If you have ever promised your child a treat in return for good behaviour, you know all about negotiating leverage.
When selling an attractive business, you also have leverage—up to the point that you sign a letter of intent (LOI), which almost always includes a "no shop" clause, forcing you to terminate discussions with other potential buyers while your newfound "fiancé" does due diligence before handing over the cheque.
After you sign the LOI, the balance of power in the negotiation swings heavily in favour of the buyers, who can then take their time investigating your company. At this point, there is little you can do.
Yet, with each passing day, you will likely become more psychologically committed to selling your business. Savvy buyers know this and often drag out diligence for months, ultimately manufacturing things to justify lowering their offer price or demanding better terms.
With your leverage diminished and other suitors sidelined, you're then left with the unattractive options of either accepting the inferior terms or walking away.
Peter Lehrman, the founder and CEO of AxialMarket, an online marketplace serving buyers and sellers of private businesses, describes a situation he witnessed first-hand:
"The company was a distributor and installer of telecom equipment to businesses and commercial real estate developers. The owner had built a nice business with recurring contracts driving $15-million in revenue and nearly $2-million in pre-tax profit. The owner made the mistake of approaching buyers haphazardly with the help of his accountant and lawyer. The most attractive acquirer insisted on exclusivity while they did some due diligence, which dragged on for many months, with the acquirer asking for concessions and delaying the process. The business owner had given up all his leverage and hadn't developed a set of alternative buyers. Finally, the deal fell apart."
Mr. Lehrman recommends four things you can do prior to signing an LOI to minimize the chances of your deal dragging on for months and becoming watered down:
1. Make sure your customer contracts have "successor" clauses
Try to have customers sign long-term, standardized contracts that include a clause stating that the obligations of the contracts survive any change in ownership of your company. Have your lawyer wordsmith the details.
2. Nurture and prepare a group of 10–15 "reference-able" customers
Acquirers will want to ask your customers why they do business with you and not your competitors. Cultivate a group of customers to act as references before you sign the LOI.
3. Ensure your management team is all on the same page
During due diligence, acquirers will want to run "isolation" interviews, during which they speak with your managers without you in the room. They are trying to understand if your company is pulling in the same direction and to identify any dissension or incoherence among your ranks.
4. Make sure you have audited financials
An acquirer will have more confidence in your numbers and will perceive less risk if your books are audited by a recognized accounting firm.
Tomorrow we'll look at the top three things you can do to ensure your deal does not become diluted or fall apart at the altar.
Special to The Globe and Mail
John Warrillow is a writer, speaker and angel investor in a number of start-up companies. He writes a blog about building a valuable – sellable – company.