So you’re in the midst of finalizing a business acquisition deal, and suddenly, the business’s performance takes a turn. You start wondering, should I proceed with the deal, renegotiate terms, or back out altogether?

In today’s article I’m going to answer that question. Before I share how to best navigate this scenario, there are a few principles to understand. Ultimately, I want to make sure you’re keeping the bigger picture in mind to get a deal done (and reach your goal of buying a good business).

Let’s dive in.

In Stephen Covey’s 7 Habits of Highly Effective People, of the seven habits outlined, the first habit is to be proactive. In his book, Covey distinguishes between proactive people – who focus on what they can do and can influence – and reactive people, who focus their energy on things beyond their control. 

The idea is that whatever you focus on increases in weight – whether it’s being proactive and focusing on what you can influence or being reactive and focusing on what you can’t (even if you’re incredibly concerned with those things). 

Similarly, as you’ll see, in deal-making, we should concentrate on what we can influence rather than fixating on external factors.

This concept also applies to the information we know versus the information we don’t know. We tend to overemphasize the information we have and downplay the information we don’t have.

A mental framework referred to as the availability heuristic operates very similarly. 

The availability heuristic is how we judge the probability of something occurring based on how easily we can recall similar events.

Within the grand scheme of everything we know or don’t know (all information), we prioritize and place a greater weight on information we know and, especially, information that’s recent (mainstream news, anyone?). 

When it comes to buying a business, when making decisions during the acquisitions process, buyers will make decisions based on information that they know and information that is most recent, versus taking in the totality of information (not recent information or information they don’t know).

Why do we do this?

Essentially, it’s a mental shortcut that helps us make decisions quickly. When it comes to business acquisitions, we often find ourselves grappling with analysis paralysis, overwhelmed by the risks involved. This heuristic can help cut through the noise so we can make a decision, even if it lends an inaccurate interpretation of the situation at hand. 

I’ll give you a personal example. 

When I was buying a book printing company, all of the rage was about eBooks, the iPad, and the Kindle just coming out. Even though the companies that needed headlines (Apple, Amazon) were making headlines, the reality was, there were still hundreds of billions of dollars being purchased in printed books every single year. There was just another medium of reading them – not a total substitution. But because newspapers were failing and bookstores were failing, people were not understanding that books weren’t going anywhere. People still wanted books and we still wanted knowledge, but it was the availability heuristic that was telling everybody else not to go into the printing business. 

I bought my first company during the halo of this effect because I knew this was going on, and I had the greater picture of a stronger trend that I was able to capitalize on. That was my first acquisition, and I ran that company as CEO for seven years before I exited.

 

Buyer and Seller Psychology 

 

You’re probably thinking, “How does some mental framework concept apply to my deal?” 

I’ll get to that. First off, let’s talk about buyer and seller psychology to understand what occurs in a deal. 

Human beings can be highly irrational – although we like to pretend we’re not, especially in business deals. What starts as a rational decision or aspiration can quickly devolve into impulsive behavior that seems right in the moment but only derails a deal. 

Let’s talk about how that can look.

 

Buyer’s Eleventh Hour Freakout

 

I’ve talked about the eleventh-hour freakout numerous times in my previous blog posts.

What is the eleventh-hour freakout?

As the closing date approaches, buyers can suddenly experience a sense of concern, which drives them to reach out to the broker in a state of panic. 

“What about this? What about that? Should we can the deal entirely?”

When you first came across the business, you envisioned a bright and exciting future – one where you were the CEO of this new company and reaping the benefits of taking over a profitable business; however, as you dove deeper in the intricacies of the business, learning “how the sausage is made” may have caused some of this allure to wear off.

It all feels so real now – and tedious. Learning about new aspects of the business might also highlight new areas to be concerned about. Then, you have ongoing discussions with lawyers, accountants, and even your spouse. What was initially an exciting venture has quickly turned into a bureaucratic nightmare fraught with risk. 

Regardless of what’s causing the buyer concern, this eleventh-hour freakout is common. I share this because I want you to refrain from putting too much stock in the feelings and concerns that come up at this time. I want you to achieve the buyer success that 90% of buyers don’t ever get to have.

Similarly, this eleventh hour freakout can be triggered or exacerbated by any sign of a dip in financial performance during the due diligence process. I’ll get to that soon.

 

Seller Freakout

 

The seller isn’t immune from experiencing a state of panic. 

This can happen for a number of reasons: the buyer is dragging their feet during due diligence, the buyer’s vision for the company is misaligned with the direction the seller thinks the business should go (it’s his or her baby, after all), challenges in obtaining financing, unrealistic buyer demands, seller suddenly appreciating the value of their business and no longer wanting to sell, and more.

