The Art of Negotiation
Negotiating styles are a lot like snowflakes; no two are alike. There are, however, certain principals of negotiating that can increase the likelihood of success when structuring a business deal.
Over the years I have witnessed deals that should have been made that blew up because of poor negotiating and others that could easily have failed but made it to the closing table because they were artfully negotiated.
The first rule of negotiating a deal is to figure out what you want. It sounds obvious, but far too often we lose sight of what we are truly trying to accomplish and the deal falls apart over matters that should not be deal breakers. In any business deal there are many aspects of the deal, some of which are more important than others. Yet being the competitive spirits that we are, we can become obsessed with “winning” a negotiation and focus too much attention on getting our way on matters that really are not that important.
I had one client abruptly break off discussions with, perhaps, the most logical buyer for his company (and the one who was in a position to offer the highest price) because he didn’t want the buyer to do business with a customer with whom he had had a bad relationship in the past.
Once you are sailing in the Bahamas, what difference does it make who the new owner does business with? The best way to avoid getting side tracked in a negotiation is to make three lists, write them down on paper, and regularly review the lists:
The key is to keep the first two categories as short as possible, then stay focused on achieving the first one while obtaining as many of the second and third as possible.
My second rule of negotiating is a corollary to the first: figure out what the other party wants. Again, this seems obvious, but it rarely happens. A deal occurs only when both parties’ objectives are met. In any negotiation, there are tradeoffs. If you can understand the goals — and constraints — of the other party, it is a lot easier to structure a deal that works. When I begin a negotiation, I make a list of what is more important to my client than to the other party and vice versa. Then I know which areas I can give ground on in order to obtain the desired result.
In a meeting between one of my clients, who was selling his company, and a prospective buyer, who ran a public company with a thin management team, my client stridently stated that he wanted to be free to walk out the door the day of the closing. I knew he had nowhere to go and he knew he had nowhere to go and he was certainly young enough to stick around for a year or two to help a new owner integrate the two businesses. He communicated a “Nice to Have” as a “Must Have.” The buyer, not surprisingly, walked away from the table convinced the deal would not happen. Because he had no internal candidate to immediately replace the owner as CEO, having the owner remain for a transition period was a “Must Have” for him.
Another tenant for a successful deal is to be creative. Deals can be structured in an infinite number of ways. A successful deal structure is one that achieves the objectives of both parties, given their respective interests and constraints. The structure is the pathway to work around the constraints to get to each others’ respective interests.
I had a client who was convinced his company was poised to experience phenomenal growth, but wanted to sell it anyway for personal reasons. He valued his company at $35 million. The buyer, who was much more sophisticated than the seller, knew that my client’s historical results did not justify a price close to what was being asked and instead valued the company at $20 million. In most cases this deal would never have happened because of price.
However, we devised a structure that got them both comfortable with the price. The buyer offered $20 million in cash at closing, plus an “earn-out.” The earn-out contract would pay my client an additional $15 million over the three-year period following the closing if certain financial milestones (which my client had reflected in his projections) were met. In effect, the buyer said, “Put your money where your mouth is.”
My client met the milestones and was paid the additional $15 million. He was happy, and the buyer was happy to pay it because they achieved the results they were after.
In another case, a buyer wishing to purchase a company could not borrow enough money to come up with the entire purchase price. The banks would lend only a fraction of the value of certain assets being acquired, as is common. So the buyer offered to let the seller retain ownership to the real estate and lease it back to the buyer, thereby reducing the cash portion of the offer by the fair market value of the real estate. At the end of the lease, my client could sell the real estate to the buyer or find another buyer for it at fair market value. In the meantime, the seller would have an income stream from leasing the property which was much more attractive than what he would have earned in a money market account. The seller got his price and the buyer was able to finance the acquisition.
One obvious rule of negotiating that is broken far too often is to never say something that is not true. It is often prudent to keep some cards close to the vest. But if you profess to have an ace in your hand, you better have one when the cards are laid down. Before a deal closes, extensive due diligence is conducted, which, if done properly, uncovers all the skeletons. If you are ever caught being dishonest or misrepresenting the facts, you will lose all credibility with the other party. They will then discount everything you have said and you will have sub-optimized your deal.
Another typical mistake made by parties in a negotiation is to mislead their agents. Often a party to a negotiation will represent to their advisor that their bottom line in a matter is X, when in fact it is Y. They assume that if they set the bar for their agent above where it really is, they will get a better result. In reality, many deals never happen because the agent has an unworkable mandate.
Select advisors you trust. Tell them the truth about what you are trying to accomplish. Incentivize them to exceed your expectations. Then they will have all the tools to negotiate the best outcome on your behalf. I recently represented a seller who felt his business was worth $22 million. Rather than structuring my fee as a flat percentage of the sale price, he paid me a below-market fee up to $22 million, then doubled the percentage for any amount over $22 million. That way I was able to get more parties interested in the deal by representing to them that the seller was reasonable in his expected value. And by having more parties interested, it was possible to ratchet up their initial offers well above $22 million. Because I had every incentive to push the price as high as possible, my client never second guessed me and achieved an outcome much better than expected.
Although negotiating styles can vary dramatically from person to person, keeping the above principals in mind should help to achieve a more favorable outcome when negotiating a deal.
Michael Jacobs, Author
Michael Jacobs is the CEO of Jacobs Capital and Professor of the Practice of Finance at The University of North Carolina at Chapel Hill. He's the author of several books and a certified speaker.
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