M&A Playbook

Mergers, acquisitions, and growth-equity advisory knowledge: deal evaluation, target client sizing, search-fund frameworks, capital structure, and post-acquisition integration patterns extracted from real M&A advisory conversations.

$2/mo

Subscribers4

Entries196

TypeCurated

Sample Entries

Mergers & Acquisitions E-book, 462 Pages (Part 5 of 5)

sci_adam_ma

The Art of Deal Making How Logic Is Used Logic is used to accomplish the following objectives: 1. Demonstrating Correctness. Logic can show why your position is the right one; why, for example, the price you're asking for your car, considering its ﬁne bodywork, is appropriate. 2. Demonstrating Incorrectness. Logic can also show why the other side's position is not right; why, to ﬂip sides in the car-selling example, the price is not appropriate since, although the bodywork looks good, the structure was damaged in a major accident. 3. Moving Ahead. Logic is a powerful device for getting and keeping deals going forward. Let's stick to the facts. How Logic Is Abused To canonize logic is to deify a computer. A machine can be taught to assess mechanical truth but not to discern whole truth. There is more to making deals than accurate analysis. People make deals, arguments do not. Logic has its place, but not the whole place. People are motivated by feelings and emotions; they do what they want, and logic may not change their attitude. An owner of a business may not sell to the highest bidder just because she didn't like their negotiating tactics. Not logical? , it doesn't matter. No deal Proving your point with logic can even break a deal, if in the process the other side gets, to use the vernacular, pissed oﬀ. Logic is often a battle winner and war loser. Using logic, you can be right and still be wrong–right in your analysis of facts and wrong in how you used them. The worst application of logic in deal making is to put down the other side. It can be tempting. Suddenly, after hours of contentious dispute, you ﬁnd the winning argument or piercing fact–and you jam it right down those bastards' throats. It makes you feel good, sure, but it hurts more than helps your deal. Your opponents may concede that one issue but they will resist you more on every other issue. You made your point, but you also made an enemy. Be careful when proving someone wrong in a meeting, especially superior in front of subordinates. Consider presenting your argument in private. It will save face, and you will be appreciated. Techniques of Logic The following are good ways to apply logic. 1. Be a Good Listener. You can't use logic's full strength unless you understand fully the other side's position. Concentrate on what your opponent says. 381 The Art of Deal Making 2. Paraphrase. Repeat back to the speaker in your own words what you think he or she is saying. Do it without judgment or critique. You make progress when you show that you really understand an opposing position. 3. Fact Association. Organize your information. Relate the data and ideas to the other side's argument. Look for those facts that undermine or subvert the opposing argument. There is a major diﬀerence between facts that do not conﬁrm an argument and facts that destroy it. The former are common; the latter are rare. 4. Coax, Don't Insult. Unless you can blow the other side's argument out of the water, which is unlikely, proceed with caution. Take heed: You don't want to alienate the opposition–only thwart their attacks. Imagine yourself a surgeon, excising only those parts of the argument that are diseased. Start with positives before negatives. Approach the argument as one ripe for mutual improvement instead of coming on like gangbusters. Use developmental phrases such as, "What happens if we modify…" Location of Logic When Logic Is on Your Side With a winning position, you don't want to muck it up with bad feelings. The idea is to make your point and gain respect in the process. Don't make the other side look bad. Your mental image is mutual victory over faulty logic. When Logic Is on the Other Side When your side has presented a failing argument, try to cloud the issue and lessen its impact. But avoid anxiety and obvious obfuscation. Heavy smoke screens are dead giveaways. Look for an excuse to move on to other topics. If the other side fumbles in explanation, be understanding. Your mental image is a minor matter of no consequence. What to Do? Two legendary corporate dealmakers were negotiating the sale of a large division from one to the other. "I like the deal you're oﬀering said buyer to seller, "The companies are excellent–dominant market share, ﬁne brand recognition, high quality, superb distribution nice cash ﬂow. I've only got one problem: If you're selling at a price why should I be buying at that price? I've never known you to leave much on the plate." What to do? Forget price. It's not the issue here. Seller motivation is what counts. The seller should give the buyer convincing reasons why he needs divest the businesses. Perhaps the division to be disposed doesn't ﬁt a new strategic posture; perhaps debt needs to be paid down; perhaps another cash- hungry acquisition has just been made; perhaps…. 382 The Art of Deal Making Deal Secret-22 Feeling the Emotion Emotion Is Not Shameful-It Is Noble, Worthy, And Valid Emotion in deals is kingmaker, tipping the balance. It often decides issues at the end, even if it does not initiate them at the beginning. Emotion, never forget, makes deals. How Emotion Works Emotions are non-rational, unplanned feelings. They are private knowledge, sensations we know ourselves but cannot demonstrate to others. They are outside the orbit of logic but do not contradict it. How Emotion Is Used Emotion aﬀects the atmosphere of deal making, casting positive or negative spells, invoking spirits that uplift or depress, Good deal-makers encourage honest emotional expression. As long as respectful, nonthreatening behavior is maintained, there is nothing wrong with putting some volume behind your words. If you're upset, show it. If you're bothered, say it. What you are seeking is candid communication, and displaying emotion is part of that candor. In this sense deal making is like group therapy; problems are discussed openly and emotion is expressed without shame. How Emotion Is Abused Faking or ﬂaunting emotions, on the other hand, is counterproductive. Fibbing or fabrication leads to more tricks than treats, and boisterous exhibitionism detracts from deal-closing solutions. Emotion shown should be sincere, or not shown at all. Don't plot artiﬁcial emotion, but don't be embarrassed to express the genuine variety 383 The Art of Deal Making Kinds of Emotion In what environment are you working? The deal-making atmosphere inﬂuences the dealmakers' attitudes. The following are some descriptions of deal-making climates. The further you can move to the left (no political pun intended), the better for getting deals done. Cooperative–Competitive. Is the environment collaborative or cutthroat? Equality–Superiority. Are the parties content with parity, or do they seek dominance? Factual-Judgmental. Do the parties stick with simple data and information, or do they evaluate motives and imagine hidden agendas? Spontaneous–Calculating. Do the parties react naturally to situations and events, or do they plot and scheme to get their way? Issue Exploring–Self-Certain. Do the parties concentrate on examining points and solving problems, or are they arrogant and cocky in their private appraisals? Problem Sharing–Self-Protective. Are the parties open and honest in investigating issues, or are they secretive and uncommunicative in their daily dealings? Solution Oriented–Ego Oriented. Do the parties focus on resolving issues, or are they consumed by posturing and vanity? Empathetic–Callous. Do the parties genuinely relate to the concerns of the other side, or are they cold-hearted and insensitive? Techniques of Emotion The following are good ways to use emotion. Set a Baseline. Get some sense of the normal emotional state of all deal participants. People are diﬀerent–some are high charged, others low key. Good dealmakers come in all levels of intensity. Be a Good Listener. Hear the nonverbal sounds–the tones and pitches of voices–being communicated. Receive the meta-messages. Be a Good Watcher. Observe body language of the people on both sides. Note how people interact with one another. Control Your Own Emotions. Control does not mean repression. Use your emotions to underscore meaning and conviction. Note Changes. Any emotional shift may indicate a reaction to the current state of the deal. No matter what words are being said, whether the other side is conceding or stonewalling, emotional change indicates something's afoot. 