Bringing an M&A deal across the finish line can be a long and perilous road. No matter how certain a transaction might initially seem, there’s always the possibility that one party can abruptly change its plans and drop out — or worse, leave the other party in limbo expecting to continue a deal that is essentially dead.
For every successful deal I’ve worked on during my two decades as an investment banker, I’ve watched many others fall apart for a multiplicity of reasons. Through my experiences in large-company work, middle-market work and venture-capital investments, I’ve developed a second sense about when a deal is in danger, partly based on pattern recognition from previous failed deals.
While every deal has its own unique idiosyncracies, there are a few common signs of trouble that M&A advisors should be on the lookout for:
1. Lack of responsiveness from the other side
During the due diligence process involving an investor-owned company, the No. 1 red flag of a troubled deal is when it seems difficult to get answers to easy questions. A sudden dropoff in communication can be especially noticeable when you’ve developed a good working relationship with another party and have been conditioned to expect responsiveness.
My firm once encountered this situation involving a sell-side client who had reached an agreement with the buyer quite easily. As part of due diligence, we had requested tax returns for review, and weren’t initially concerned about their slowness to arrive. When the investment fund eventually got back to us, it had a surprising reason for the delay. We both learned that this company had been collecting taxes from customers but had not been paying that money during a period of financial distress.
Ultimately, even this issue was outweighed by the benefits of the business combination, and we eventually closed this deal after renegotiating the terms.
If you encounter a situation that feels like unresponsiveness, don’t immediately jump to conclusions. Due diligence is a thorough process where some questions from a buyer or source of financing are genuinely hard to answer. Be wary, but stay hopeful that any delay is accidental until the signs become clear that something is not right.
2. Indications of doubt or uncertainty
In a typical deal process, there’s one set of people that does the work (the decision-makers) and a second set of stakeholders (company owners or a board of directors, for instance) that typically stays removed from the day-to-day process so it can retain its objectivity. If those noninvolved stakeholders start to become more present in the dealmaking, it can mean one of several things:
- Sometimes it’s a sign that the stakeholders’ level of buy-in about the deal has changed, perhaps because a better alternative has shown up.
- Sometimes they’ve lost trust in their deal team.
- Sometimes information has been discovered in the course of due diligence that is raising eyebrows about the original assumptions.
- Sometimes it’s a negotiating tactic.
During one deal I worked on, a point person on the other party’s deal team communicated directly to me — more than once, on one-on-one calls — that their investment committee was losing interest because it had other deals in its pipeline that looked better. Initially, I wasn’t sure if this was a negotiating tactic or a real risk. My response was to huddle with the most experienced people on my deal team for a discussion, asking ourselves what we would be doing if we were on the other side.
Our conclusion was that this was noise, not signal, and we reasoned that a rational person would see this deal through to completion. We proceeded with caution, without raising any alarms. On that particular deal, our logic was validated.
Other situations might have led to a different response on our end. If the other side is communicating doubt or uncertainty about a deal, you first have to decide whether you believe them or not. If they’re credible, then you go into problem-solving mode. If they’re not, you sometimes just proceed.
3. A poorly run meeting process
The key to a smooth, quick deal process is a good project manager and good negotiation managers who are experts at communication and group decision-making. If there are no meeting management experts in the key meeting management roles, that should be an indication to a deal team that the other side is placing a low level of importance on the deal.
The deal negotiation process often takes the better part of a year and involves getting a moderately large group of people to come to agreement on how to create value and fairly divide it. So, it’s crucial for meetings to be run in a way that enables effective group decision-making. If you have inexperienced people at the helm, the process will be more difficult and exhausting than it probably needs to be — which should raise questions in your mind about why that is. Listen for and interpret who is at the table and who isn’t.
4. Incorrect metrics and other signs of disorganization
Similarly, as you get a closer look at how the other side manages its business, it can be a red flag to see signs that they’re disorganized. This can happen when one side initially supplies metrics that are not accurate. While this could be interpreted as deviousness, it’s more often a sign that they aren’t tending closely enough to their bookkeeping, perhaps because they’re in financial distress. Maybe they couldn’t see their own profitability well enough and took on more business than they could afford to take on with their level of working capital.
If one side’s metrics are demonstrably wrong in a big way, it requires a very high level of transparency moving forward to overcome lingering concerns and rebuild that broken trust. It’s truthfully very difficult to do that, and takes probably more time and tolerance than most people have. If it doesn’t signal the end of the deal, it’s because there is a very patient person on the other side.
The value of experience
While these are the most common red flags, other situations can set off alarms for seasoned M&A professionals who’ve been through the deal process many times before and can recognize good and bad patterns.
But just because there’s smoke doesn’t necessarily mean there’s fire. It’s important to stay alert for signs of trouble, but it’s also necessary to use instincts and logic to interpret the situation and decide what your response should be.
If you’re representing a well-meaning and serious client, make sure you’re not feeding into anyone’s pattern recognition about danger on the other side. While pursuing a deal, make sure you’re doing everything you can to make the process go smoothly and have a successful result.
About Frank Williamson
Frank Williamson is the founder of Oaklyn Consulting, a different kind of investment banking firm for small- and medium-sized companies under private ownership. Oaklyn plans and executes its clients’ most complex transactions, including mergers, acquisitions, capital-raising, recapitalizations, and lender and investor relations. By working as consultants, not brokers, Oaklyn helps in situations where traditional investment bankers typically cannot.