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Business Advisor and Dealmaker Testimonies: Deficiencies in Privately Held Small Businesses Leading to Failed M&A Transactions

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Abstract

The Value Examiner (July/August, 2024): Like running a company, the business exit process is complex and filled with uncertain outcomes. Some individuals start a business without much thought of an eventual exit while others enter with a goal in mind, an exit strategy from the onset. Even with a planned strategy, circumstances affecting business owners such as life situations (like retirement, health, family, time commitments, relocation, or burnout), strategic opportunities (like harvest, divestiture, growth, or turnaround situations), and other owner interests (both business or non-business related) outside of the company frequently arise while macroeconomic issues may interject potentially altering exit outcomes. Unfortunately, only a small percentage of businesses listed for sale eventually sell. This article provides insight to business owners and advisors on what major deficiencies exist which lead to unsuccessful ownership transfers of privately-held companies. To gain this insight, a study was conducted with business advisors and dealmakers who engage with small business owners in helping them sell their companies. This qualitative analysis involved coding the responses of 50 seasoned certified business intermediaries and exit advisors with median advisory experience of 15 years working with small business owners in the transition of their companies. These consultants responded to open-ended questions related to past experiences. Five central themes of deficiencies leading to unconsummated transactions were uncovered through the analysis: Problems associated with the business financials, management issues, operational issues, customer issues, and the lack of business owners understanding the selling process.
Business Advisor and Dealmaker Testimonies- Deficiencies in
Privately Held Small Businesses Leading to Failed M&A
Transactions
Date:
August 28, 2024
Journal:
The Value Examiner
Authors:
Kipp Krukowski, Colorado State University, http://orcid.org/0000-0002-0993-3566
Abstract:
The Value Examiner (July/August, 2024): Like running a company, the business exit process is
complex and filled with uncertain outcomes. Some individuals start a business without much
thought of an eventual exit while others enter with a goal in mind, an exit strategy from the
onset. Even with a planned strategy, circumstances affecting business owners such as life
situations (like retirement, health, family, time commitments, relocation, or burnout), strategic
opportunities (like harvest, divestiture, growth, or turnaround situations), and other owner
interests (both business or non-business related) outside of the company frequently arise while
macroeconomic issues may interject potentially altering exit outcomes. Unfortunately, only a
small percentage of businesses listed for sale eventually sell. This article provides insight to
business owners and advisors on what major deficiencies exist which lead to unsuccessful
ownership transfers of privately-held companies. To gain this insight, a study was conducted
with business advisors and dealmakers who engage with small business owners in helping them
sell their companies. This qualitative analysis involved coding the responses of 50 seasoned
certified business intermediaries and exit advisors with median advisory experience of 15 years
working with small business owners in the transition of their companies. These consultants
responded to open-ended questions related to past experiences. Five central themes of
deficiencies leading to unconsummated transactions were uncovered through the analysis:
Problems associated with the business financials, management issues, operational issues,
customer issues, and the lack of business owners understanding the selling process.
Keywords:
selling a business, M&A, exit planning, business consulting, business for sale, entrepreneurial
exit
This article (or a version of it) originally appeared in The Value Examiner, 2024 July/August
issue, published by the National Association of Certified Valuators and Analysts® (NACVA®).
All Rights Reserved. To learn more, please visit www.NACVA.com/ValueExaminer.
This article is being made available for educational purposes.
Business Advisor and Dealmaker
Testimonies: Deficiencies in
Privately Held Small Businesses
Leading to Failed M&A Transactions
By Kipp A. Krukowski, PhD, ASA, CVA
4The Value Examiner
Valuation
As a shock to many locals, an iconic Cleveland business,
Corky & Lenny’s, closed its doors in December 2023. The
owner, responding to a journalist’s question about seeking
a buyer to purchase the business, replied that her co-owner
husband (Kenny) was
running into a wall or just sort of breaking down
energetically. Kenny is a machine running the business
and while we do have employees, he really takes on the
responsibility of making sure that everything gets done.
... He just felt like he probably should have done this over
a year ago, for his own physical, mental, and emotional
well-being. It is sad to see the business close. [We’re] still
making money. ... We had a number of [possible buyers
and partners] for the business. A variety of different kinds
of deals. They all fell through for one reason or another.1
This gut-wrenching response likely hits home to many
business owners and advisors; a decent business shuttering
operations due to a failed attempt at an M&A transaction.