384 The Art of Deal Making Character of Emotions Emotions can inﬂuence deals. Once you understand what's happening, you can use it to your advantage. Assess Commitment The depth of the other side's commitment to its stated position is the best clue to how hard you can push and how far you can go. An emotional upswing suggests increasing commitment while an emotional downswing indicates decreasing commitment. When Emotion Is High Maximal emotion can cause deal volatility. Heightened intensity can either (1) help take control of the deal-making process or (2) disrupt progress. High emotion is like a catalyst in a chemical reaction. Whatever is supposed to happen will happen more swiftly. This car mean higher eﬃciency or bigger explosion. When Emotion Is Low Minimal emotion can cause deal lethargy. Depressed intensity either (1) lose control of the deal- making process or (2) allow momentum to run down. Deals languish with low emotion. When Atmosphere Is too Tense High emotion generates tension, but tension in itself is not bad. Moderate tension may even be beneﬁcial. Excessive tension, however, should be diﬀused, since it puts everyone on edge. Try humor especially the self-deprecating kind. ("If I weren't such a masochist, I’d enter a more relaxed profession, like risk arbitrage in the stock market") When Atmosphere is too Comfortable Looseness and sloth do not close deals: A serene, untroubled environment is generally conducive to making deals, but sometimes a little zip is needed to prod things along. How to add zip? Try injecting some competition for your deal, or at least the threat of it. What to Do? A church hierarchy threatened by schism summarily defrocked several leading ministers in an attempt to crush dissension. The ministers' complaint was both administrative and doctrinal, with charges of blasphemy and heresy being whispered. As the controversy bubbled and boiled, allegations of moral lapses on both sides started to surface. The confrontation was getting ugly and the media was getting interested. What to do? 385 The Art of Deal Making Emotions must be contained before an explosive chain reaction uncorks and the split becomes public and permanent. Those ministers deemed essentially faithful should be reinstated and given a formal opportunity to present their grievances. Ground rules must assure a nonjudgmental, problem-sharing, solution-oriented atmosphere. Those ministers whose basic beliefs are no longer consistent with the church should be separated as amicably as possible, with proper appreciation shown for their past service. Viliﬁcation should be avoided at all costs. 386 The Art of Deal Making Deal Secret-23 Changing the Attitudes Good Or Bad Attitudes Mean Good Or Bad Deals Deal making begins under every conceivable circumstance. You never know what to expect when you ﬁrst walk into the room: The other side may be desperate or unconcerned, ready to peel you apart or determined to play it straight. Your side also brings along a mixed bag of interests and attitudes. Attitude is a frame of mind, within which the entire picture of deals are portrayed. The right attitude maximizes the chances of making a good deal. Even if the deal opens well, you must work at keeping it that way. Good attitudes must be maintained throughout all of the deal's problems. This requires constant attention. Bad attitudes must be changed from natural competition to mutual cooperation. This takes special talent. Types of Attitude Changes The following are the diﬀerent types of changes that occur in attitudes. 1. Incremental Change. This type of attitude is generally positive. It is a gradual, almost imperceptible shift. No major movement is noticed, but after a while you can see the diﬀerence. Positive changes are usually incremental. 2. Sudden Change. This type of attitude is rare. It is usually triggered by a particular event that either destroys or enhances the party's conﬁdence in the deal. For example, if something you said is proven false, trust is shattered. Conversely, a sudden step for the better can occur if the other side realizes it made a judgmental error. For example, if they thought you were holding back ﬁnancial information, only to discover that their accountants had it all the time, their attitudes could mellow as a form of penance. 387 The Art of Deal Making 3. Self-Induced Change. Sometimes attitudes seem to improve by themselves. This can happen as conﬁdence grows in the deal's progress. In this case, you don't interfere, but simply maintain the momentum. Your attitude is a potent tool. The aura you project aﬀects the strategy you plan. Your attitude toward the other side inﬂuences their attitude toward you. Smiling, for example, is contagious; it's also simple, cheap, and eﬀective. Techniques for Changing Attitudes The following are good ways to change attitudes. 1. Build Trust. Since the common assumption is that you will say anything and do anything to win your point, the only way to build trust is by being truthful and consistent. Trust is elusive in deal making. It takes time to build–and no time to destroy. 2. Reduce Resentment. Few deals start out with an overload of animosity although many wind up that way. Resentment is resilient and resourceful extraordinarily hard to eradicate. If your deal is so aﬄicted, perhaps you can signal a change in attitude by reapproaching the issue from a diﬀerent angle. Find the root of the problem. If it's a misunderstanding, be open about it. If it's real, work around it. 3. Reduce Seriousness. The best dealmakers work seriously but do not take themselves that way. A bloated sense of personal importance will antagonize, not impress. A light touch is the strongest pressure. 4. Transfer Credit. It is remarkable how much can be accomplished if you are willing to give others the recognition. In one organization where change was vital, I was the only one who really knew what to do but I was too young to do it myself. I had to work through the senior leadership, getting several executives to internalize my ideas and present them as their own. I didn't mind because I was deeply committed to that organization (normally I would mind!). Its success was all that mattered to me. You can change the world as long as you don't need the credit. 5. Build Relationships. The more impersonal and unapproachable you seem, the harder it will be to modify attitudes. Try looking and acting human, with problems as well as positions. Perfect, you're not. 6. Use Informality. Social settings are good environments to break ice and reduce tension. Sometimes, inviting your counterpart to an informal meal can help. A warm countenance can melt metal. 7. Use Humor. It is hard to get mad at someone funny. A good sense of humor is a marvelous asset in high-tension deal making. No tactic is better. 