Don't buy the business if you should walk away from it

A client sent a short note after several weeks of diligence and negotiation on a deal that had been moving steadily toward closing: “Just wanted to follow up to close the loop. As expected, we formally terminated the LOI and walked away from the deal. In addition to disagreements about the APA terms, an even bigger issue was the continued steady decline of the business. Exactly as you had intuited, this deal was simply too risky, and we had to walk away.” There was nothing dramatic about the message, and no attempt to frame the outcome as a win or a loss, just a straightforward update that the process had come to an end. From the outside, this outcome might appear disappointing, especially after the time, energy, and attention that went into getting a deal to that stage. Most people implicitly define success in acquisitions as a completed deal with something of a positive outcome. Conversely, they’d view a terminated process as a failure or a missed opportunity. In my experience, however, saying no was a huge success story. Deal or No Deal The business had naturally been presented as a strong opportunity by the owner and the brokers. While it met many criteria that a buyer might look for in the initial review, we started to see as different picture as we spent more time with the underlying financials. There wasn’t a single data point that was alarming, but a consistent direction of the numbers that clued me into a potential issue. Revenue had been gradually declining over time, while profitability was compressing alongside it. The dynamic created a pattern that was difficult to ignore. None of these changes, taken in isolation, would necessarily stop a deal, but together they said things were moving in the wrong direction. Buyers tend to want to justify continuing in a situation like this, given the sunk cost. It is easy to focus on the chance that performance will stabilize or improve with the new leadership. While this is possible, it’s still a huge risk. Say the deal closed and the buyer takes on a personally guaranteed loan. If the business were to continue along the same trajectory, it would have to deal with the previous pressure of poor financials combined with the stress of new ownership and all that goes into that transition. It’s not exactly a recipe for success. Instead, the decision was made to walk away. The EV of an M&A Deal By this point in the process, the costs that have already been incurred are real and immediate. Meanwhile, the risks that are being avoided are hypothetical and less tangible. Regardless, the most relevant comparison is not between closing and walking away as isolated events; it is between walking away now and owning a business that may not be able to support its debt over time. I like to explain this concept through expected value (EV), a term you might be familiar with if you majored in math or you play too much Texas Hold’em. In poker, serious players don’t judge a decision based on whether they won the hand, but on whether the play had positive EV. You can make the right call and still lose if the odds were against you in that draw. Over time, however, consistently making high EV decisions where the probability and payoff are in your favor will result in you coming out on top. Here’s an example with our scenario. I’m somewhat arbitrarily giving it a 10% success rate based on what I saw in the trends. Viewed through that lens, the decision becomes a simple math problem. In a situation where the underlying trajectory of the business raises legitimate concerns, it’s less about abandoning a deal’s upside and more about protecting the downside. Leave the Math to Us Unfortunately, these walk-away outcomes do not show up anywhere in a visible way, so they’re not typically counted when people talk about M&As. However, they often represent some of the more important decisions in the process. Now that we’ve done over 500 deals, we’ve been able to spot some patterns about the trajectory of a deal and its business. A good QoE will tell you about the upside and downside of a business based on its numbers. Knowing both sides of the equation might help you find a level of risk that may not be acceptable, particularly when leverage and personal guarantees are involved. If this resonates with the way you think, email me to discuss our deal at redacted