Understanding a Buyer’s Mindset on Risk

Selling a business is tough, but even tougher when a buyer(s) seems obsessed with analyzing risk that in the seller’s mind may be immaterial.  Owner/Operators and management teams are often so familiar with the business, its operations, and the market, that they can become immune, and sometimes complacent, to the inherent risks that may be deeply embedded in the business. 

A new owner or potential buyer needs time to understand and assess those embedded risks and the strategies they can use to mitigate them or they will simply discount their offer to cover their perceived downside risk.

Of course, when the buyer is intimately familiar with the industry, the ability to understand and assess those embedded risks will be a lot easier.  However, even when a buyer has experience in the industry, they are starting from a point of fear – fear they will make a disastrous acquisition that will haunt them for years.  Meanwhile, the seller is starting from a point of comfort with those same risks.  Same facts but with a vastly different viewpoint!

The fear of loss is a powerful human emotion.  One simply needs to look at what happens in the stock market when overall sentiment changes from greed to fear.  Studies have shown that fear of losing money is much stronger than the desire to make money.  Sellers need to understand this basic human reality before they begin negotiating a sale of their business.

Add to this, that buyers also tend to be hesitant to accept or at least somewhat skeptical of the business’s upside potential.  No wonder so many M&A discussions go nowhere!

So how does a seller prepare, knowing that most buyers will focus on the risks and be skeptical of the upside potential; the balance of which will be reflected in an offer.

The first step is to objectively identify the inherent risk in all aspects of the business: operations, suppliers, human resources, customers, etc.  Just because something has not happened in the past, does not mean that it can not happen in the future.  Buyers will not place much weight on that argument.

Starting with the top line, what are the risks associated with the market you participate in and the customers you serve.  Are there steps you can take to mitigate the potential for customer defection, even if no one is leaving?  Can you demonstrate customer loyalty with more than simply pointing to historical sales, with tools like Net Promoter Scores?  Are there strategies you can deploy to make customers stickier?

On the operations side, are your operating procedures up to date and relevant?  Can they be effectively used to train new staff when employees leave, even if you believe they will stay until retirement?  Do they incorporate the latest and best practices for safety, regulatory compliance, and quality control?

Risks that buyers may perceive around sales employees or key management defection can be mitigated with stay bonuses or other incentive structures.

Are there new suppliers that you need to bring in as backup or are current supplier contracts in need of a revisit?

It is important to understand that by being flexible on the deal structure, you can help alleviate the concerns buyers have about the risks associated with buying the business.  Being open to an equity roll, vendor take-back, or earnout, for example, will demonstrate confidence in the existing business and its operations, but will have the added value in that it demonstrates confidence in its future as well.
​
When the buyer perceives the seller wants to “run for the hills”, it can be extremely difficult to capture true value.

---