388 The Art of Deal Making Deal Secret-24 Sensing the Changes Change Is Sure-Only PERSON_NAME "Fresh water runs on, and if you stop it, it becomes stagnant," observed Jawaharlal Nehru, former prime minister of PERSON_NAME. "Nothing in the world that is alive remains unchanging." Deal making is an environment of constant ﬂux. Everything is ﬂowing, altering, and being altered. These changes may be for better or worse. In either case, they aﬀect the deal. Signs of Change Pregnant Questions Questions are self-protecting mechanisms that allow negative response without loss of face. It's better to test waters with tiny toes before jumping in with large bodies. For example, if you want to break a deal deadlock by lowering your asking price, you might ask, "What could we trade oﬀ if I were to reduce the price a bit?" This approach shows neither weakness nor concession. Trial Balloons Trial balloons allow you to ﬂoat ideas without actually committing to them. You test your thought by observing the reaction. If good, you can make it oﬃcial. If not, you've learned another idea that won't work. The prime objective is self-protection. You certainly don't want to make a concession and then have it refused. Trial balloons are released in numerous ways. For example, the lower-level parties on your team can speak oﬀ-the-record to their peers on the other side. (Nothing, you must assume, is ever really oﬀ-the-record.) Alternatively, principals can go one-on-one and use a pregnant question. Mood Shifts Most deal people aren't good poker players. Their moods are read easily. For example, I'd be concerned if a person's demeanor plummets when I've made a concession or we've concluded the deal. I'd wonder if there's more here than meets the eye. 389 The Art of Deal Making Tone or Body Shifts Your sixth sense can tell you when the other side is more relaxed or more tense, more responsive or more obstinate, more inclined to compromise or more steadfast to stonewall. Direction is more telling than position: The way things are moving is more important than the ways things are. Changes in voice tone and body language are the signals. You only have to listen and watch. Note ﬂuctuations of voice and body, the subtle sounds and movements. For example, are the words more calming or cutting, the tones more comforting or sarcastic, the pitch more pleasant or high-strung? Are the torsos more straight or slumped, the hands more steady or shaky, and the faces more open or crimped? Direction of change, remember, is the key. Increased Humor A witty spirit cannot come forth from a sullen soul. Even a small, unfunny joke from a generally dour person is a positive sign. Conversely, silence from a generally ebullient sort screams a warning. If parties on the other side evince an uptick in humor, whether telling detailed jokes or making oﬀ- the-cuﬀ drollery, you're making progress. I like to encourage humor during deal making. It makes the process more enjoyable; more important, it's a positive inﬂuence on emotions and outcomes. THAT IS WHAT OUR CEO HAS ALWAYS DONE ON DEAL NEGOTIATIONS. Indirect Expressions of Attitude If some of the participants on their side are mixing freely with peers on your side, that's a good sign. If the sides maintain strict formality around the negotiating table in meeting after meeting, that's a bad sign. (If the latter, you might try breaking the spell by pulling up a chair on their side: "Thought I'd see how the deal looks from this side of the board.") Telephone calls are another sign. Some people obey protocol strictly regarding who calls whom. Any changes here should be noted. Increased Informality and Personal Rapport If your opposite invites you to a business meal, gym workout, or weekend social visit, that's positive movement. During the deal-making process, such outings are a sign of success. The results for both sides might even be good enough to build a long-term relationship. Change Within Organizations Massive change is never made without turmoil and disruption, and deal making energizes the process. What happens to deal making within organizations beset by fundamental ﬂux? This subject is a personal passion. It focuses on how changes are made within organizations in transition. The key is commitment, which I deﬁne as the link between personal meaning and organizational 390 The Art of Deal Making mission. How to study commitment? Much can be learned under conditions of intense religious fervor. The results show remarkable parallels between business and religion. Change in Business and Religion Which pieces of the past do you honor? Which traditions are so sacrosanct that they are forever above challenge? Such questions are addressed at critical times during the life cycles of both religious and business organizations, and the sets of answers that emerge have much in common. Framing the issue for religion: When are doctrines and dogmas still ﬂuid? When do they solidify? When do they ossify? How do beliefs deﬁne the boundary of spiritual groups, and what happens to internal deal making when some of those beliefs must change? Framing the issue for business: When are strategies and policies still ﬂuid? When do they solidify and ossify? How do corporate goals deﬁne the boundary of commercial groups, and what happens to internal deal making when some of those goals must change? The Life Cycle of Change One might consider the issue of doctrinal or strategic change within the context of an organization's life cycle. In the early days of a religious movement or business company, there is generally free discussion between the founder and his or her ﬁrst followers or employees. Doctrines or strategies are hammered out freely and openly, with opposing views vying for dominance. Yet something happens as an organization matures. Doctrines or strategies stiﬀen, then harden. What was once considered loyal somehow becomes disloyal. Whereas at ﬁrst it was supportive to challenge and prune, later it becomes supportive to defend and preserve. The more success an organization has, the more immobile its positions become. The cycle turns on itself, since such doctrinal or strategic rigidity facilitates fracture. The character of internal deal making changes in the process. What to Do? When Business Truth Must Change When a business refuses to change or adapt to new realities…it dies. Remember KODAK, invented ﬁlm and the cameras? It refused to see the future in digital photography, and lost it all…because it refused to change/adapt. 391 The Art of Deal Making Deal Secret-25 Sending the Probes Probes Coax-Statements Coerce What's your game? Puﬃng ego or doing deals? If the former, send barbs, not probes. If the latter, get smart. Often, searching questions–probes–are needed to communicate serious intent in deal making. Probes explore limits and boundaries without risking insult and alienation. They are the best way to discover how far you can go in a deal. Objectives of Probes The following are some purposes of probes. Solicit Information. Get new knowledge from the other side: How old is the building? Transmit Information. Give new knowledge to the other side: Did you know that our building was remodeled two years ago? Project an Attitude. Show the other side your mood: Could you assist me in understanding these numbers? (Beseeching), when are you going to stop retrading the deal? (Showing irritation). Stimulate Reﬂection. Encourage the other side to do some thinking: Assuming we can come close to your price, how much do you really need in cash up front? Focus Attention. Make the other side concentrate on a fundamental issue: If you refuse to do any seller ﬁnancing, is it worth continuing discussions? Finalize the Deal. Bring the other side to a conclusion: If I agree to your last point, can we close in 30 days? Probes that Make Progress These questions usually help. They inform and instruct, thus encouraging the deal-making process. 392 The Art of Deal Making 1. Fact Probes. Questions to gather data and information for building knowledge–asked with neutral emotions: How current is your inventory? What is the aging of your receivables? How much is that doggie in the window? 2. No Limit Probes. Questions that cannot be answered by a simple yes or no: What do you think the future strategy of the business should be? What is your opinion of current management? 