Top 3 Buyer Mistakes when Buying a Business
It’s not an easy thing to buy a business. Even when the mergers and acquisitions market is a buyer’s market, buyers often make mistakes. Here are some of the most common ones.
When I was working with a client buying an existing franchise, she had done all her homework and the negotiations went great. However, she had not realized until very late that there is an additional process of approvals from the franchisor, a franchise agreement and disclosures. My client was so focused on closing on time that she was ready to forego a careful review of these documents.
I encouraged her to step back and see that a delay in closing isn’t a big deal and that we had built that flexibility into our purchase agreement. It was much more important to take the time to make sure that buying it was a good decision.
Delays are common in business purchases. It's not the end of the world if the closing date is postponed.
Even though “M&A” stands for mergers and acquisitions, most M&A deals are acquisitions. When buying a business, there are two choices: an asset purchase where you buy itemized assets, or a stock purchase where you buy the whole company. Generally, buyers want to buy assets, so they can pick those assets they want and leave behind those they don’t.
A mistake that buyers often make is not considering the best structure. Just because usually an asset purchase is beneficial, that doesn't mean that there aren't times when a stock deal may be preferable.
Here's a good example: in the process of buying a software company’s assets, my client realized that all 20,000+ of their contracts were not assignable. Renegotiating all of them was not an option. Instead of buying the assets, my client could buy the stock and take over those contracts without needing to assign them. Sometime a stock deal makes more sense.
3. Sunk Cost Fallacy
For a buyer who has put time and money into a negotiation to buy a company, it’s tempting to be committed to closing the deal NO MATTER WHAT.
It may be hard to walk away, but if a deal doesn’t make sense, then staying committed to it just because of the expense you’ve already incurred is a mistake called the sunk cost fallacy. Sunk costs are already spent, they can’t be recovered, so there’s no point worrying about them.
My client had already spent tens of thousands of dollars on advisor fees, due diligence and negotiations. He was very driven to close the deal, but everything he learned along the way made it clear that it was a bad deal. He had to walk away.
When you are tempted to say “we’ve already spent $x and all this time, so let’s do this deal” - that’s a red flag. Stop and think. Usually the risks of closing a bad deal is much worse than whatever has been spent.