Like running a business, the exit process is complex and filled
with uncertain outcomes.2 Some people start a business
without much thought of an eventual exit, while others enter
with a goal in mind; an exit strategy from the outset.3 Even
with a planned strategy, circumstances affecting business
owners frequently arise, such as life situations (e.g., retirement,
health, family, time commitments, relocation, or burnout),
strategic opportunities (e.g., harvest, divestiture, growth, or
turnaround situations), and other owner interests outside
the company (both business- and nonbusiness-related).4 In
addition, macroeconomic issues may alter exit outcomes.5
Business owners and their advisors face an uphill battle
when it comes to successfully transferring a company to
new ownership. “According to the International Business
Brokers Association and Forbes, only 10% of businesses
listed for sale eventually sell.6 But why is this statistic so
low? This article helps to uncover this mystery, providing
business owners and advisors with insight into major
deficiencies that can lead to unsuccessful ownership
transfers of privately held companies.
1 Peter Chakerian and Paris Wolfe, “Corky and Lenny’s Co-owner Amanda Kurland: Here’s Why We Closed the Restaurant,” Cleveland.com, December 13, 2023, https://www.cleveland.com/
entertainment/2023/12/corky-and-lennys-co-owner-amanda-kurland-heres-why-we-closed-the-restaurant.html
2 Karl Wennberg and Dawn R. DeTienne, “What Do We Really Mean When We Talk about ‘Exit ’? A Critical Review of Research on Entrepreneurial Exit,” International Small Business Journal 32, no.
1 (2014): 4–16.
3 Dawn R. DeTienne and Melissa S. Cardon, "Impact of Founder E xperience on Exit Intentions," Small Business Economics 38 (2012): 351–374.
4 Kipp A. Krukowski, Nicole A. Flink, and Br yan D. Edwards, "Why Are You Selling Your Business? Underst anding Signaling Effects of Seller Rationale at Time of Entrepreneurial Exit," Journal of
Business Venturing Insights 20 (November 2023): e00427.
5 Kipp A. Krukowski and Dawn R. DeTienne,"Selling a Business After the Pandemic? How Crisis and Information Asymmetry Affect Deal Terms," Business Horizons 65, no. 5 (September–October
2022): 617 630.
6 Arnez Rodriguez, “Business Brokers in the US,” IBISWorld Industry Report OD4796 (2021).
7 Barney Glaser and Anselm Strauss, The Discovery of Grounded Theory: Strategies for Qualitative Research (Abingdon, U.K.: Routledge, 2017).
To gain this insight, a study was constructed to get
answers directly from the source: business advisors
and dealmakers on the front lines working with small
business owners to help them sell their businesses. This
research followed a grounded theory methodology,7
which allows survey participants to provide responses
related to their experiences. As a qualitative inquiry,
findings are exploratory. Using this approach, theory is
grounded in field data, from the bottom up, making sense
of phenomena through rigorous coding and interpretation
procedures. Focusing on the core research question of
what deficiencies lead to unsuccessful business exits when
attempting to sell a company to an unaffiliated individual
or company, this qualitative analysis involved coding the
responses of 50 seasoned certified business intermediaries
and exit planners, with median advisory experience of 15
years, working with small business owners in the transition
of their companies. Participants were asked open-ended
questions about small business deficiencies—as well
as value creation strategies (to be discussed in future
articles)—and were paid $50 each for their thorough
participation in the study. The median time spent answering
the questions was 40 minutes per participant.
To capture their unique experiences accurately, participants
replied in their own words and these answers were captured
within Qualtrics, a surveying tool used by researchers.
Data was then coded outside of Qualtrics, removing any
personal identification. Each of the 50 business advisors
was assigned a number, coded as BA01–BA50, tied to their
specific responses. In some cases, responses that covered
multiple deficiencies were assigned to multiple themes.
