We see this happen regularly in the market: an entrepreneur who has been approached by an investor or a strategic partner. They sing each other’s praises, talk about a quick deal, and everything seems to be going smoothly. In practice, however, things turn out to be more complicated: requests for information keep piling up, speed turns into delays, and in the worst-case scenario, one party pulls out. As an entrepreneur, how can you prevent such a nightmare scenario?
As always, it all starts with the expectations of both parties and reality. For example, prior to a transaction, it’s unclear to most entrepreneurs just how much time (and effort) and attention a proper transaction process actually requires. But try asking a fellow entrepreneur who has sold their business. One after another, they’ll share horror stories about the due diligence process, the legal documents, deal structures, earn-outs, and you name it.
And there’s a good reason for that. The process of selecting a new partner is often exciting—and even fun. The parties approach each other from a commercial standpoint and try to win over the entrepreneur. But as they move toward the “engagement,” serious decisions must be made for the first time. What is the valuation, and what kind of structure (cash-on-closing, reinvestment, vendor loan, earn-out) will be put in place? In addition, entrepreneurs are confronted with leaver provisions they are unfamiliar with. In short: we’ve gone from dancing to drawing up the prenuptial agreement.
At this point, the dreaded audit has yet to begin. We often see parties claim they have nothing to hide—and in practice, this is indeed the case. However, many people forget that the buyer’s advisor, who conducts the audit, also needs to recoup their costs. As a result, we regularly see entrepreneurs with the best of intentions provide all the necessary documents, while the advisors, on the other hand, attach financial consequences to them—consequences that are usually poorly substantiated.
Information asymmetry also plays a problematic role in both the legal and financial spheres. The buyer knows exactly what is in line with market conditions, but for the entrepreneur, everything is new, and without the right advice, it will always remain unclear to him or her whether the deal being closed is really such a good one. This discomfort can also have a negative impact on the collaboration with the new partner even after the deal is closed; after all, trust comes on foot and leaves on horseback.
In addition, limited competitiveness also works against the seller in this process. As a seller, you’re deeply involved in a deal and invest a lot of time, energy, and attention into it. Yet the buyer holds all the power, can drag things out, impose additional conditions at the last minute, and walk away from the deal at any time. For a private equity firm that closes ten deals a year, this is no problem. But for an entrepreneur who’s temporarily working a second job and might only close a deal like this once or twice in their lifetime? It’s disastrous.
But how can you prevent this information asymmetry and limited competitiveness from affecting you? It’s actually quite simple. Set up a one-on-one process the same way you would organize a broader auction. It involves three steps:
- Hire a specialized M&A advisor
This helps reduce information asymmetry. A reputable advisor whom you trust can confidently tell you whether a deal is good, bad, or great. This allows you to make a decision with confidence. The buyer also immediately understands that he shouldn’t try to pull any “tricks.”
- Create an Information Memorandum
Just as in a broad process, create a clear set of information that highlights the core of your business and makes any areas of concern—or USPs—transparent. This ensures that there is a clear set of information on which a party can base a bid, and it also helps you avoid surprises during due diligence.
- Make a shortlist of other potential partners
The best way to maintain competitive pressure is to see which other parties might be interested. Because there’s an IM, you can quickly reach out to get a sense of these parties. The current buyer feels the pressure, and you, as a business owner, can compare offers to see if you’re really getting a fair deal: “You can only sell your business once.”
In conclusion: entrepreneurs often underestimate the time and effort involved in a process. Much of this effort comes after finding a partner, which means that, in terms of effort, a one-on-one process rarely results in a much faster deal. It is therefore important to prepare for this just as thoroughly as you would for a standard process.
Would you like to know how we can make a difference for you—both in a broad-based process and in a one-on-one process? Contact us here.
