I never tire of what I do as an investment banker: I sell companies; I help companies
buy other companies/assets; and, I raise money for companies. It was Lloyd Blankfein of Goldman Sachs who summed it up in a series of unforgettable comments in 2009:
"We're very important." "We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. It's a virtuous cycle." "We have a social purpose." "I'm doing God's work." Business Insider 2009
What I'm not: a consultant (although I do offer advice about stuff); a financial planner -- I don't set up financial plans for you; a stock broker - I don't sell stock or bonds to widows and orphans; a lawyer; or, an accountant.
I've been asked what are the most common reasons that deals (M&A and private placements) become undone or are re-priced downward after a letter of intent (LOI) has been signed. I spoke to several of my colleagues and the answers haven't changed over time. The most common reason is first:
(1) Missed numbers (usually revenues, EBITDA, FCF, or net income). This really happened: a client was looking to raise money and an investor put in an acceptable LOI. Client had 12 months of consistent slightly growing monthly revenues of $250K. The month the non-binding LOI was signed monthly revenues dropped to $50K and client couldn't confirm that the revenues had simply slipped to the right and would be picked up the next month. My client's position: "no big deal, we're a great company." The investor's position: things came to a screeching halt. When revenues failed to ramp in the next two months, it was "see ya, stay in touch" time.
Another tale of the tape: after a LOI was signed, a sell-side client lowered the remainder of the year's revenue projections by $4mm. EBITDA went from positive to negative. The client expected no adjustment to price as future projections were so great. Uhhhh....it was one of these moments: "Those who cannot remember the past are condemned to repeat it"...Santayana.
The buyer came back with a lower offer; the client accepted it; and the deal got done. Word to the wise, if you know you're about to miss your numbers, let me and your other advisers know immediately. I can start to socialize the message and lessen the shock and impact. It's along the lines of telling me if due diligence will disclose that you killed your parents. Tell me ahead of time so that I can position you as a recent orphan. The goal is no downside surprises.
(2) Management team turns out to be incompatible with buyer's team or are too prickly/difficult for the investors to embrace. Sometimes this can result from a CEO who wants to cut the deal alone or lead negotiations on everything. Not a great idea. There are always times in negotiations when someone needs to be the bad cop. That should be the investment banker or attorney. CEOs, CFOs, CMOs, and other c-level management types think they're impressing their new bosses by being hard-nose guys/gals. Usually they come across as lacking self-awareness, ill-versed, parochial, and out-of-their element. My advice to clients is to run their company so number 1 above doesn't happen and prepare to come in at the last minute as the tie-breaking Solomon. Leave the plumbing to the plumbers. Being in the trenches is overrated.
(3) Due diligence hiccups. See my advice above about disclosing problems to me and your other advisers. Everything tends to come out during due diligence, so the goal is no negative surprises. Have an undisclosed CERCLA exposure at that old manufacturing plant? Uh oh. Have a growing number of disgruntled customers? Think they won't be found out? Uh oh. Took an aggressive stance on revenue recognition? Think it doesn't matter? Uh oh. Have some undisclosed off-balance sheet liabilities? Even ignoring fraud issues and the consequences thereof, these types of problems cause offers to be re-priced at best or pulled at worst. If a buyer or investor concludes that my client isn't honest or forthright, the usual remedy is "we're outta here" under the theory that life's too short and there are too many alternatives to have to do business with crooks or the ethically challenged.
(4) No leverage. I run into this when I'm pulled in at the last minute to close the buyer or investor at the table which is "almost about to wire the funds." Sometimes I get an assignment when a prospect comes in to tell me that that "sure thing" financing didn't close. I don't have to be CSI to figure out how this has gone: the buyer or investor realizes that the client is dealing only with them and no one else. The CEO and his/her team are doing all the work and there's not an investment banker in sight. The thought is corroborated by the fact that the client is using an inexperienced attorney. It's off to the races. The offer comes down; the pre-money comes down; the liquidation preferences go up; last-minute terms are added, indemnities mushroom, etc. If a deal does get done, it's suboptimal. These folks are penny wise and pound foolish, but are absolutely loathe to admit it. They saved a dime and lost a buck.
I also see another version of this when potential clients come to me with 6 months' worth of cash burn and no plan on how to fund the company after it runs out of money. Buyers and investors will realize this and won't tend to respond with the top dollar offer. They will take a "let's wait to see what we'll accept when we miss a payroll" approach or their offer will implicitly be discounted to value financial distress.
(5) Who really owns the intellectual property (IP)? I find that if the IP is key to the value proposition for a buyer or investor, the deal won't get done if IP rights are in question. When I was at IBM, IBM would walk every time if IP ownership wasn't clean. Indemnification isn't sufficient because damages can far exceed the consideration paid.
(6) Passage of time. When deals linger on with little to no apparent progress, they become untethered and float away. Without too much self aggrandizement, but in keeping with Blankfein's comments, my job is to make things happen. It's how I get paid. Left unattended, VCs or PEs will go on to the next shiny thing in the road. A strategic buyer's business development team will move on rather than report lack of progress. My client will look like Mrs. Havisham and I like Pip. Not a great ending after such great expectations.
I could go on, but the above 6 are a decent sample. I may re-visit this again and focus on reasons deals fold pre-LOI, but those are hard times when your baby is deemed to be too ugly to even get a smile, a wink, or even a nod.
Jack Langworthy is a Managing Director at Covington Associates. He can be reached at 617-314-3950 or firstname.lastname@example.org.