riverside actually visited 347 companies in 2009. These management meetings are often preceded by a phone call to determine if a visit is warranted. If it is, there are expenses for hotels, meals and airline tickets on top of Riverside’s existing infrastructure to handle their deal flow.
Understanding these dynamics helps to realize why many investors require a minimum of $1 million to $2 million of net earning (EBITDA) to take a close look at a company. There is almost the same amount of due diligence for a $10 million purchase as there is for a $150 million transaction.
I spoke with a client just yesterday who confessed he is excited to receive a pending LOI and completely distracted by the possibilities his deal represents to him personally. He finds himself thinking more about the sale than about how to grow his business, which is quite normal. Once we get past the LOI stage, he’ll have to produce plenty of due diligence materials, which will also require time and attention.
Experienced buyers recognize this and will use human nature to their advantage when timing their transaction process. Time is most often on the side of the buyer, and good buyers will often use that advantage to wear you down mentally and emotionally.
Selling your company is a long process with many ups and downs, timetables, information requests, accountants, lawyers and advisors. If you want to sell your company for maximum value, be sure to have a good team of advisors who will let you know when to get excited. (Hint: It will not be when you get your first LOI.)
Thanks a lot for your great post, Todd
This reminds me of when I was in automobile franchising, and the sales manager always told the salespeople that “it’s not a deal until money changes hands…their money.”
The Franchise King
This is really helpful. Two years ago someone was looking to buy my business and it was a huge time suck and my sales slowed because of it. Ultimatley nothing came of it (except my lost sales) and I thought it was something I did or did not do properly. Thanks for this persepctive…
Todd, why do you think that Riverside was only able to close on around 25% of their LOIs? If they put that much effort into screening, what would cause them to lose nearly 3 of every 4 companies they give an LOI?
That is a great question and one for them. If I speculate, many PE firms are more focused on the financial aspects (because they are financial guys) than the strategic aspects.
If you have a strategic buyer who can leverage parts of your business across their sales team, client base, etc, they are often times more flexible because there are more immediate opportunities to make an immediate financial impact.
Keep in mind though, statistics in the industry tell us that 2.5 LOI’s are required to bring a deal to close Said another way, 40% of LOI’s actually result in a closed deal.
It is a tricky process and a bit more difficult in current economic environment.
Todd–you make many good points in your post regarding Letters of Intent (LOI). We have found many business owners starting down the path to sell their business have never understood or participated in the (M&A)selling process. They often think the M & A process is similar to their experience selling their home or other real estate. It is not! Our experiences with business owners have convinced me that the Letter of Intent is a great place to truly access whether a buyer is serious and to negotiate the most important terms of the deal. If the deal is going to actually close, the seller gets a chance to address the important terms sooner than later. This article discusses some of those finer points which have proven to be important in a Letter of Intent: http://www.exitpromise.com/articles/Letter-of-Intent
Best of luck to those involved with selling their businesses!
Holly Magister, CPA, CFP
Good point, Holly.
We will try to advance conversations pretty far before LOI as a “no shop” is typically requested by the potential buyer. Given any LOI is a 50/50 proposition, we’d like to add as much certainty to the process as possible…
I have actually been involved in several sales and purchases of small private companies, having sold two and bought three. I have to say that the LOI can be anything anyone wants it to be. Some sellers won’t even tell you basic info without an LOI, whereas others will give you nearly everything you need to decide without one. Certainly, the business broker loves an LOI because he can both show results to his client, and also create a sense of urgency from other prospects. I agree with Holly about an LOI indicating a serious buyer, but requiring one too early in the game always makes me a little suspicious, and may be what leads to the low closing ratio.
Good comments, Scott, Thanks!
Great article. My business partner and I have sold 1 business and are on the cusp of selling another. The LOI wasn’t terribly critical because in both cases the only buyer who submitted an LOI was the one who actually purchased the business. I imagine much has to do with the individual approach of the broker.
A few trends we’ve noticed lately:
— Many buyers are requesting multi-year, delayed payout based on future profits.
— But… many buy/sell agreements don’t allow the seller to audit the buyers finances to ensure accurate reporting of future profits.