Business Deals ‘Under Contract’ Often Do Not Close
It may surprise many business owners that approximately half of business deals which are ‘under contract’ do not end up closing. The phrase ‘under contract’ in the realm of business sales means that the buyer and seller have signed a Letter of Intent (LOI) or purchase agreement with an appropriate deposit and period of exclusivity in place. Once a deal is ‘under contract’, the buyer is enabled to conduct formal due diligence by which they will fully investigate all aspects of the business, as well as to begin the process of assuming the seller’s lease (particularly important for retail-related businesses). Formal due diligence and lease assumption are almost always contingencies to close. Let’s explore common sense ways in which to reduce the odds that a buyer will use these contingencies to walk away from a business deal.
Keys to Closing Business Deal
An experienced and knowledgeable business broker will reduce the odds (but not eliminate the risk) that a buyer will decide not to purchase a business after the deal goes ‘under contract.’ The keys to reduce the risk of a buyer walking away from a business deal are to set firm deadlines for the buyer throughout the buying process, ensure to the best extent possible that the buyer will not face any major surprises during formal due diligence, and to anticipate problems and issues that may derail the deal. Assuming the buyer has the funding to close, they are much more likely to do so if they are not thrown any ‘curveballs’ in the form of surprises or changes to their general valuation of the business after the deal goes ‘under contract.’
Set Deadlines for Buyer
- One way to improve the chance that a business deal which goes ‘under contract’ actually closes is by setting deadlines for the buyer throughout the buying process.
- The most important deadline is the period of exclusivity that a buyer has in which the seller may not entertain other offers.
- The period of exclusivity is negotiable and often memorialized in a Letter of Intent.
- Typically, the period of exclusivity is 30-60 days.
- Note that the final purchase agreement (which supersedes an LOI) has a binding closing date (subject to contingencies), giving the buyer exclusivity until the closing date.
- The period of exclusivity must be reasonable from the seller’s perspective.
- The seller should expect the buyer to act crisply and without delay during the exclusivity period.
- After all, if another buyer comes along during the exclusivity period, the seller is giving up the right to engage with them.
- Further, any period of exclusivity should have other self-imposed deadlines (or timetables) by which the buyer takes certain steps in furtherance of closing.
- Such steps include the buyer submitting their formal due diligence request list, the buyer proposing a purchase agreement (or the parties agreeing upon a purchase agreement), and the buyer assuming the lease (if applicable).
- If the buyer is obtaining external funding as a contingency to close, then deadlines should be imposed requiring evidence of loan approval.
- Reasonable deadlines usually are adhered to by most serious buyers, who should be prepared to close in a reasonable period of time prior to making an offer.
Reduce Surprises During Formal Due Diligence
The best way in which to avoid surprises during formal due diligence (and thus avoid the buyer from walking away from the deal) is incorporating a buyer’s formal due diligence request list in the LOI or purchase agreement. The seller may not have certain requested items or not be able to prove certain items on the buyer’s formal due diligence request list. The LOI or purchase agreement should thus reflect the negotiated level of formal due diligence acceptable to both parties Most importantly, both parties should be fully aware what to expect during the formal due diligence process.
Preliminary Due Diligence Reduces Surprises During Formal Due Diligence
Preliminary due diligence occurs prior to the buyer making an offer, and typically includes basic financials such as tax records or profit and loss statements, a comprehensive description of important aspects of the business, and a physical asset list of items included in the sale. Further, buyers may inspect the business premises or meet with the seller (and the broker) prior to making an offer so they can directly ask any relevant questions concerning the valuation of the business. While still carefully protecting the seller’s confidentiality, properly carrying out preliminary due diligence will lead to less surprises during the formal due diligence stage.
Buyer Should Understand How Formal Due Diligence Will Be Accomplished
Formal due diligence substantiates the income of the business along with any other other material aspects of the business. This involves a much more thorough review of the financial records of the business (such as bank statements, payroll records, sales tax records, invoice records, or suppliers records). Further, formal due diligence may also involve the buyer ‘observing’ the business for a period of time in order to substantiate customer volume and transactions. This method is frequently used when the business does not have conventional financial records that accurate reflect its true income. There must be a meeting of the minds between the buyer and the seller prior to formal due diligence as to the methods by which the buyer will be able to conduct formal due diligence.
Anticipate Issues to Keep the Deal Together
- Besides setting deadlines and facilitating formal due diligence, another important aspect of closing deals is to anticipate issues or problems ahead of time.
- Anticipating issues allows negotiation to occur without undue surprises.
- The transfer of the lease, for example, may become problematic if the landlord imposes unreasonable lease transfer fees or changes the terms of the lease for the buyer.
- This usually may be overcome by the seller’s cooperation in negotiating with the landlord.
- Another example of anticipating issues to keep a deal together is how a smooth transition will occur after the sale.
- Many buyers have serious concerns that a business may not function the same without the seller.
- In such circumstances, the buyer and seller should speak directly and have a general meeting of the minds (before the buyer makes an offer) as to how a smooth transition or hand-over of the business will take place.
- Each individual business sale poses its own unique characteristics, and a professional business broker must anticipate any other relevant issue and ensure that they are addressed and negotiated by both parties prior to a deal going ‘under contract.’
While approximately half of business deals that go ‘under contract’ do not make it to closing, the odds of success greatly improve with prudent planning and anticipation. By setting clear deadlines, avoiding surprises during formal due diligence, and holding a deal together by anticipating issues before they become deal-breakers, a business sale has a much greater chance to close.
Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.