Why M&A Deals Fail in Diligence: 5 Fatal Flaws to Avoid

Due diligence is a critical stage for any software M&A deal. After all, the purpose of diligence is for the buyer to validate what they are purchasing and for the seller to keep forward momentum in the deal.

Come into diligence unprepared, and it’s more likely your deal won’t close. Going on your own — without an expert advisor to lead you through the process — can create many of the issues we’ll enumerate here. However, rest assured that all these issues can be avoided with the proper guidance from day one.

In this blog, we dive into five reasons why deals fail during diligence and how to avoid these critical errors before you start.

1. Sellers Aren’t Prepared for Buyer Negotiations

When deals fail during diligence, it often comes down to the seller going into diligence unprepared. After all, most buyers have done this before while most sellers haven’t. Not only that, but buyers have experienced, professional teams at their disposal — always with the goal of trying to purchase for the best terms and price possible.

What do buyer tactics look like during diligence? Numerous documentation requests, questions on every part of the business, negotiations on terms, and constant back-and-forth (for weeks!) are all elements to consider.

The real deal-killer here? Negotiating on terms the seller doesn’t want. When buyers find anything that qualifies them to conduct a re-trade, they will try to negotiate on things like:

• Price
• Terms
• Deal structure
• How to calculate net working capital
• Defining indebtedness, etc

All of these small items can add up in a major way during diligence that leads to what we call “death by a thousand papercuts.” How can sellers avoid this? Referencing a comprehensive due diligence checklist is a great place to start.

2. Founders Experience Deal Fatigue

A common reason M&A deals fail is deal fatigue. Deal fatigue occurs when parties on either side of a deal feel frustrated, helpless, or exhausted by a seemingly unending negotiation process. Some common things that lead to deal fatigue include:

• Changing business conditions
• Complex deal structures
• Inaccurate information

When founders experience deal fatigue, one of two scenarios typically occurs. First, the seller might compromise their ideal terms in order to move the deal forward (not ideal). Second, the deal ends entirely because neither party is able to accurately negotiate or move through the process in a helpful way (even less ideal).

One way to preemptively avoid death by deal fatigue is by having a third party manage a deal. At SEG, for example, we take care of all communications, monitor consumption of materials and push if there are delays, schedule regular status updates, and advocate for the seller in all our deals.

3. Founders Focus on the Deal Over Their Business

When M&A deals overshadow core business operations, you know you’ve got a problem. Yes, diligence is intensive, but it should never come in the way of what matters most — bringing value to your customers.

Founders who stop focusing on their customers in order to focus on a deal are in danger of two fatal deal killers: losing big customers or missing financial projections. Either of these are enough to give a potential buyer pause.

How can you keep the business running while going through diligence? Here are five ideas straight from the Harvard Business Review and McKinsey:

• Separate the M&A process from business operations
• Create a dedicated deal team
• Implement structures focused on keeping the customer experience at 100%
• Don’t neglect your culture
• Continue to recruit and retain top talent

4. Buyers Uncover Hidden Issues During Diligence

In SEG’s 30 years of experience, we’ve learned that 80% of all information should already be shared between buyer and seller prior to diligence even commencing. The other 20 percent? It should confirm what the buyer already knows.

In other words, material surprises uncovered during diligence are often deal-killers. Some common deal-killing surprises include intellectual property issues, technology issues, or problems around finances.

Our list of diligence dos and don’ts can help you know what to avoid, and what to prepare, so no issues arise during this stage of the acquisition process.

5. The Deal Stalls

Last but certainly not least, timing is key to everything during due diligence. Without momentum in some form, deals are likely to stall. And stalled deals often fail.

The best way to ensure a deal doesn’t fail during diligence is to make sure it keeps moving forward. There are a few ways sellers can keep the momentum going in any software M&A transaction:

• Have all diligence documents prepared beforehand, and get familiar with what a successful diligence process looks like. It’s a good idea to reference a diligence checklist or a due diligence timeline in order to prepare before diligence even starts.
• Go into diligence after entertaining multiple offers. Having more than one offer provides the seller with more leverage, and also provides for a backup plan if a deal falls through.
• Work with an expert who’s managed diligence before. Without someone in your corner, sellers are at a disadvantage both in resources and expertise when it comes to diligence. Evening the playing field by hiring an M&A advisor always helps.

How SEG Can Help

At Software Equity Group, we aim to avoid any of these fatal errors during an M&A process with our clients. We prepare sellers for diligence by thinking about it from day one. Not only do we have a comprehensive checklist ready from the start, but we also walk our clients through the process at every stage.

In short? We do the work so our clients can focus on their business . This means getting ahead of any “bad” information, sharing 80% of information with the buyer ahead of time, and doing the daily work to keep momentum charging forward at every stage until close.

We minimize risk and maximize value in all of our M&A transactions. If you’d like to see what a potential SEG partnership looks like, even if you’re months or years away from a potential deal, we’d love to chat. Contact us here.