The con man refers to his target as a “mark” – easy prey to be exploited.
Private Equity (PE) guys are too polite to refer to their victims in such pejorative terms, but, as I learned this week from a friend , PE firms now have a saying for a business owner who is an easy target: The Proprietary Deal.
When acquirers use the term “proprietary deal” they are referring to buying a business directly from the owner without the hassles of a “greedy” investment banker / business broker driving up the price by soliciting – or threatening to solicit — competitive bids for your company. You see savvy buyers and in particular PE firms well know the impact competition creates for desirable deals. The very last thing they want is “good old supply & demand” kicking in and driving up their costs (and your profits)
Falling victim to the proprietary deal is easy. You get approached by a partner in a PE firm or a senior person from a big company in your industry you know and respect. They shower you with compliments about your business, invite you to a fancy lunch and then ask if you’d consider selling. Once you agree to a conversation, they convince you there is no need to involve an adviser to represent you – why pay the money, they’ll say, to some guy or gal who has done nothing to help you build your business – we’re friends after all.
But becoming the mark in a proprietary deal is much more expensive than having your wallet pick-pocketed by a street crook. Here are five reasons to avoid being the target of a proprietary deal:
You’ll get a lower price
Obviously with nobody else bidding for your business – without even the threat of a competitive offer — the price an acquirer will pay is lower in a proprietary deal. And if all goes well you have not consulted anyone independent of the transaction who can give you a solid valuation of your business in the open market. Nothing drives up the value of your company faster than the possibility of two or three acquirers fighting over it.
Due diligence becomes protracted
Once you agree to negotiate with one buyer, they will force you to sign an “exclusivity agreement” which allows the buyer time to do their due diligence. When a buyer knows they have a proprietary deal, diligence often gets dragged out for months. We call this getting the seller “pregnant”. You become emotionally involved in the process and in the deal. You begin making plans for the monies coming from the sale and mentally “check out”.
Shrinkage
Not only will due diligence become excruciating for you, proprietary deals often get discounted with the buyer lowering their offer price after you’ve agreed to a set of deal terms. The longer and more painful they make the due diligence, the weaker you become to defend against a last minute price drop.
Seller’s Remorse
The last time I was in Marrakesh I bought a rug. The street vendors must have seen me coming from a mile away with my camera slung over one shoulder, map in my hand and goofy NIKE sneakers on my feet. I was convinced I was going to show them who was boss. By the time our negotiation was finished, I had bargained the price of the rug down by 50%. I walked away proud of my negotiating savvy until, on the ferry back to Spain, I learned one of my fellow travelers had got his rug for 80% off the asking price.
When you sell your business, you’ll ponder whether or not you got a fair price for your life’s work. That’s natural but if you fall victim to the proprietary deal, with no other buyers bidding for your company, you’ll go to your grave never knowing if you were taken.
Out of market terms
Another buyer tactic in a proprietary deal is to keep the price agreed to in the Letter of Intent the same but asking for “out of market terms” on other economic issues that have the net effect of lowering the sellers take from a deal. Some examples of this are buyers running a proprietary deal can ask for an abnormally large escrow (a whack of cash you need to give to a lawyer to hold for a year) or working capital requirement (the amount you need to leave in your company when you hand over the keys). Other areas where buyers can peck away at value include the structure of earn-outs, consulting or employment contracts, or risk issues like how indemnification works for various representations that the seller must warrant to the buyer.
At first blush, negotiating on your own with one buyer can look simpler. Life is short after all and you might argue it’s better to make a quick sale to a friendly buyer even if you leave a few bucks on the table. But the illusion of the easy deal can quickly turn into what amounts to a one-sided swindle.
Summary
The point of this is that good brokers add value. Experience counts. Make sure when you engage a firm they have a long and successful record of performance. That they have the resources to go the distance, and they are motivated to do the best deal possible. A good firm will be one that leverages the market dynamics to create competition and competition is good.