But if the performance of the business goes up? Suddenly, the seller will feel like the buyer is getting the business for a discount. This is the seller’s final paycheck they’re going to receive for the business, and now, with the increase in financial performance, the seller feels short-changed.

 

Performance Changes Before Closing

 

So if there are performance changes before closing, how do you handle them? 

 

Decrease in Performance

 

Let’s use an example. 

So in this example, we have a business that doubled in revenue two years in a row. For easy math, we’ll say in the first year they went from zero to one million in revenue. The second year, they went from one to two million, and in the third year, they went from two to four million. We’re looking at three years of financial performance here. 

However, during due diligence, after the seller received an offer, something happened to where the last four weeks dropped. Business dropped, and overall, it’s been a terrible month. 

You probably already know what I’m going to say here: we’re comparing four weeks to three years. 

If we take a step back, we know there’s obvious infrastructure in the business, and there are a lot of great things that are making it work. This one little blip is comparatively insignificant to the first three years, and by giving too much meaning to the last four weeks, we’re exemplifying the bias inherent to the availability heuristic. In weighting this event too heavily, we risk making a rash decision that doesn’t take into consideration the entire three years of financial picture. 

If you find yourself in this position, ask yourself the following questions:

Is this a material change? If the change is up or down 10% or less, it’s likely not material. It could be seasonal, or commonly, the seller could be distracted with selling his or her business. This actually happens fairly often, as the process of selling your business can be consuming. Focusing on selling the business and working with the buyer during due diligence can inadvertently pull the seller away from the operations of his or her business.   

Secondly, does this change impact your mid to long-term outlook? Is there something significant and fundamental happening here that will permanently change how the company runs? 

Lastly, what change in terms can I propose? Instead of pulling out of the deal, if the performance change is significant enough, you can ask the seller for concessions or alternative terms. It depends on the given situation, but this is an option that allows you both to keep the deal alive while you get “repayment” for the business’s recent decline. 

 

Increase in Performance

 

Now, the opposite is also true. 

I can also use this four week scenario to illustrate the business suddenly starting to increase at a more rapid rate than before. 

Usually, when this happens, the seller will talk to me, concerned that they’re selling low. Ultimately, they think they’re facing a decision point on whether to get more money from the deal or move on from it. 

The same questions apply:

Is it material? Is the gain a significant one that’s here to stay, or is it simply a by-product of us moving through time while trying to conduct this transaction? 

Bigger picture, is it worth walking away from their goal of selling their business? 

Whether they’re looking to sell due to one of the four D’s (death, disability, divorce, or disagreement – debt can also be another one) or simply looking for a change in lifestyle (e.g. Baby Boomers retiring), there was a lot of thought put into the decision to sell the business. To pull out over a relatively insignificant change in business performance would be short-sighted and derail a seller from achieving his or her main objective.

 

What if It’s a Hot Potato?

 

Now, there’s a very slight chance that the business is a hot potato. 

Majority of sellers are trying to do the right thing – they’re selling their businesses for legitimate reasons and aren’t trying to scam a buyer into taking over an unprofitable, nonexistent business. 

However, if you’ve run into this situation, I hope you’ve conducted a proper evaluation and analysis process before submitting your offer (we teach you how to do this in the Acquisition Lab). You should be able to vet if a business has strong fundamentals and is worth pursuing, and a four week change in performance shouldn’t have a bearing on your conclusions. 

 

Keep the Big Picture in Mind

 

There are a few takeaways for today. 

The availability heuristic, a mental framework we operate within when making decisions, has a way of making us overemphasize the most recent events over the macro reasons for wanting to do something. 

Additionally, this heuristic underscores one moment in time over the long-term picture. In the private market, when you buy a company, it’s almost always a one moment in time transaction, versus if you’re trading public stocks, you might buy some here or there depending on the day and their performance. 

Once you buy a business, it’s yours. You own it, then hopefully sell it to someone else down the road for a profit (please don’t die with your business). 

It sounds like a simple concept, but because business acquisitions are a one moment in time transaction, the availability heuristic emphasizes that a purchase price is set in stone. This can make the seller feel like they’re getting their last paycheck and make the buyer feel like they have to really get this right. 

This is the wrong perception to have, though. Without sounding like I’m oversimplifying the situation, you’re ultimately looking for good businesses you can operate and grow – businesses that will transform your life and what you enjoy doing. 

A good business rarely has a deal-stopping event in the short-term. 

De-risking the acquisition is important, but it’s not really where the magic of acquisition entrepreneurship is. The magic is in finding a business you love, you’ll enjoy operating, you’re proud of, and one where you can make a difference. 

Don’t let the availability heuristic cause you to flush a once-in-a-lifetime deal.

Ready to acquire a business in the next 12 months? The Acquisition Lab is your first stop. Reach out to us today and get on the fast track to becoming an acquisition entrepreneur.