Top 10 Reasons Lower-Middle Market Deals Fail

Key man risk is the number one reason why businesses fail to exit — or why valuations are severely ratcheted down. Key man risk occurs when the owner, or someone critical to the business, is a bottleneck: if that person is removed, the business can't operate.

Examples include being the only person with critical knowledge, the only one who can perform critical tasks, or the only person who communicates with top clients.

Owners frequently confuse control with being the bottleneck. Control means understanding your business and the market. Being the bottleneck demonstrates lack of control — it shows the business can't operate independently of you, which translates directly to failed sales.

• Hire a General Manager or CEO as your replacement
• Document your critical processes
• Build your critical tasks into employees' objectives
• Delegate your tasks and spend less time in the office

Disorganized financials create two problems: you have no idea how much money you're actually making, and when it's time to sell, it becomes a chaotic scramble to get organized. Other consequences include not paying the correct taxes, not understanding gross margin, and no ability to forecast.

• Hire a great bookkeeper and ensure a monthly financial close
• Build a plan with your accountant to bridge from current state to desired state
• Document your General Ledger so everyone understands your financial categorization
• Review financials monthly with your bookkeeper to ensure consistency
• Start budgeting and forecasting

SDE (Seller's Discretionary Earnings) is a marketing term: EBITDA + add-backs. When a business's profit isn't strong enough on its own, bankers and brokers add expenses back to EBITDA to make it look more attractive. The most common is owner's salary — but we've seen add-backs as creative as marketing and travel expenses.

Smart buyers remove add-backs every time. In fact, it's often the first thing they do when reviewing a CIM. Add-backs create initial distrust and will always reduce your expected valuation.

• Ensure your financials are accurate (see #2 above)
• Build solid profit first — don't build a business based on add-backs
• Be honest with buyers

You must understand sales attribution — where your sales come from. Not understanding this makes it very difficult for a buyer to understand how your business model works. Lack of clarity equals lack of valuation.

• Build an attribution map
• Document your sales strategy across the attribution map
• Explain category or client growth by segment
• Discuss the strengths and weaknesses of each attribution channel

When a buyer purchases your company, they need a manual on how to operate it. Not all businesses in your industry run the same way. If buyers can't understand what's going on, you're conveying disorganization — and disorganization kills valuation.

• Start with simple Standard Operating Procedures (SOPs) for your most critical processes
• Documenting processes also helps you see what's working and what's not — right now, not just at exit

A scalable process can be easily taught and ramped up when sales increase. A non-scalable process relies on one or two people, can't easily be taught, or is heavily manual. Sophisticated buyers want businesses that work — and when they invest capital, they want processes that can scale. Most buyers do not want fixer-uppers.

• Cross-train on critical tasks
• Utilize technology to automate manual steps
• Build succession planning into operations
• Outsource where appropriate

In many cases, having one dominant sales rep can be worse than a key man issue. The rep has leverage over you — if they leave, revenue could fall flat. Owners are often hesitant to address it because of that leverage. And buyers? This freaks them out. They buy the business and the key sales rep leaves. Game over.

• Move the sales rep into a leadership role managing other reps
• Slowly add additional sales reps over time to dilute concentration
• In some cases, terminating the rep — with advance planning — leads to a healthier, more diversified business long-term

Your business should be a mullet: creative and aggressive on the go-to-market side, straight and narrow on the back end. Nothing signals disorganization to a buyer faster than missing, outdated, or unfindable legal agreements. And beyond the optics — no legal documentation is a deal killer because it literally means your business cannot transact.

• Start early: build a central folder for all key documents (customer agreements, vendor agreements, employment agreements, IP, licenses)
• Hire a good attorney who can identify gaps and keep you organized

Similar to key man risk — take out a major client or vendor and the business crumbles. No buyer wants to touch concentration issues, and banks won't finance an acquisition with them. This issue limits both your buyer pool and your financing options.

• Build customer and vendor diversity intentionally — with a documented strategy
• Spend more time with smaller clients to grow their share
• Increase marketing efforts to attract new accounts
• Add product or service lines to diversify revenue streams

While this one may not kill a deal outright, the absence of a budget process will reduce your valuation. PE firms expect a business that knows how to plan for the year ahead — and how to measure itself against that plan. At minimum, a budget forces you to think about targeted growth.

• Start with a simple budget — if you're mid-year, build a plan for the second half
• Pair the budget with an initiative plan: what actions will drive you to meet or exceed the numbers?