CEO of ECA: CEO and CFO executive search and consulting for private equity backed companies. Author of book Evidence-Based Recruiting.
I work with private equity firms for a living. Over the years, I’ve interacted with hundreds of entrepreneurs who have sold their companies to these investors. Some of these entrepreneurs are happy about selling their businesses; others are not. And it often doesn’t take long to tell who’s who.
Here are a few steps small-business owners can take when selling their businesses to minimize the chance of spending the next few years feeling like they made a mistake.
Beware Of Investors Only Focused On Price
Many small-business owners who retire quickly realize that spending too much time relaxing can become stressful. They therefore end up accepting a board seat or two at PE-owned companies. After stepping into these investors’ shoes, they often come to regret that they didn’t see the difference between private equity investors and lifestyle buyers when selling their own businesses.
Lifestyle buyers typically focus on buying businesses that will require minimal oversight from them. As these buyers are not aiming to manage the business actively, they typically are more focused on buying a business at a bargain price or with minimal risk for themselves, rather than trying to understand the business and its growth potential. Buyers focused mostly on price tend to rely more on hard-bargaining tactics, which can leave entrepreneurs with a bad taste from dealing with investors altogether.
Many small-business owners try to protect themselves from similar bad experiences by asking for all-cash offers or minimizing interactions with investors before asking for a bid. This is usually a mistake.
The more cash an investor has to pay upfront and the less an investor understands about a business, the riskier the deal will be for them. And someone has to pay for that risk. This drives down the amount they can pay for a business.
But Don’t Treat All Investors The Same
The entrepreneurs I see who are happiest about their exits dealt with their fair share of disingenuous investors. Yet they took the time to see which investors were truly interested in understanding their business versus those who just wanted a bargain price.
Once these entrepreneurs confirmed whether the investor was worth engaging with, they spent a fair amount of time trying to understand the deal from the investor’s perspective. This helped them receive more serious bids. Unlike with lifestyle investors, factors like working capital, inventory, customer concentration, etc., typically do impact how much private equity investors are willing to pay for a business. The more private equity investors believe they can improve these business drivers, the higher the valuation they can usually become comfortable with.
Try to understand what aspects of your business the investors are still trying to wrap their heads around or are genuinely worried about. Then, try to help them understand the risks associated with these topics, and how they might be mitigated.
Set Up A Process For Reasonable Negotiation, Not Haggling
The added benefit of understanding the acquisition from the buyer’s perspective is that you can agree on key elements of the deal early in the process. For example, if you believe that a reasonable amount of working capital for the business is 70% of your current cash balance, you should bring that up before the investor places their bid. Bringing this critical fact up afterward can lead to a loss of trust and them in turn trying to haggle over other details of the deal.
The entrepreneurs who end up happy about selling their businesses are typically the ones who spent more time agreeing to such details, as well as clarifying questions that might come up during due diligence, before receiving the letter of intent. This helped them negotiate less and focus more on understanding whether a deal was a genuinely good fit for both parties.
The added benefit of a good faith approach like this is that you’ll set a cooperative tone for the eventual purchase agreement and potential collaboration after the acquisition. The more investors believe that you will help them overcome potential issues after the transaction in good spirit, the more they will likely be willing to offer for the company. In an article for Harvard Business Review, David Frydlinger, Oliver Hart and Kate Vitasek point out that it’s nearly impossible to control every aspect of a transaction in a lengthy contract. Instead, they argue that deals creating the most value for both parties are structured around principles of fairness and reciprocity.
Some executives I’ve spoken with remain skeptical about how well these theories apply to the real world. They are, however, supported by real-world examples showing that haggling often leads to worse outcomes for both parties in a negotiation.
Before You Agree To A Price, Do The Following
Start by understanding the other party’s perspective. Before landing at a price, discuss the key drivers of success at your firm — and set clear expectations about how you want to approach aspects of the deal that might present a challenge to negotiate.
Do negotiate, but don’t haggle. Look out for signs of hard-bargaining tactics. If the other party uses such tactics, gently point this out and state that you prefer to negotiate in good faith but can only do so if they reciprocate. If they don’t seem willing to do that, politely push away from the table and keep looking for another acquirer.
Yes, this might mean that you will need to restart what already might seem like a lengthy process. But think about it this way: You’ve spent a tremendous amount of effort building a business you can be proud of. Do you want to spend the next few years feeling happy about who you sold your business to, or would you rather get frustrated and second-guess whether you pushed hard enough when agreeing on the fine print?