How dealmakers can spot red flags early and avoid failed transactions

Imagine you’re tasked with landing a transformative deal for your new investment platform.

You’ve identified a target company that looks like a strong investment on paper, but you’ve noticed some misalignment in the company’s leadership team. The deal needs to close before the end of the quarter, so you move forward.

Other potential deals fall to the sidelines as this one still seems most promising. Then, right at the finish line, your target’s leadership team experiences high-profile departures, exposing red flags you should have noticed early in the process. Your deal is dead, and you won’t close another before the quarter is over.

A failed deal means time, money and energy lost, and it’s the dealmaker’s job to detect problems as early as possible. While most firms use due diligence frameworks to uncover potential issues, these don’t always fully capture the human element.

As the person who initiates in-depth conversations about the state of a business prior to any signatures being exchanged, you have a responsibility to weed out bad deals as early as possible. This practice often comes down to using soft skills and emotional intelligence to vet prospects.

Here are a few ways we recommend evaluating target companies to get an early read on a deal’s feasibility:

Ask hard questions early

One of the best ways to test whether a deal will work is by asking the toughest questions early and keeping them open-ended to seek an accurate response.

A good approach is to ask about mistakes the company has made and what they’ve learned from them. If the management team gives vague or overly positive responses, that could be a sign they’re not being completely up front.

When dealmakers push for specifics and listen carefully to the answers, they often uncover hidden risks before getting too deep into due diligence.

Look for transparency

A seller who genuinely wants to make the deal work will share reasonable information without hesitation. If they resist requests for things like pipelines, customer trends or visiting operations, it could mean they have something to hide.

Additionally, what isn’t said in a conversation can be just as important as what is said. If a seller avoids answering certain questions or shifts the discussion away from challenging topics, that’s a sign there may be deeper issues.

Related: The value of landing a proprietary transaction 

For example, if a CEO only talks about new customers but avoids discussing retention rates, there might be a problem with churn. Smart dealmakers try to find inconsistencies in responses and press for details when something doesn’t add up.

Subtle gaps in the story often point to risks that could make the deal fall apart later.

Use EQ to understand those you’ll work with

Body language and tone of voice can reveal more than words.

When a seller hesitates, avoids eye contact or fidgets while answering a question, it might mean they’re uncomfortable or not being fully honest. If a CFO looks to their CEO before answering a question about financials, that could be a sign of uncertainty or disagreement.

A good dealmaker pays attention to these cues and asks follow-up questions to get to the real story. Small signs of discomfort often point to bigger issues that need to be uncovered before moving forward.

Understand the company culture

Even if the numbers look good, a deal can fail if the teams don’t work well together. Cultural and leadership dynamics matter just as much as financials.

If the management team seems disconnected or dismissive of each other’s input, it could mean they have deeper internal issues. Asking questions about how decisions are made and how they handle disagreements can provide insight into how they operate.

If there’s a lack of alignment on vision and expectations, it’s better to recognize that early rather than grappling with conflicts after the deal is done.

In summary:

To avoid wasting time and resources, dealmakers must detect red flags early by leveraging emotional intelligence and soft skills. This means asking tough, open-ended questions up front and assessing the seller’s transparency.

Additionally, observing leadership dynamics and company culture can reveal deeper issues that may signal long-term incompatibility, helping dealmakers identify tripwires early rather than investing in a bad transaction.

To learn more, contact Sean Curley at (336) 217-9125 or sean.curley@charlesaris.com.