3. Sequential Probes. Inquiries that are part of a step-by-step train of thought: If we were to solve the question of price, which issue would then become most important to you? 4. Conclusion-Suggesting Probes. Leading questions of the variety not allowed in court: Since you make money at $7.75 per item, why not sell them to us at that price even if we only buy DIGITS? You wouldn't have made such an absurd oﬀer if my client weren't in Chapter 11, now would you? 5. Introspective Probes. Queries that peer into the inner sanctum of one's mind: How do you feel about selling your business after 25 years? Would you like to consider a consulting contract after you sell? 6. Solicitous Probes. Questions that express an attitude of supplication and appeal: Would you mind if I ask your accountant for help in understanding these schedules? 7. "What If…" Probes. The easy entry for trial balloons. It's hard to get angry at a "What if..." It conveys personal uncertainty and mutual respect: What if we were to reduce your cash at closing, but more than make it up within two years? 8. Questions that Deﬂect. Bounce the ball of inquiry back to sender: Why should I accept less cash up front? Probes that Retard Progress These questions usually don't help. They intimidate and alienate, thus fouling up the deal-making process. Deceptive Probes. Any answer is wrong: The classic, when did you stop beating your wife? Or in business, when did you stop inﬂating your inventory? Bristle Probes. The only purpose is to antagonize: Having made a public fool of yourself, don't you think you should apologize to your peers? Insulting Probes. The respondent is put on the defensive: How dare you charge $450 for last year's model? What prompts you to make such an insolent oﬀer? Spot-Putting Probes. The respondent is put in an awkward or embarrassing situation: Since your boss is here now, tell him to his face why you said that his price was a sham. Intimidating Probes. Confrontation, not information, is the objective: How can your projections be so perfect? Why do you think you're so much smarter than we are? 393 The Art of Deal Making Coercive Probes. Forcing an answer to agree with your opinion: I think that your building is really run down, don't you? Responding to Probes People answer questions in diﬀerent ways, from complete truths to outright lies to clever evasions. Generally, the best way to answer is with targeted, unembroidered information. Everything you say is correct, but your objective is clear and your focus is sharp–there is no loose talk and no words are wasted. Lies may solve the immediate problem, but they can cause bigger problems later. When you tell the truth you never have to remember what you said. But what happens when you just can't answer a question? Side-stepping direct probes is diﬃcult. Try using polite answers that convey sincerity and interest but little substance or information (e.g., "I know how you feel," or "I hear you"). 394 The Art of Deal Making Deal Secret-26 Lighting the Sparks Sparks Start Fires–Fires Warm Or Burn In deals, as in forests, there are two kinds of sparks: controlled and uncontrolled. Controlled and used properly, sparks can start small ﬁres that keep you comfortable. Uncontrolled and used improperly, sparks can ignite large conﬂagrations that scorch and destroy. Sparks that Warm Helpful sparks are elusive to deﬁne and diﬃcult to use. There's the ever-present danger of the ﬂedgling ﬂame ﬂPERSON_NAME out of control. In deal making, your intent can be taken out of context and blown out of proportion. Take care when making these sparks. You really are playing with ﬁre. Kidding and Ribbing You can often say humorously what you cannot say seriously. Jest is a marvelous form of communication, as long as you avoid sarcasm and sensitive subjects. A joshing remark can convey an important message. Do not pick on a single target. And be sure to sprinkle your humor with a healthy dose of self-mockery. Chiding and Chastening This is a cross between constructive criticism and general kidding. The tone is sharper, but the spirit is still good-natured. Such remarks are intended to make a point. You can say, for example, "You are focusing so much on the tax issues that you are forgetting about the business. How about taking that trip to the plants?" Deadlines and Ultimatums Used carefully, setting deadlines and giving ultimatums can push deals to conclusions. They remind everyone there's movement to be made. After all, you can't negotiate forever. Closure must happen 395 The Art of Deal Making or deals must collapse. Put the bad news nicely: "Well, my boss has given me the word. If we don't sign by next Tuesday, we're going to have to solicit other oﬀers." Sparks that Burn Harmful sparks are generated in two ways. Some people ﬂy oﬀ the handle with minor provocation. Sometimes it's words they don't mean; sometimes it's words they do mean but shouldn't say. Other people plot and plan their rudeness. Thinking they can control the deal through coarse dominance, their malice is both insidious and premeditated. Outbursts and Rudeness Loud disruptions and temper tantrums are very unpleasant. They might take control for a time, but they hardly create the proper climate. Negotiating with terrorists only encourages more of the same behavior. Don't cater to it. Don't give in to it. Just wait with a slightly annoyed, slightly bored look gracing your face. Sarcasm and Insults Slurs and accusations heat emotions and compel retaliation. Try to avoid this natural reaction and encourage the decibel-producing party to calm down. If the ranting maniac does not cool oﬀ, the deal is over, anyway. If decorum is restored, you might gain an advantage as the rational party or gain sympathy as the injured party. You have nothing to lose by not jumping into the gutter. Clashes and Confrontations These types of attacks are disagreeable, but they can be constructive. There is an issue to ﬁght about. Try to get the other side to explain their position in detail. Ask complex questions about their views. It's hard to be analytical and scream at the same time. Threats and Warnings These are the most distasteful of all. Here you are being browbeaten and coerced and perhaps intimidated and frightened. You are being accosted by lurid statements of what the other side is going to do to you if you do not agree to their terms. The threats, which are generally vague, should be taken seriously–irrespective of whether they are in fact serious. If the threats are real, it is better to back oﬀ from a deal than to stir such hostility. If the threats are only a ruse, you will force the other side to confront the unpleasant consequences of their inappropriate act. 396 The Art of Deal Making What to Do? As a buyer, your purchase hinges on the quality of the seller's inventory. The stuﬀ is obviously inﬂated well above its current market value. But when you bring up the subject, it's as if you were stepping on a land mine. Boom! Your intelligence is insulted and your character is impugned. What to do? First, keep a lid on your own emotions, which, understandably, may be bubbling over. Don't try to reason with the person until some calm is restored (or at least some quiet). Then start by conﬁrming the behavior in a manner that enables the person to explain away his or her actions. Start by trying to ﬁnd some reason–any reason–to justify the absurd outburst. Yes, justify! Make it easy for the ranter to recant. Even apologize for something you didn't do. Remember, you're trying to do a deal, not exact confessions. "You know, I think I understand what you're getting at," you might begin (with trepidation). "I didn't mean to suggest that you were overstating your inventory for your company just that those goods aren't worth book value to our company... 