Through the analysis, five core deficiency themes emerged
that led to unconsummated transactions:
• Business financials
• Management issues
• Operational issues
• Customer issues
• Lack of understanding of the selling process
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A Professional Development Journal for the Consulting Disciplines
Business Financials
One central business deficiency theme related to poor
business financial records. Business advisors pointed
out that owners’ lack of understanding of their financial
status and the absence of good books and records (e.g.,
miscategorized expenses), make it difficult to communicate
actual performance, leading potential buyers to take a
more cautious approach to an acquisition. Other advisors
commented that personal expenses are often commingled
with business expenses, making it difficult to separate
the two. Part of the problem, one advisor [BA33] noted, is
that “main street business owners are typically handling
bookkeeping themselves,” leading to delays in financial
activities, such as due diligence and loan evaluations,
because information is not readily available. Other advisors
echoed similar concerns, observing that many owners
do not know their businesses’ “financials, key ratios,
performance against goals, profit margins, etc.” [BA47]. This
lack of financial literacy and poor recordkeeping makes it
difficult to accurately value and position the business for
sale. Not only are potential acquirers turned off by poor
financials, but business advisors may be turned off as well.
As one advisor [BA50] stated, “Perhaps the single biggest
initial challenge is qualifying who prepares their financial
statements.” This same advisor followed this up by stating,
“I have walked away from potential assignments as an
appraiser and business broker, not feeling confident in the
financial materials I was reviewing.” In summary, the lack of
solid financial management and proper recordkeeping is a
significant barrier to the successful sale of a business.
Responses Categorized under Financial Deficiencies
• Personal expenses commingled with business expenses
• Low margins
Charging below-market rent when facility is owned by the seller
Absence of properly prepared financial statements and
records, either intentionally or through ignorance
Lack of consistent financial performance
Inconsistent or miscategorized expenses in the financial
statements
Failure to maintain financial statements on a monthly or
even quarterly basis
Failure to prepare current year-to-date financial
statements with all expense items
Owner’s salary not segregated out from general payroll
account for identifying owner benefits
Declining revenues and profitability as an owner has taken
his or her eye off the ball
Poorly assembled financials violating basic accounting rules
• Poor grasp of future revenue and profit projections
Financial statements, tax returns, leases, and other
corporate documents not readily available
Lack of advanced planning to minimize discretionary
expenses categorized in a way not accepted by potential
acquirers or lenders
Leases that have expired, are month-to-month, or are
based on a handshake agreement between the landlord
and seller
6The Value Examiner
Valuation
• Failure to pass along cost increases to customers
Financial statements and tax returns that do not easily tie
with one another
• Poor accounting and recordkeeping systems
Financial statements that are not structured with enough
revenue and expense breakdown to assist in managing
the business
Financial statements that are structured and designed to
minimize operating profit for tax purposes
Lack of understanding of the appropriate level of working
capital needed for operations
Too many personal expense adjustments in the financials
• Unreported cash receipts in an effort to minimize taxes
• Inaccurate (or lack of) balance sheet
Official financial results delayed due to filing for tax
extensions
Owners that have a poor understanding of financials and
business metrics
• Lack of reinvestment into the growth of the business
Management Issues
Another key deficiency relates to the centralization of
responsibilities and knowledge around the owners, making
the business overly dependent on them. One business
advisor talked about owners wearing “too many hats” and
failing to delegate duties. The owner was too integral to
the day-to-day operations to make it easy for a new owner
to step in. Another advisor highlighted the challenges in
transferring critical functions and knowledge as owners are
“often uniquely gifted and suited for the business, making
the transfer of those skills and relationships very challenging”
[BA03]. While this uniqueness might create a competitive
advantage while owning and operating the business, at the
time of exit a potential buyer must be convinced that the
business will retain these attributes.
Some business advisors pointed out that there is often an
absence of middle management and poor organization of
staff and resources. This overreliance on the owner makes
the business too dependent on one person, hindering its
ability to operate independently. Similarly, as one advisor
observed, a large percentage of sales is often driven by
owners, making them irreplaceable. Excessive dependence
on the owner for key business operations and decisions
creates a significant challenge in transitioning the business
to a new owner, and potential buyers find this obstacle
difficult to overcome.
