The deal

You want to buy a piece of a company, you’ve found the company and met with the seller. The deal is on. It’s go time. The company is a 100% family owned business, who are courting investors to spur growth.

You (the investor) crunch the numbers and make an offer. The seller is not happy. They want more money for less shareholding and they want to retain complete autonomy. In other words, give us your money and shut up.

That’s a bad deal and you know it. How do you proceed?

Negotiation

At this point, you are in for negotiations.

We are going to talk about negotiation strategy and tactics. But our focus is on strategy because that will be guided by your brand promise (or brand reputation) as an investor, whereas as tactics will vary from situation to situation.

I speak of brand promise because each type of investor promises something different.

For instance private equity firms promise to invest for a period of time (e.g. 5 years) and then sell their shares to the next investor. Corporate buyers promise to buy your company and bring it into their corporate world.

Our company, Dass Capital, has its genesis from an (almost) 90 year old family business. So we promise long-term partnership, trust and growing together.

As you will see, our promise guides our negotiation strategies.

Bargaining power

The first thing to understand is your bargaining power. Bargaining power is your source of strength in a negotiation. Each side, the buyer and seller, have sources of power.

Buyers typically have the following kinds of bargaining power:

• Capital. They have money which the seller would like to access.

• Skills. They have skills which can assist the seller to grow the company. For instance buyers can bring operating and investing discipline to the company.

• Network. They have a network in the business world which can be used to unlock growth opportunities or access more sophisticated financing.

• Exit opportunities. They have experience and access to value adding exit options. These can be things like trade sales or initial public offerings (IPOs).

• Modesty. What? Don’t laugh, let me explain. The world of investment banking and private equity is full of big-talking, high-falutin, showy people who are trying to get the best deal. So it is very easy to differentiate yourself just by being modest.

Sellers typically have the following kinds of bargaining power:

• Good business. If investors are interested, the seller has a good business and knows it. So they are under no pressure to sell.

• Organic growth. Even without investment, there are usually opportunities to grow, albeit slower. Again, no pressure to sell.

• Patience. Multi-generational business owners are often under no pressure to sell. They are not thinking about making a quick buck.

Strategic negotiations

Back to our offer. Lets look at strategic negotiation options to take the deal forward.

Build trust

In my opinion, the best way to proceed is to build your relationship and increase trust. You do this by showing good faith.

For instance, when we are doing a deal, we get to see the ins-and-outs of a company. As we go through things, we freely share our insights and use our specialised knowledge to assist the owners. This builds a relationship.

Sometimes, even if we are not going to work together, the owners will call us and ask us what we think. We oblige. We don’t charge for it and we don’t do it for any other reason than to be helpful.

Over time, we noticed that if you put an effort into helping others succeed, it builds trust and friendship. People reciprocate because they enjoy working with people who want them to succeed.

Our brand promise is to be trustworthy and help others grow. We behave accordingly and use our skills to be helpful. This becomes a source of bargaining power, because some sellers will want to work with us.

Sources of power: skills

OUR EXPERIENCE

In 2021, we wanted to invest in a business that had two founders. We could not make the deal work. So we walked away, but we had made a friendship.

In 2022, one of the founders called us and explained their backstory. The other founder wanted to retire and sell out. We shared insights on their deal candidly. But it didn’t involve us at all. Again, we went our separate ways.

In 2023, we spoke to the founder and he told us that he went ahead and took over the entire company. Now he wants to grow and he has extended an invitation to us to visit.

Maybe something will come of it or maybe not. But you won’t get invitations from people who don’t trust you.

Close the bargaining gap

The next option you have is to close the bargaining gap in the negotiations. The bargaining gap is difference between what the buyer and seller want. Normally, the biggest part of the gap is price, but it can also include conditions.

For the buyer, the best way to close the bargaining gap is with information. Find out more about the company’s prospects and try to understand the opportunities the insiders see.

You may not agree with all of it, but guaranteed, you will find more sources of value as you understand the company better. This gives you the opportunity to close the gap with a better offer. (Beware of overpaying!)

Source of power: capital.

You can also close the gap by demonstrating value adding directions the company can take and how you can help it get there.

Help the seller to understand the valuation and its assumptions. Tell them why you think the company is worth a certain amount. Remember, private businesses operate in bit of a bubble. They don’t always recognise that interest rates, politics and market movements affect their business in the same way that it affects public companies.

Show the seller how your involvement can increase the value of the business. (Make sure that you are not making unrealistic promises.)

Sources of power: network, exit opportunities.

Financial structures

In cases where you cannot close the valuation gap (i.e. the difference in price between the buyer and the seller), you can use financial structures to bridge it.

An earn-out is where you agree to a price today, but you also agree that if the company achieves higher profits in the next year or two, that you will pay a higher price.

This structure gives the seller, who believes that significant growth lies ahead, a chance to participate in that growth. It also protects the buyer, who does not want to pay for growth that may never materialise.

A ratchet is another structure that can be used. Here the deal is done but if the company outperforms in the year or two ahead, the buyer returns some shares to the seller. On the contrary, if the company underperforms, the seller must hand more shares over to the buyer.

In summary, an earn-out adjusts the price based on future outcomes, whereas a ratchet adjusts the shareholding based on future outcomes.

These approaches have pros and cons, but you can design something that works for both parties.

Source of power: skills

No deal

Remember, the seller also has sources of power. In fact, the seller of a good business has a lot of power - they don’t have to do anything. Here’s what Warren Buffett had to say in his 2022 shareholders letter.

You can never recover from overpaying or having no ability to influence the company that you have invested in.

Your final option is to walk away. No deal is better than a bad deal.

This is not your go-to option in the opening round of negotiations. You can usually close the bargaining gap, if you work through it.

But if you cannot close the gap, then this is your best method of countering the seller’s sources of power. M&A is littered with examples of the winner’s curse. Walking away is the only antidote.

Tactics that do not work well

Here’s a few tactics to avoid:

1. Playing hardball. Take-it-or-leave-it tactics will not work unless one party is desperate. Even if you can pull it off, the party that has to take-it will find a way to get their own back. This also doesn’t work well for your brand reputation.

2. Leverage. If the valuation gap is too large, you might be tempted to borrow more money to make the deal work. You might even feel very smart if you can get seller finance. Always remember, overpaying results in bad investments. It does not matter how you finance it.

3. Financial engineering. This is where you use complex financial instruments and structures to compensate for deal deficiencies. Don’t fool yourself, nothing can fix a bad deal.

Conclusion

Business is done on trust. If a deal is not quite where you want it to be, build trust and work it toward where you want it to be.

This is quite simply, the art of the deal.

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