Timing M&A, Part V: Under the Microscope

As previous posts have discussed, unsolicited interest from potential buyers is a key indication of a good market for selling a company. 

Switching perspectives from external factors to internal, we find that an equally critical factor in timing an exit is a company’s operating performance.

When a company enters discussions with buyers, its day-to-day performance is put under a microscope.  Fluctuations that might previously have been considered noise in the company’s long-term growth trajectory can suddenly carry great weight.   It’s similar to being a public company, where a minor miss in quarterly results can trigger a nosedive in a company’s share price.   If a private company that is in discussions with buyers has a bad quarter—or even a bad month—it’s not uncommon for buyers to significantly lower their valuations.   The converse also happens to be true:  if a company is talking to buyers and their operating results exceed expectations, buyers will get excited and often will be willing pay more.

While these might seem like overreactions, they are rational in the context of a buyer evaluating a private acquisition target.  The best way to predict the future is to extrapolate from the present.  If the present turns out to be less attractive than previously thought, the future looks even worse.  The last thing the decision-maker at a buyer wants to do is look like he missed signs of flagging performance, particularly in the event a deal goes sideways or achieves negative returns.  Moreover, every buyer is wary of informational asymmetries.  A negative surprise can shake a buyer’s confidence, creating the expectation that there are additional negatives in the target company that have yet to be discovered.

The ‘under the microscope’ factor has two extremely important implications for entrepreneurial companies.  First, if a company hopes for a high valuation, it should only engage buyers when it has a high degree of confidence in its outlook for the short-term (the next few months) and medium-term (the next 6-12 months).   Second, when a company does engage buyers, it should provide buyers with a conservative view of its near-term and medium-term projections.  An entrepreneur's natural optimism can get in the way of following these rules, but that fervor can come at a painful price.