397 The Art of Deal Making Deal Secret-27 Defusing the Bombs Avoiding Explosions Is Delicate Work There is a ﬁne line between equilibrium and explosion. Dealmakers operate near the ﬂash point where spontaneous combustion is an ever-present threat. Disaster is never far away as any disturbance can trigger a rapid rise in temperature. Explosive Situations Deadlines Once a deadline is set, there's no going back. One of three things must happen: 1. The deal gets done despite adverse conditions for the party not setting the deadline. 2. The deadline is postponed, putting the setter of the deadline in an adverse position. 3. The deadline passes and the deal aborts. Tough choice! Ultimatums Ultimatums in deals focus on speciﬁc issues. Here, there are three possible outcomes: 1. The ultimatum is met and the deal progresses 2. The ultimatum is not met and the deal collapses 3. The ultimatum is not met but conditions are changed Some examples of ultimatums are: From buyer to seller–"Either agree to guarantee the quality of your receivables or we reduce the price 50 cents on a dollar." Or from seller to buyer–"Put up $200,000 good-faith money by PERSON_NAME or we're history." 398 The Art of Deal Making Verbal Attacks When engulfed by a tidal-wave tirade, the issue is how to maintain personal dignity while not conceding deal control. (See Deal Secret 26.) You have a choice of response tactics: Answer softly, allowing the insults to wash on by Answer in kind, confronting strength with strength Proverbs explains both sides of the question: Answer not a fool according to his folly, lest you be like him Answer a fool according to his folly, lest he be wise in his own conceit Defusing Attitudes Attitude more than technique determines how to smooth the situation. Keep Perspective How important is the overall deal? How important is the contentious point? Weigh relative values. Compare current pressure with desired results. Decouple the other side's behavior from your side's needs and wants. If the deal is still good for you in spite of any deadlines, ultimatums, or verbal attacks, stick with it. Look for Negotiating Gain Is the deadline meetable? Is the ultimatum workable? Even if the answer to both questions is yes, try to exact concessions from the other side. After all, they threw down the gauntlet and might be feeling a bit badly. Before succumbing too quickly to their pressure, try to gain some deal trade-oﬀs. Never Judge the Motivation of Others You never know why other people do what they do. You don't know all their problems and pressures. It's tough enough to keep track of your own reasons for doing things. We tend to judge others as if they should be saints while giving ourselves every beneﬁt of every doubt. Consider the boy with old shoes, who felt deprived until he saw a boy with no shoes, who felt deprived until he saw a boy with no feet…. Don't Take Yourself too Seriously Throughout the struggle, keep in mind that this is just one deal. It's not your life. Salvation is not at stake. If you ﬁnd yourself becoming overwhelmed by emotion, call a time-out. 399 The Art of Deal Making Techniques for Defusing The following tactics reduce the likelihood of deal detonation. Deﬂate the Pressure Try to throw the ball right back into your opponent's court. Say something like, "If my answer has to be now, my answer has to be 'no.'" Switch Issues Substitute a viable option for a troublesome condition. For example, instead of guaranteeing all receivables as demanded by the buyer, you as the seller might suggest putting some of the purchase price into an escrow account to cover any possible shortfall. This satisﬁes the buyer while limiting your exposure. As another example, if a seller demands substantial good-faith money from you as the buyer, you might try softening the terms rather than reducing the amount. The idea is that you should have so many outs that it's hardly worth the seller's eﬀort. Puncture Seriousness Relieve the tension of the moment by injecting a little humor. Coaxing a smile from your opponent's face can facilitate a favorable trade oﬀ. Get the other side to see themselves as human beings. Sure, they're professionals doing work, but they should also be people having fun. Humor is the most potent weapon to disarm the dreary. (See Deal Secrets 23, 24, and 40.) Give a Fair Reading Restate the other side's ultimatum or deadline to reﬂect a position with which you could live. You are not being deceptive by modifying their statements–you are overtly trying to make it a livable oﬀer. Assume the seller gives you a ﬁrm and ﬁnal three weeks to close the deal. A fair reading might be "As long as our ﬁnancial institution, as an independent third party, takes to complete its due diligence" –a more ﬂexible time period. If they want to break oﬀ the deal, nothing will stop them. But if they really want to make the deal, they will listen to your fair reading. What to Do? Often the most dangerous situations involve the falling out of trusted employees. As in a marriage and divorce, love and hate are strangely similar emotions. Your strongest advocates can turn into your most ardent adversaries. How to handle the severance of once-loyal employees? These are delicate cases and normal snapback reactions must be tempered. No one ever emerges clean from 400 The Art of Deal Making a mud-throwing contest. Granted, some may come out dirtier than others, but all get splattered if not smothered by ﬁlth. What to do? Always continue talking. It's hard to ﬁght when you're communicating. Look for compromises of pay and position. Often, the public posture of the severance is more important to the employees than the ﬁnancial settlement. After all, future employment may depend on previous reputation (if not recommendations). No other company would want to hire a sore loser. Therefore, try to construct a respectable scenario of departure. Also, inject lightness into your talks. Try to recapture the personal part of your prior relationship. Recall the good days, the mutual accomplishments. Both sides gain by not losing. 401 The Art of Deal Making Deal Secret-28 Playing the Tricks You Can't Trick A Trickster I'm going to describe several dealmaking gambits. We've covered some of these tricks elsewhere; now we play them together. Learn how they work, how to recognize them when they're being played against you, and what you can do to thwart their impact. This Deal Secret–the "tricks"–are designed to be like karate moves–killers that are best used for self-defense. As in fencing, parry is what I oﬀer, not thrust. Lowball Buyer's Version As the buyer, keep a straight face and test the market by oﬀering the lowest possible price. You never know, you might get lucky–recall the chess adage, "Give a check, it may be mate." The seller will scream, but how loud and how shrill will tell you where the deal is going. The greater your relative power the more serious lowball becomes. This is especially true when the seller is under time pressure. Seller's Version As the seller, lowball is less common. The object here is to attract as many potential buyers as possible in hopes that some will become seriously interested. This way, more parties will be around when you raise the price. If a lot of buyers are smoked out, it may pay to go into a formal auction. (See Deal Secret 9.) Highball Buyer's Version As the buyer, highball is a competitive trick. You want to get the ﬁrst shot at the deal and keep other bidders blocked out. Try entering into an arrangement with the seller that limits negotiations to you. Once you get all the inside information, you can make your actual proposal. 