Killing a Deal
Big Deal Small Business: Killing a Deal
If this was forwarded to you, check out the archive or subscribe below.
Deals Die All The Time
The search process is about getting deals done, but today’s post is about killing deals.
In both PE and SMB M&A, killing a deal is the default outcome.
For context, I have tracked every deal I’ve looked at for work over the last several years. I have looked at ~65 deals beyond just an initial screen (i.e. done at least 2-3 weeks of work).
Of those ~65, I have done “deep” work on 33 deals, which I loosely define as a site visit, month-plus of work, etc.
Of those 33 deals, I have made large investments in 5 (I’ve made some smaller public trades, but only 5 meaningful investments). And I’d consider myself fairly lucky in terms of getting staffed on deals that have closed at a high rate relative to my peers.
In other words, <10% of deals that we do real work on will close; that number is probably <2% once you include every deal we screen.
These “funnel” metrics are even worse for SMB. In PE, most businesses have been properly vetted by investment bankers who only take on a client if they’re confident it will sell. In PE, a sale process is primarily a valuation exercise.
In SMB sales, many businesses should probably never sell. They’re too tied to the owner to have value once the owner exits. Further, many SMB deals just won’t be a good fit for you as a searcher — this isn’t an issue in PE as we can generally find managers to fit any business.
As a result, the closing rate on SMB deals is also very low. This means you have to kill a lot of deals.
Unlike PE world, killing an SMB deal just feels different:
The brokers tend to be more gung ho/unrealistic about the value of their clients, the Sellers have never been in an M&A process before, etc.
As a result, I’ve been reflecting on two things:
Killing deals quicker or slower
How to deliver the message
Killing Deals Quicker or Slower
On the one hand, killing deals quickly allows you to focus on higher-likelihood businesses. It avoids wasting time for both you and the Seller. It helps the broker view you as a serious, decisive actor.
On the other hand, killing a deal too quickly can cause you to miss a diamond in the rough. My experience has been that both brokers & sellers in this market are quite bad at “telling the story” of their business value.
In PE, we pay investment bankers large fees to tell the story, create hooks for different buyer types, lay the groundwork for buyers’ theses & post-closing strategy, etc.
In PE, if you don’t feel intrigued by the business as you read the CIM, you’re probably never going to get to the finish line.
In SMB, I’ve noticed the opposite. There are plenty of deals with terrible (or non-existent) CIMs. It’s common for me to like a deal more as I do diligence. If a CIM provides an inkling of a hope, I tend to grab it and look for more information.
It’s unsatisfying, but I think the answer to how quickly to kill an SMB deal is “it depends” — I have to keep honing my radar for deals I should move on from quickly, versus deals that have a prayer.
It only takes one deal to have a successful search, so I will continue to keep my threshold to kill a deal higher in SMB than I have it in PE.
How to Deliver the Message
I’ve seen two schools of thought on how to deliver the message that you’re passing on a deal:
Quick and to the point, no explanation
Explain issues, test the process, give a chance to respond, leave the door open
With #1, the idea is to move on cleanly, not waste anyone’s time, and focus on the next deal.
The explanation for passing is just “not a good fit for me” with no deal-specific comments. If you give deal-specific comments, it opens the door for the broker/banker to respond to why your read of the deal is wrong. If you’re 100% sure you want to move on, why leave that door open?
With #2, you leave the door open. The broker might come back to you with info you missed. But more interestingly, the broker might come back with “we totally hear your concerns, and the seller’s price expectations reflect those concerns.”
In deciding which path to go down, my threshold question is “Do I want to own & operate this business?” (Note in PE, the question is only “Do I want to own?” without the “operate” part.)
If I do want to own & operate the business, but only have an issue around price expectations, then I’ll go down path #2. It’s more of a negotiation tactic than it is a deal killer.
If I truly don’t want to own & operate the business at any price, then I stick to #1 and move on. The only explanation I give is to help the broker tailor their outreach to me on future deals.
Conclusion
In summary, I kill deals slower in SMB than in PE. I deliver the message cleanly if I truly want to move on, but there are more tactical ways to kill a deal if you want to test the process.
As always, I’d love to hear your thoughts / opinions — how do you know when to move on from a deal? What are your threshold questions for whether to deliver the message along #1 or #2?
Hit reply to this email or find me on Twitter.
Thanks,
Guesswork Investing
P.S. I’d always appreciate introductions to potential acquisition targets or brokers (primarily targeting $750K-$1.5M+ of SDE or EBITDA, ideally located in the Northeast, West Coast, or Colorado).