The due diligence process of a transaction may frequently reveal additional facts that may impact value and, subsequently, the price a buyer is willing to pay. Here are some examples:

Key Personnel  

It is not unusual for the owner to function as CEO, CFO and COO. An owner may be making $200,000 a year to serve in all three functions. A new owner will most likely have to have at least two people or possibly three people filling these spots.

This management team will probably make in aggregate more than the $200,000 allocated for the departing owner. The perks required by these two or three will also be substantially more than the previous management team of one. As a result, the free cash flow/operating profit of such a company could decrease for the new owner.

Typically in this type of situation the buyer may feel a negative adjustment to the owners compensation is appropriate and it will be hard for the owner to debate this effectively; the buyer and seller may negotiate a new go- forward number for owner's comp which could add $100,000-$150,000 (including taxes and benefits) to the operating expenses and lower the Pro-Forma Profit number by a similar amount. 

Maybe there is somebody internally who can move up and the buyer could look at replacing the lower priced employee, which should save some money. Your Advisor can help with these matters before you present anything to propsective purchasers. This should be a non-issue.

Short-Term Contracts

Reviewing the customer contracts may reveal that they are, for the most part, short term. If the contracts are with major customers, these customers may require extra service or even deep discounts. It costs much less to keep one existing customer happy than it costs to obtain a new one.

Customer Diversification

Single- service line companies are at a much greater risk due to competitive services and competitive pricing. Many purchasers of staffing services prefer to limit the number of suppliers they need to interact with; therefore if you are not providing them for instance with IT Services that they use, you can be sure they are getting those needed IT Services from another supplier.

In a pinch, they may try that other supplier for help in a category you usually handle for them and they may find that other supplier did a great job and the purchasing firms Managers may request more staff from that supplier and all of a sudden your core business with this customer is under review. Dangerous!

Customer Concentration

Typically in staffing deals a Buyer will tolerate one customer doing up to 20% or so of the total annual sales volume, particularly if the next several customers are below 10% each. If you have three customers doing for example 55% of your annual revenue, you and even more so the buyer has tremendous exposure should one or more of those customers stop doing business with the seller.

That is a lot of business to replace so often the buyer will look for protection from having to chase the money they advanced on the down payment on the seller's business in order to recoup their investment. Only, in situations where the change of supplier was caused by some policy or action of the buyer who chased the customer to another supplier, can the seller hope to get some relief, particularly if that clause is added to the Purchase and Sale Agreement at the outset.

The protection a buyer will often seek may be a lower down payment, a longer earn out period, breaking out those larger accounts to have their own earn out either as a group or individually to try to ensure they get what they have paid for in the acquisition. These are just some of the methods Buyers utilize to lower their risk.

Third-Party Approval

Franchises may be a good business opportunity, but when it comes to selling, being a franchisee may present a real obstacle. The franchisor usually has the right to approve any potential replacement -buyer and may impose other conditions such as an overhaul of the facility or a complete face-lift.

Franchisors may also have the first right of refusal, which makes it more difficult to sell. Most buyers don't want to compete with a franchisor and the more difficult the franchisor, the more likely the buyer is to drop the deal.

Other factors that may impact the valuation are: ESOP ownership - too many owners; and intangible assets - patents, copyrights, brand names, goodwill, etc. may have great value but can be very difficult to quantify.

Saving your Deal from Due Diligence

There are a number of ways to avoid killing a deal as a result of due diligence. The most effective way as discussed in our introduction is to divulge all the company's warts up front and get them on the table early. There should also be explanations as to why or how the warts have or can be addressed and overcome. Buyers don't like surprises, especially late in the game.  If it is going to be an insurmountable issue that the buyer feels is a deal-killer it's best to know earlier rather than later. That would save both parties a lot of time and professional fees for a deal that never had a chance anyway.

For example, say a company has excessive customer concentration -- a major concern for many buyers. The seller should be able to either explain that the situation has successfully endured for the past five years or that the situation has been successfully addressed by substantially reducing the company's dependence on these customers over the past year.

A few Tips for an Easier Sale

If the buyer indicates that he or she will be submitting a letter of intent, it's often a good idea and can be important that the seller's Advisor tell the potential buyer right up front what items should be addressed such as:

• What are the price and terms?
• If it is to be an asset sale, what assets are being purchased and what liabilities are to be assumed?
• What seller representations and warranties are to be covered?
• Lease or purchase of real estate.
• Responsibility for employee agreements or severance agreements.
• Determine how A/R will be handled.
• Time schedule for due diligence and closing.  

Set time frames for completion of the various procedures in the sale. For example, agree on timing for a letter of intent, reps and warranties, due diligence, a closing date and definitive agreements and closing documents, etc.

Deals that drag on, often don't close. Time delays are the enemy of many a deal, the deal loses energy and momentum while lowering the desire of each party to close.

When negotiating, it is critical that the negotiations deal with the actual decision maker. Too much time can be spent negotiating with the wrong person.

For a sale to actually close, both sides must be motivated.

Try to express your perspective without any attitude, rancor or animosity, most of us like to deal with pleasant people and often we will get more with honey than vinegar.

It pays to have an intermediary handle the negotiations. They are equipped to mediate, act as a buffer and carry on sidebar conversations to see the transaction through.