Responses Categorized under Management Deficiencies
Lack of organizational structure and senior management
outside of the owner
Critical functions, relationships, and know-how are
centered on the owner, who is often uniquely gifted
and suited for the business, making the transfer very
challenging
Dependency on an owner who is too involved in day-to-
day operations and decision-making
Owner reluctance to make needed personnel adjustments
to avoid conflict
Owner suffering from “fatigue” accompanied by a lack of
drive to continue the business forward
• Lack of a mix of tenured, cross-trained employees
• Key employees retiring at the same time
Insufficient human resource documentation of individual
employee growth and future plans
Ownership strong in one aspect of the business but
lacking in other expertise and know-how to supplement
their weaknesses
• High staff turnover
• Owner is the “face of the business”
• No exit strategy
• Failure to delegate responsibilities
Unwillingness or inability to transfer key knowledge, skills,
and relationships to key employees
• Lost focus on the business
Failure to continually review business performance to
identify problems and opportunities
• Unwillingness to take advice from others
Excessive dependence on
the owner for key business
operations and decisions
creates a significant
challenge in transitioning the
business to a new owner,
and potential buyers find this
obstacle difficult to overcome.
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Operational Issues
Business advisors pointed out that operations often suffer
from a lack of documented systems and processes. As
one advisor observed, there are often “no real systems for
running the business (i.e., operations manual, organizational
chart, etc.) that can be passed on to a new owner.
Everything is in the sellers head, which makes transitions
sometimes more difcult than they have to be” [BA33].
Several advisors noted that the absence of key systems
(e.g., customer relationship management [CRM], enterprise
resource planning [ERP], and accounting), policies, and
procedures make for a difcult sale. Others raised concerns
about excess and obsolete inventory due to lack of controls.
In addition, lack of personnel documentation, such as
employee manuals and job descriptions, make it more
challenging for potential buyers to gain comfort in what will
remain after a transaction. Poor operational documentation
can also lead to excess or obsolete equipment and
inventory, as well as poor maintenance and disorganized
facilities. This deciency theme underscores the importance
of having well-documented, organized operational processes
for a business to be attractive to potential buyers.
Responses Categorized under Operational Deciencies
• Key systems and processes not documented
Inadequate (or lack of) CRM, ERP, point of sale (POS), or
accounting systems
• No documented policies or procedures
• Inaccurate inventory counts and value
• Excess or obsolete inventory
Excess equipment not needed for existing or projected
future requirements
• No employee job descriptions and manuals
• Unresolved legal issues
Poor cleanliness, maintenance, and organization of facilities
High reliance on employee skills instead of documented
systems
• Short history of operations
• Old facility or equipment
• Questionable facility suitability
• Uncertain supplier relations
High dependency on (and lack of) available workforce
for growth
• High vendor concentration and dependency
• Lack of a forward-looking business plan
Customer Issues
Customer concentration is a signicant issue for many small
businesses. As one business advisor observed, the risk
of having “a disproportionate share of business generated
by one key customer/client” [BA03] can be a red flag to
potential acquirers. Customer issues may go beyond high
concentration. For example, job shops and project-based
work without contracts create uncertainty regarding future
revenue streams. Also, declining revenues or lack of growth
in the customer base are signs of weakness that may cause
concern to potential acquirers. This theme illustrates the risks
associated with high concentration and uncertainty, which
can make the business less appealing to potential buyers
due to perceived instability.
Responses Categorized under Customer-Related
Deciencies
Disproportionate share of business generated by a few
customers
Owners relaxed marketing efforts to obtain new customers
Business is primarily a job shop or project-based without
recurring revenues or contracts
Dated (or nonexistent) internet and social media presence
• Lack of revenue growth or growth in the customer base
8The Value Examiner
Valuation
Lack of Understanding of the Selling Process
The selling process is often hindered by unrealistic seller
expectations. One business advisor mentioned the
challenges of finding a successor with a similar skillset. In
niche industries, which often tend to be more profitable
than fragmented industries, the potential buyer pool is even
narrower. Frequently, one advisor observed, owners are
“ready to sell but the business is not [in a position to sell] and
they are not receptive to making the changes necessary to
unlock the highest level of value” [BA05]. The most frequent
response was that business owners often have unrealistic
price expectations and lack an understanding of business
valuation in general. This can be concerning because even
if a potential buyer is identified, a misinformed seller may
reject a reasonable offer and negotiations may never lead to
a transaction. If sellers initially hold off in hopes of receiving
a better offer, eventual price adjustments may be too late;
potential buyers may have moved on to other opportunities.