402 The Art of Deal Making Seller's Version As the seller, you start by setting the highest possible price while still within the realm of reason. Test the market. Again, give luck a chance–give that check. Buyers will complain, but how strong and how long will tell you where the deal is going. The greater your relative power, the more serious the game. This is especially true when you have no time pressure. Bait and Switch The intent of this gambit is to attract–even entice–the other side with a deal they can't refuse. Once they're hooked, the gloves come oﬀ and the real oﬀer is made. In a sense, this is similar to a buyer's game of highball and a seller's game of lowball. Bluﬃng Bluﬃng is saying one thing and meaning another. Up to a point, it is an accepted part of deal making. For example, a buyer may tell a seller that the oﬀer will only stay on the table for 48 hours. The buyer hopes to shut oﬀ other bids and prevent the seller from shopping the deal. A seller may tell the buyer that other bidders are oﬀering more in hopes of getting the buyer to bid against himself or herself. Bluﬃng is deception but not lying (although I am struggling to explain why not). It is easier to deﬁne where bluﬃng ends and lying begins. Giving false ﬁnancials, for example, is clearly a lie. Speeding up last month's good reports while slowing down this month's bad reports–just as the deal is being consummated–is borderline. Perhaps a good analogy is that bluﬃng is pretending you've got great cards while lying is stacking the deck. Sandbagging In sandbagging, one party strings the other side along, allowing (encouraging) them to think that they have a deal at their price. Only after they have invested substantial eﬀort and resources (sunk costs)–really hooking themselves on the deal–are actual prices sprung. If you ﬁnd yourself on the receiving end of this trick, if you sense sandbags piling up, make the other side be as explicit as possible. Stop and conﬁrm your understanding at every step, preferably in writing. Sting Operation This is more dangerous. It involves the collusion of two or more parties who are conspiring to get the best of you. As buyers, their tactics may involve one of these set-ups to drive your price down: One party lowballing the price to give the other feedback 403 The Art of Deal Making One party highballing the price and then suddenly dropping out to disorient you One party giving you discouraging reports to intimidate you into accepting their compatriot's oﬀer New Entrant As a deal moves toward completion, the other side introduces a new wrinkle to disrupt the deal. Often, the wrinkle is an actual person who has suddenly materialized to conduct the negotiations. The relationships carefully built up over the course of the discussions are shaken. Since you seem so close to closure, and you've sunk so much into the deal, there may be a tendency to give a little extra to placate this new person. (It's like paying an insurance premium.) Sometimes, the new wrinkle is a ﬁctitious third party who has unexpectedly made a better oﬀer. The other side professes to be embarrassed, moaning about their ﬁduciary responsibility to accept the best oﬀer. Although there is no binding contract, they avow a moral responsibility to you– consequently they will give you the option of matching the new oﬀer. Keep your wits about you. The whole scene may be a ruse. The new entrant may only be a bluﬀ. Appeal to Authority Blaming an uncontrollable force is a favorite gimmick. If the person doesn't have the authority, a better oﬀer can't be made. This tactic is especially useful when an intangible, such as the budget, is the target of the appeal. For example, what can you do if the other side says, "It's just not in my budget"? The answer lies in devising creative proposals. Suggest splitting your price, for instance, so that whatever is not in the budget this year can be paid out of the budget next year. Just make sure that your contract is enforceable and carrying costs are included. What to Do? You are being recruited by an executive search ﬁrm for a high-level managerial job that you really want. There are ﬁve other ﬁnalists for the position. Credentials and experience seem about equal. One issue is compensation. What, you are asked, are your requirements? The industry scale at your level is very broad. What to do? If you play highball, you could be deemed expensive or arrogant. If you play lowball, you could be judged cheap or insecure. So, try a combination: Play lowball and highball at the same time. Be willing to take a minimal guaranteed salary, near the bottom end of the scale, and a relatively short contract. But couple it with a performance-based contingency that can produce the highest total compensation in your class. This way, they have the least risk–and you radiate conﬁdence. 404 The Art of Deal Making Deal Secret-29 Haggling the Trades It Takes Two To Make War–Or Make Love There is an old Spanish proverb about getting rich: Buy from those who go to be executed, since they don't care how cheap they sell; and sell to those who go to be married, since they don't care how dear they buy. Unfortunately, we can rarely choose so carefully those with whom we trade. Trading is the essence of deal making. One side gives something; the other side gives something. Both give a little; both get a lot. Bargains are struck. Agreements are made. Value Is Relative If you get what you want, don't worry about what the other side gets. Only you can judge whether you are getting a good deal. It's diﬃcult for anyone else to label your deal good or bad. One just doesn't know another's reasons and motives. Generally, if both sides get what they want, then the values are equivalent. Making Trades Count When making trades, make them count. Surprisingly, much of what's oﬀered in deals is more meaningful to the giving side than to the receiving side. Thus, to make good trades, it is imperative to know what's important to your opponents. Hit these hard. For example, if the seller needs cash, you can probably cut a better price by cutting a quick check. A cash-rich seller, however, might be happier with taking back part of the purchase price in high interest-bearing notes. Finding and pushing hot buttons is more art than science. It involves the senses of touch and smell more than sight and sound. It demands empathizing with opponents and thinking the unusual. First Oﬀers Most people do not give their best oﬀer up front. No one expects them to. It's just not done. You can't swim upstream, so you might as well start in a range where you can make some movement. The percentage of reserves in deals may diﬀer but the principle is the same. No fooling, it's the same. A prominent ﬁnancier told me, "There's always 10 percent in every deal, maybe more." 405 The Art of Deal Making All Cards on the Table Complicated deals contain so many issues that it's easy to fall prey to the salami technique. Each slice doesn't take too much oﬀ, but after many cuts you've lost a lot of meat. Getting nickel-and- dimed to death is a variation on the same theme. Here each little coin seems trivial, but the process never ends. Such deals can rupture more for the annoyance they cause than for the amount they lose. The solution to this problem is to get all the issues out on the same table. Whenever I sense a salami slicer (especially if I hear the jingle of small change in his pockets), I stop discussing any minor matter. no matter how minor. "We are going to get all the issues out on the table," I proclaim, "and solve them all together, not one at a time." I stress that although every issue may be negotiable, they are only negotiable collectively, not individually. I must see the entire puzzle before altering any particular piece. (Gathering all points together is especially important when dealing with those most infamous of salami slicers–lawyers.) Playing the Game In each deal-making situation you must play according to the rules. In the souk, you must at some point begin to walk out, even if you have no intentions of leaving. If you worry, "But I really want to buy," you're an easy-mark amateur. Never forget that the buyer is the one spending the money. Each deal follows its own path to completion. If you go through the required ritual the deal will probably work out. Some corporate dealmakers use tough-talking attorneys to get in some additional whacks. Others blame faraway executives or nameless committees. Preserving the honor of