Honesty is the best policy - How seller honesty can protect a premium exit value
Honesty is the best policy
When selling your car, it's understood that there will be minor defects, some marks of wear and tear from previous owners. Some like scratches, we tackle with some elbow grease and polish, while others can be more challenging and will be likely visible to the observant buyer. If the car is a quality vehicle, and there is strong market interest, making it clear in the sale notice that there is a slight dent in the bumper will likely have a negligible impact on the market value ultimately achieved. Selling it however as “pristine and perfect”, will likely invite some difficult negotiations and frustration when the potential buyer ultimately seeks to reduce the agreed upon price for the previously undisclosed bumper damage. In such cases being honesty about any defect at the outset, will usually conclude a better, quicker and altogether less emotional deal.
This is no different when selling your own business, particularly when it is an accepted truth that is no business is perfect. This is however the truth that “well-meaning” corporate advisors like to bend at times, and will seek to obscure anyperceived problems that your business may have within the glossy pages of the Information Memorandum that they have diligently prepared. The corporate advisor’s reasoning is indeed honorable since they often view any problem as being an admission of weakness which will reduce both the exit value and their commission.
Acknowledging problems as signs of growth and development
To better understand the conflict that their attitude presents, we must first recognize that admitting to any problem in a business is not a criticism of the seller, but simply a truthful acknowledgement that developing a business often involves hitting some bumps along the road. Any entrepreneurial buyer will recognize from their own hard-earned experience that failure is not the opposite of success, but indeed part of it, and that you often learn more from failure than successes. Einstein stated that “a person who never made a mistake never tried anything new”, and it is to be expected that any equity story of a growing entrepreneurial business will have its fair share of battle scars as well as its success. The equity story must be credible reflection of the journey the business has taken, and the entrepreneurial buyer will be as interested in your learnings from bad-experiences as your secret recipe for success.
The objective of a buyer’s due diligence is to identify any problem within your business
The second point to consider is that the whole objective of a buyer’s due diligence is to identify any problem within your business. This then moves the argument back to the “car sale” analogy, where the discovery of a defect on inspection can be more detrimental to the sale price, as opposed to explaining that you accidently dented your bumper while parking it diligently in your garage. While the dented bumper may well be visible, the fact that the car has been well-kept in a garage over the winter nights, may give greater confidence to a buyer to complete the purchase at the market price. The corollary of this, is that it is human nature when finding an undisclosed problem, to assume there is more than one, and a buyer may well seek a lower price to compensate for this additional risk.
An additional consideration for a seller who may be keen to remain within the business post-sale, is that this perception of being honest or otherwise may indeed reflect the future relationship you have with the buyer. From a buyer’s perspective, the perception of an honesty seller is paramount, since they are the very M&A executives who will ultimately have to convince their board of the merits of the transaction, and may well suffer the consequences if problems arise from previously undisclosed issues.
A seller’s problem may be an opportunity to the buyer
The last point to consider is that often “beauty is in the eye of the beholder”, and that a seller’s problem may be an opportunity to the buyer. If say a senior business development director decides suddenly to leave the business, trying to immediately replace him with an untried or tested candidate will unlikely be the right answer, since the buyer may have plans to share his own business development resource, and this timely departure will provide him with an immediate cost synergy. Many buyers expect problems and far from seeing these as deal killers, view them simply as obstacles to overcome. For that reason, being open about the issues within your business can often lead to more positive conversations on how the buyer can assist in the solution.
At Red Swan Partners our team have extensive experience from growing and selling their own businesses, being TIC corporate’s M&A executives, as well as working with a wide range of TIC business owners to support them in the development of their own exit strategy. This wealth of relevant market experience allows us to work with business owners to ensure that early disclosure of problems will be both aligned with the equity story and ensure you can still achieve a premium value for your business.