Another business advisor highlighted the importance of trust,
noting that “both buyer and seller [need] to trust each other
to get the deal done” [BA07]. Timing is also important, and
unfortunately owners often wait too long to sell. Waiting too
long may leave no option but to close the business, similar to
what happened to Corky & Lenny’s. Advisors also revealed
that some owners mentally check out before a buyer is
identified. The result, one advisor commented, “is that they
back off of marketing and sales, or perhaps unconsciously
back away from the hard work to keep the business growing.
The result can be a decline in sales and profitability and that
leads to less interest on the part of buyers” [BA47]. When
revenue begins to decline, buyers become more skeptical
that issues might be larger than they appear, and that
revenue is poised for a freefall.
Many business owners lack a good grasp of the due
diligence process and how experienced advisors, attorneys,
and accountants play a crucial role in negotiating and
facilitating a transaction. Planning and preparation can
help ensure that all stakeholders are on the same page
and the business is prepared to hit the market. This theme
underscores the importance of realistic expectations of
value and the selling process. The process often takes
an extended period of time, and business owners should
continue running the business without letting up.
Responses Categorized under Lack of Understanding of
the Selling Process
Unrealistic price/value expectations based on actual
results of operations
Unfamiliarity with the time required to find a buyer and
to complete all the steps required to consummate a
transaction
Lack of understanding of all the documents and
information buyers will require during due diligence
• Confusion regarding business valuation and value drivers
Underappreciation of the importance of experienced
advisors, attorneys, and accountants in the process
Lack of agreement among stakeholders to pursue a sale
of the business
• Lack of preparation in putting the business on the market
• Lack of tax planning
Some Closing Optimism
Selling a small business is a challenge. The statistics show
that there is a strong probability that a small business owner
will not make it to the closing table. While this article will
not magically change the outcome of all failed transactions,
understanding the deficiencies that often exist in small
businesses is the first step toward identifying potential
solutions that can improve the odds of a successful exit.
As this article highlights, there is an opportunity for
advisors to better position business owners in advance of
M&A transactions. Future articles will examine business
models to identify value creation opportunities and explore
strategies business advisors and owners can use to improve
transactional success.
Kipp A. Krukowski, PhD, ASA, CVA, is a clinical professor of entrepreneurship at Colorado State
University. Dr. Krukowski earned his PhD from Oklahoma State University, his MBA from Carnegie Mellon
University, and his BE in mechanical engineering from Youngstown State University. He earned the CEPA
designation from the Exit Planning Institute and the CBI designation from the International Business
Brokers Association. Prior to entering academia, Dr. Krukowski founded several business advisory firms
and has served as an expert witness. He has been recognized by Business Brokerage Press as an
industry expert on selling manufacturing companies. Email: kipp.krukowski@colostate.edu.
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References
Chakerian, P., & Wolfe, P. (2023). “Corky and Lenny’s co-owner Amanda Kurland: Here’s why
we closed the restaurant,” Cleveland.com, December 13, 2023,
https://www.cleveland.com/entertainment/2023/12/corky-and-lennys-co-owner-amanda-kurland-
heres-why-we-closed-the-restaurant.html
DeTienne, D. R., & Cardon, M. S. (2012). Impact of founder experience on exit intentions. Small
Business Economics, 38, 351-374. https://doi.org/10.1007/s11187-010-9284-5
Glaser, B., & Strauss, A. (2017). Discovery of grounded theory: Strategies for qualitative
research. Routledge.
Krukowski, K. A., & DeTienne, D. R. (2022). Selling a business after the pandemic? How crisis
and information asymmetry affect deal terms. Business Horizons, 65(5), 617-630.
https://doi.org/10.1016/j.bushor.2021.08.003
Krukowski, K. A., Flink, N. A., & Edwards, B. D. (2023). Why are you selling your business?
Understanding signaling effects of seller rationale at time of entrepreneurial exit. Journal of
Business Venturing Insights, 20, e00427. https://doi.org/10.1016/j.jbvi.2023.e00427
Rodriguez, Arnez, "Business Brokers, IBISWorld Industry Report OD4796," Retrieved from
IBISWorld database, 2021.
Wennberg, K., & DeTienne, D. R. (2014). What do we really mean when we talk about ‘exit’? A
critical review of research on entrepreneurial exit. International Small Business Journal, 32(1),
4-16. https://doi.org/10.1177/0266242613517126
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