principals is always a primary objective. What to Do? In one corporate deal, we worked on, the parties were about $10 million apart in a $50 million transaction. Negotiations had proceeded as far as possible without resolution. What to do? Suddenly, in the course of a casual conversation, it was discovered that the buyer, not in the real estate business, had a money-losing property that he was trying to dump. The property was worth, to the buyer, under $5 million. The seller, with a large real estate operation, could easily run such a property with minimal additional over-head. To the seller, the property was worth above $10 million. You guessed the outcome; the buyer's property was thrown in as additional payment to the seller and the deal made. 406 The Art of Deal Making Deal Secret-30 Creating the Innovations Being Better Means Being Diﬀerent Deal making is competitive. To make deals that are better, you must make deals that are diﬀerent. That's the purpose of creativity and innovation. Deal-Making Creativity and Innovation Creativity is the generation of original ideas. Innovation is the transformation of such ideas into practical applications. Innovation, then, is the end result, and creativity is how you get there. Innovation aﬀects all aspects of deal making, especially breaking deadlocks and bridging gaps. Almost every deal requires a few twists, some inventive ways to leap high hurdles. Creativity, the process stimulator, and innovation, the deadlock breaker, should not be closeted until needed. They are capricious characters, not accustomed to performing on cue. You must nurture them, caring for them regularly. Good dealmakers think often about novel and unusual ways of doing things. Most people think that creativity and innovation are limited to high technology. This is wrong. The best business examples of creative and innovative management in action come from low-tech companies doing high-tech deal making. Principles of Creativity Develop a Climate for Creativity A creative climate is supportive, with enough freedom to explore individual ideas and clear direction to maintain collective focus. People are told what to accomplish, but not how to do it. They speak openly, not worrying about voicing silly-sounding ideas. Encourage Everyone to Be Creative 407 The Art of Deal Making The freshest ideas can come from the most unexpected sources. Creativity is no respecter of persons. Wide knowledge may not help. Ditto for seniority. Neither technical brilliance nor lengthy experience are sure generators of original proposals. In fact, both brilliance and experience may inhibit creativity by solidifying long-standing grooves of thinking. Reward Success, Don't Punish Failure Creativity fails more often than it succeeds. To talk innovation but reward failure by personal penalty (or, worse, career wipeout) digs deep credibility gaps. To make your team comfortable with taking creative risks, give them a high ceiling for which to leap and a soft cushion on which to fall. Creative Techniques The following are mechanisms and tools for generating original options and alternatives. Most were developed by creativity specialists. They stress the composite character of ideas and the need for making new connections. Note that these techniques are methods for getting the ideas. As such, they are not the ideas themselves. They are the process, not the content. (See Deal Skill 6 to increase receptivity to new ideas.) Linear Techniques Linear techniques apply step-by-step thinking to innovative problem solving. This is the so-called left-brain dominant mode where analytical reason rules. A logical progression builds the next idea on the previous idea. The following eight methods are linear. Break Apart. This technique breaks down a problem into its component parts, lists all possible subparts under each part, and then develops new ideas by combining the subparts in odd and unusual combinations. Mix and match–and watch what happens. Figure 30.1 illustrates how a payment problem is broken apart. Matrix Squares. This procedure lines up two lists of categories, across the top and down the side of the tic-tac-toe-like squares (on X and Y axes), and generates new ideas to ﬁll in each box of the grid thus formed. Being forced to address each empty square stimulates thinking about relationships not heretofore considered. For example, payment schedule (down payment, at closing, in one year, etc.) may be paired with payment types (cash, notes, stock, etc.). Filling in the one year–stock box may suggest a novel contingent payment in common stock (see Figure 30.2). 408 The Art of Deal Making Figure 30.1. Break apart creativity. Suppose payment is the problem in an acquisition. Perhaps you bridge the gap by issuing, for part of the purchase price, a convertible note contingent on future earnings, with full guarantees by the new subsidiary and limited guarantees by the parent corporation. Figure 30.2. Matrix square creativity. 409 The Art of Deal Making Figure 30.3. Force ﬁeld creativity. The tug-of-war between best and worst states when dealing with your boss. Force Fields. Here, a tug-of-war between two opposite conditions–often, the best and worst states imaginable–is used to understand the essence of the underlying issue. The battle fallout is a better understanding of the desired state. For example, assume you are discussing your career with your boss (see Figure 30.3). The best state is a promotion; the worst state is being ﬁred. The procedure calls for pitting each condition against the other by specifying its pulls and powers. Evaluating which of the multiple opposite outcomes is more likely can give insight into what one should do to make the best state happen. Confrontation. Two teams are assigned–both on the same side of the deal–to work out diﬀerent and conﬂicting solutions to the same deal-making problem. The confrontation between these teams highlights underlying assumptions and suggests creative synthesis. After tussling on your side, you are ready for the other side. Assumed Perfection. This technique encourages participants to imagine the best possible deal conditions. The only restrictions are that the deals (or deal points) are technically feasible and operationally possible. A systems approach is used so that each new idea is integrated into a complete deal structure. This process has two purposes: It releases participants from unconscious limitations; and it can suggest ways to approach the ideal. 410 The Art of Deal Making Transforming Ideas. This method uses checklists of concepts to trigger new thinking. Such lists, which can be broadly general or highly speciﬁc, are massaged by various verbal operations: Change? Use? Adapt? Modify? Maximize? Minimize? Substitute? Rearrange? Reverse? Combine? Alternative Scenarios. This approach develops families of related plans to deal with sets of possible circumstances. Patterned after military war games, these contingency-based scenarios assume a radical change from the current expectation (i.e., a discontinuity). For example, the sudden surge of oil prices in the early 1970s and their precipitous decline in the mid-1980s are discontinuities that were ripe for scenario planning. In deal making, alternative scenarios develop responses to diverse possible oﬀers from the other side. What would we do, for example, if the other side unexpectedly oﬀered to pay our price but demanded stiﬀer guarantees? Such exercises are good preparation for handling real oﬀers. It can also trigger new ideas. Intuitive Techniques Intuitive techniques apply holistic thinking patterns to innovative problem solving. This is the so- called right-brain dominant mode where emotional feelings and integrated images control, Logic is overruled. Whole solutions are swallowed in one gulp. Perception beats analysis. The next six categories are intuitive. Brainstorming. Brainstorming sessions are meetings at which a group of people exchange ideas without fear of looking