Can your company be repriced after the letter of intent?
Here’s a dreadful prospect that you want to avoid. Let’s say that you put your company on the market, and—for ease of math—you are putting up good numbers at the time of sale, say, $2 million in Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA.)
Your investment banker (broker) sends the deal teaser out to prospects, you get some interested parties, and someone comes in with a Letter of Intent (LOI) that offers a nice price. Say they offer today’s going multiple of 5.5x adjusted EBITDA. In this case, the offer would be $11 million.
You like the price, so you turn away the other suitors, and agree to enter into the due diligence process and move toward a closing.
The LOI will often have a clause in the document that cites your projections for the amount of EBITDA you expect to book between the acceptance of the Letter of Intent and the closing date. To maintain that $2 million EBITDA pace, you have to continue to put around $183,000 in EBITDA each month on the bottom line.
Now what? Well, unfortunately, the due diligence process takes months. During that time, you’re substantially distracted (as I’ve written about before) with a boatload of requests for information, information that you never dreamed someone would ever want to know, e.g. environment assessment of your various real estate locations, drug tests for your truck drivers, introductions to customers to interview…the list goes on and on. In fact, you’re so distracted by the due diligence process that you miss your numbers, and you don’t earn $183,000 in EBITDA two months before closing. In fact, you miss your number by $20,000. Then, the month before closing, you miss your numbers again, slipping $25,000 below the $183,000 projection.
These slippages off the pace of EBITDA are all reported to the prospective buyer on a monthly basis. That first month you miss your numbers, the buyers may have a few raised eyebrows, and they might even voice some mild concern. But that second month that you slip off the pace is trouble. The buyer may look at the two months as a trend, a downward trend…and they will surely vocalize their concern. The call starts out friendly, and goes something like this:
“Joe, I can’t help but notice that you are not making your numbers. Any reason for that? I have to say that we are having some concerns…”
Joe says, “Well, heck Bob, I’ve been so distracted by all of your requests that I have not had time to focus on managing my sales team. Plus, I have not been able to make the calls that I typically make each month for our biggest customers.”
“Is your business so unstable and your profits so fragile that a few hours of your time each week can cause the business to tank? I think we have to reprice the deal,” Bob says. Reprice the deal? That is a phrase that has sent many a seller to the medicine cabinet, scrambling for his heart pills, followed by an equally concerned investment banker who is trying to find out exactly how serious the buyer is about repricing.
“Ironically, if you exceed your projected numbers during the due diligence process, there is little chance the buyer will reprice upwards, to give you a higher valuation. But negative repricing is all too real.”
How would the buyer reprice? Well, the math is simple and rather brutal. Since they are paying on a multiple of EBITDA (e.g. 5.5x), they will apply that same multiple to the new EBITDA, adjusted downward, and calculated over a 12-month period. The $2 million EBITDA that got you an $11 valuation may drop to $1.7 million, dropping the purchase price from $11 million to $9.35 million. (Remember, every dollar you drop in EBITDA can have a negative implication, x5.5.)
Ironically, if you exceed your projected numbers during the due diligence process, there is little chance the buyer will reprice upwards, to give you a higher valuation. But negative repricing is all too real.
The solution: Avoid distractions during the due diligence process; don’t neglect sales, and consider bringing on staff that you can delegate parts of the due diligence process to. There’s nothing worse than working a lifetime to prepare your business for sale, only to have a couple of months of bad performance knock a million dollars or more off your value.