Over the past several months, I have witnessed buy-sell agreements fall through in businesses because of unanticipated developments that converted an appealing opportunity into a calamity of hidden surprises that ultimately killed the deal. As more and more Baby Boomer business owners are looking toward selling what they have built over the years, as well as Boomers ready for a second chapter in their lives, willing to invest in a business venture, it is important to be fully aware of some of the pitfalls that can cause a promising venture to go off track.
The reality is that there is tangible and intangible equity within every business. The key is to understand each type of equity and how it has played into building the business, sustaining the business and creating value in the business. If any of these are misunderstood, misappropriated or mishandled, then what was once a promising opportunity diminishes into a disappointing deal gone awry.
1. Sweat Equity: Sweat equity isn’t always an investment of the business owner. In many cases, when a business is getting off the ground, key initial employees are engaged with the understanding that their sweat equity will translate into value as the company grows due to the intellectual capacity or capability they are bringing into the business. Clarity of understanding is essential to avoid misunderstandings and disengagement down the road, including clearly defining percentages of equity in the business earned for efforts made and results realized. A promising business purchase disintegrated when key employees were prepared to jump ship once they realized they were not in the equity equation upon the sale of the business. With no non-compete agreements in place, the buyer realized he would be buying a business that wasn't on as solid ground as originally presented.
2. Investment Equity: Understanding the amount of investment contribution made by owners in a business and its legitimacy is also critical to understand. Be certain there is a paper trail of when these investments were made and what was the end result that contributed to the growth of the business. Otherwise, this balance sheet item could be simply a means of lining the pockets of owners above and beyond the sell price distribution under the guise of payback.
3. Creditor Equity: A business with plenty of tangible assets in facility, equipment and inventory may appear appealing on the surface, until investigated further to realize that it is all collateralized against debt owed. If no aggressive effort has been made to reduce the debt while supposedly raking in sales, then where have the profits been allocated? Typically, if profits have been focused more on salaries to owners instead of reinvestment and pay-down of debt, it is a red-flag that priorities and focus within the business is not aligned.
4. Family Owner Equity: Too often, within a family business dynamic, small equity owners are not considered a real threat or concern. The expectation is they will be paid the proper percentage according to their shareholder equity holding without much say in the matter. However, especially in a family-owned operation, it is important to be clear on both sides what say and influence a small equity owner has in the sale or transfer of business majority equity. In one instance, it was realized that an inactive adult child who owned single-digit percentage in the family business was wielding great influence behind the scenes, which was continuously causing delays and renegotiating to occur. Ultimately, the deal fell through.
5. Emotional Equity: Probably the most valuable or volatile equity in a business can be the emotional equity that exists. When a business has built Share of Heart internally and externally to a point of true market preference for its brand, this intangible equity can realize a big pay-off for shareholders at the time of a sale and long after to the new owners. When ego gets in the way, however, this can be a volatile situation that can unravel a deal fast and furiously. Due diligence in one instance helped a potential buyer realize that key employees were excited about the sale of the company in hopes that the current owner would take the money and run so the business could realize its full potential. Problem is, the current owner would only agree to the sale if he was retained as CEO. Once the buyers realized that employees would likely not stay if the current owner was retained, the deal couldn't be reached due to ego and control being the drivers from the other side.
The due diligence that is necessary to fully comprehend and know exactly what you are selling or buying is a critical step that cannot be over-emphasized. In all of the examples of deals that didn't happen in the end, it was discovery during due diligence that ultimately caused the potential buyer to have justifiable second thoughts and back away. Consider if any of these snags could occur in your business as you prepare your exit strategy.
Sherré DeMao is author of the nationally acclaimed books, 50 Marketing Secrets of Growth Companies in Down Economic Times, www.50marketingsecrets.com, and Me, Myself & Inc., www.memyselfandinc.com, Her column seeks to help business owners build and grow sustainable enterprises and businesses with economic value and preference in the marketplace.