5 Ways SMB Buyers Get Played
The small and medium-sized business (SMB) acquisition market is still the wild wild west in many ways. Sellers and buyers have a lot of competing intentions when walking into a deal making trust difficult to develop. While plenty of upstanding sellers just want to offload their company (and life’s work) to a reliable buyer, deciphering which players in the industry you can trust is difficult, especially for new acquisition entrepreneurs with little experience.
As a deal guy who has spent years buying businesses and advising on deals, I’ve seen the many ways buyers can get played in their SMB deals. If you don’t stay on your toes, you could get pulled into a deal that isn’t what it seems. Keep your eye on these five situations to make sure you don’t get played in your deal.
Key Takeaways:
Don’t change your strategy unless you know for a fact competition is heating up.
Deposits during the first 30 days of an LOI are not standard for deals in the $1-10 million range.
A QoE can save you from a terrible deal no matter how small or messy that deal is.
The seller has the data you want, no matter what they say.
Run if you think a seller will compete with you after close.
1. Get Baited Into Thinking You Have Big Competition
Competition in SMB deals is common. If you find a deal appealing, other buyers will probably find it appealing for similar reasons. Especially as SMB acquisition becomes more popular, the competition for deals will continue to intensify. While competition is to be expected in SMB deals, you should be wary if the seller or broker starts to make a big deal about how sought-after your target company actually is.
Think about why a seller might try to convince you that the competition is heating up. It puts you on the defensive. Thinking that there are competitors chomping at the bit for your deal reaffirms your opinion that you found an amazing deal—whether or not that is supported by verified facts. It also makes you more likely to increase your offer and overpay unnecessarily.
Competing buyers may also inflate their own interest in a deal by increasing initial offers just to get a Letter of Intent (LOI) signed. After doing this, they can always negotiate the purchase price back down with whatever they find in the due diligence process. Check out this War Story to hear about a time this happened to me.
How do you prevent this from happening to you? Only trust the facts!
2. Pay 1-2 Deposits In The First 30 Days Of An LOI
Paying deposits to the seller during the first 30 days of an LOI is not standard for SMB deals between $1 and $10 Million. The LOI merely states your intent to purchase a company, and signing it does not mean you owe anything to the seller. You can even add a clause to your LOI that states you will not be paying a deposit until a purchase agreement is finalized.
Sometimes sellers may request a “good faith deposit” or “earnest money” which is meant to offset the seller’s time involved in negotiating the LOI and participating in the due diligence process. The argument here is that the potential buyer can walk away at any time leaving the seller empty-handed after putting in work. Sometimes this deposit then goes towards the buyer's deposit on the final deal.
The problem with expecting you to pay a deposit as a potential buyer is that you don’t know enough about the company yet! You can’t even meaningfully get to know the company until due diligence starts after the LOI is signed. During this process, you may discover facts in the deal that change your mind about wanting to buy—meaning you’re walking away after already investing in legal and due diligence services. A deposit may make you appear more serious to the seller, but signing an LOI and hiring advisors should be enough assurance that you are genuinely interested in buying.
3. Believe Your Deal Is "Too Small" Or "Too Messy" For A QoE
SMB deals can be messy. Small business accounting and family business books often don’t reach the quality or standardization that you might expect from a larger, more professional company. When due diligence starts, you may receive haphazard spreadsheets and financial documents that are thrown together by hand. Even if the deal is relatively small, verifying financial details and confirming an adjusted EBITDA is essential.
Rather than indicating a Quality of Earnings (QoE) is unnecessary, a small or messy deal may give you more of a reason to hire a due diligence professional to sort through the facts. The QoE analyzes the business’s financial statements against bank statements to ensure the numbers line up. This is the best way to ensure the company has earned and will continue to earn what the seller has claimed.
Beyond earnings, your QoE can also unearth other details about the company involving cashflow and the consistency of margins as the business grows. This helps you make the best buying decision possible no matter how messy or small the deal may be. Anyone trying to convince you to forgo a QoE likely has ulterior motives. What don’t they want you to find?
4. Data Is Not Available (With Some Great Story)
Don’t believe the story. The seller has the data. Sellers try to hold back data for plenty of reasons, and they’re usually shady. Difficulty getting the data is one of the first red flags that we run into when working on a client’s QoE.
The delay can occur for several reasons. The seller might not actually be ready to sell so they procrastinate sending over vital documents. They may also be trying to figure out the best way to present their data to present their company in the best light and secure a higher purchase price. That can include anything from creative accounting to blatantly covering up concerning data.
Whatever the reason might be, never accept the answer that the data is not available. Have your team put on the pressure to avoid harming your own relationship with the seller. If the seller refuses to hand over data that will help you make an informed buying decision, then you can’t really make an informed buying decision. That means it’s time to walk away from the deal.
5. Seller Plans To Compete With You Before The Deal Closes
The seller is an expert in the business that you want to buy. Their knowledge and experience are valuable, and they may try to use it in a way that impacts the business after you take over. Sometimes sellers try to get out of their companies because they see a new opportunity in the same industry that may end up competing with their previous business.
Starting or joining an existing business in the industry gives the seller a huge advantage since they are already deeply familiar with the market and the major players. They have established expertise and relationships that they can lean on. A few months into owning the business, you might find that some of your main customers are deserting you in favor of the seller’s new opportunity.
If you get wind of the seller’s plan to compete with you, it might be a big enough reason to walk away from the deal. To avoid this problem altogether, you can include a noncompete clause in your purchase agreement to prevent the seller from getting involved in the same industry for a period of years.
The ways you can get duped in a deal are manifold. The best thing to do is to stay vigilant and rely on trusted, experienced advisors to help you through your deals.
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