ridiculous. Unconventional ideas are encouraged. The natural tendency to criticize is suppressed. No idea is too wild. No suggestion can be summarily rejected. Session participants use a free association technique in which one idea triggers another. These ideas are listed publicly (e.g., written on a blackboard) and the group is directed toward expanding the scope and outlandishness of concepts. Craziness should be contagious. The only thing forbidden is critical comment. The session's output is a checklist of ideas. Distant Analogies. The technique of distant analogies (i.e., relating things from unrelated contexts) was pioneered by Synectics. It joins together dissimilar and apparently irrelevant elements to suggest new solutions to old problems. These farfetched metaphors are rich sources of connection-making material and can cast new perspective on the problem at hand. For example, an executive who is drawing an analogy between her company and an octopus may seek deals that would attach divisions to customers through multiple tentacles. The process should begin with "How to..." or "What if….” Then, a ﬁeld or domain should be chosen to draw the analogy. Bizarreness helps. A good rule of thumb is that the greater the distance between the ﬁeld of the metaphor and the ﬁeld of the problem the greater the chance for freshness. 411 The Art of Deal Making Analogies from nature–wind, water, sky, ocean, trees, forests –are common. "Making the familiar strange, and the strange familiar" is Synectics' maxim. Imagery. This method uses symbols, scenes, sounds, or feelings as windows to your inner self. It can unlock ideas long in gestation. Imagery can be encouraged in guided fantasies conducted by experts when you are in a state of deep relaxation. It can be used to snap out of ruts and develop radically new approaches for breaking a deadlock in a deal. Dreams. Daydreams and night dreams reﬂect the state of your subconscious. They can suggest remarkable ideas at the unlikeliest times. The key is to write down whatever comes to mind–images, words, moods–before they are forgotten. Allow broad interpretation, since true insight may be hiding beneath the literal meaning. Wishing. This technique surmounts current limitations by allowing you to imagine whatever outcome makes you happy. Idealize outcomes as you would want them. Visualize those marvelous scenarios. Then, while temporarily suspending judgment, verbalize a series of statements that start with "I wish….” Wishing can free thought processes and galvanize imaginative thinking. Meditation. Breathing, walking, chanting, listening to music, and guided fantasies are all meditation techniques. They can be used to tap into one's creative potential and unlock novel ways to get deals done. 412 The Art of Deal Making Deal Secret-31 Managing The Time Time Is A Dealmaker's Most Valuable Resource Strength in sports means nothing without timing. In swinging, throwing, shooting, and hitting, when is more important than how hard. The same is true in doing deals. Functions of Time Time serves various functions in deals: It is the standard of progress against which milestones are measured. It is an ally of the less pressured side and an enemy of the more pressured side. It is a resource to be conserved and spent wisely. Every deal has a critical period. There's a strange spirit in a deal, a mutual feeling of movement that engenders positive feelings. However, pass the critical period and trouble ensues-up emotions swing down and the entire transaction becomes less likely to happen. To make deals, various things must be timed to occur simultaneously. When you are negotiating to buy a business, for example, you must reach agreement, arrange the ﬁnancing, coordinate the legal work, audit the ﬁnancial statements, and plan for future operations-not to mention maintain harmony and focus within your own organization. Principles of Timing The following are suggestions for using timing in deals. 1. Assign Speciﬁc Functional Responsibility. Be sure that one individual is answerable for each independent activity (e.g., accounting due diligence, working with management, factory visits, appraisals, bank negotiations, etc.). 2. Assign Speciﬁc Timing Coordination. Be sure that one individual is responsible for controlling all independent activity. Whenever possible, this person should be the principal dealmaker. 413 The Art of Deal Making 3. Monitor Progress Regularly. Keep in close touch with the key people in each functional area of responsibility. Communicate on a regular basis. Require each area leader to maintain and update a detailed timetable of milestones and accomplishments. Using a personal computer can aid such project planning activities. Deadlines Deadlines add volatility to a deal and kick a series of events into motion. Your side may set the deadlines. You may need to force a ﬁsh-or-cut-bait decision (also known as “- - - - or get oﬀ the pot”). If the other side sets the ﬁrm time limit, you must decide whether it's in your best interest. If it is, ﬁne. If it isn't, what will happen if the deadline is not met? A deadline must always be taken seriously. Never give the impression that you think it is a charade. You must convey the gravity of the act to the other side. Deadline setters must confront the consequences of their actions. However, if you are unsure about just how ﬁrm the deadline is, test its resilience. Ask a question such as: "Our lawyers can't close until three days after the deadline expires-so what can we do to bridge the time gap?" The answer will give you the clue you are looking for. Slowdowns Slowdowns are one side's deliberate eﬀort to stall. They may be playing out an alternative opportunity because they think it could be better. Or, they may be using a coercive tactic because they suspect you are under heavy pressure. It doesn't really matter. The bottom line is that the deal is not going anywhere. What to do when faced with a slowdown? The best counter tactic may be an ultimatum. If the other side is working another deal, you'll put them on the spot-right where they belong. If they're trying to pressure you to make concessions, they'll ﬁnd out that the tables have been turned. Making Meetings Eﬃcient Time is a precious commodity-especially in deal making. Since deal-makers must monitor their time, they should follow these caveats: Meetings need reasons Brief telephone calls can replace long meetings Everyone doesn't have to be at every meeting Specialists (e.g., lawyers and accountants) can meet with their counterparts alone A smaller team can often accomplish more in a shorter time than a larger team can in a longer time 414 The Art of Deal Making Perhaps most important, your team's chief dealmaker must stay personally in touch with all participants working with the other side. Reports, even if brief, should be given after every meeting. What to Do? The buyers willing to pay the most money for a property you must sell have questionable ability to ﬁnance the transaction. They have asked for an exclusive for a period of time in order to line up their sources of ﬁnancing. You'd love to get the price they're oﬀering, but you risk blowing oﬀ the other, ﬁnancially capable buyers. What to do? Give the questionable buyers a tight time frame in which to work. Make the outside date for closing the deal as short as possible. (You can always extend the deadline if the buyers almost have the money-but at that point it would be your option, not theirs.) Next, require a hefty, nonrefundable deposit to begin the exclusive period. This deposit must be suﬃciently large so that it would be very painful for them to leave on the table. At the same time, require convincing evidence that a capable ﬁnancial institution has serious interest. 415 The Art of Deal Making Deal Secret-32 Maintaining The Momentum Go For Mo! Recall the frustration of a faltering deal? We've all felt the ﬁzzle. Suddenly, spirit seems sapped. Both sides lose enthusiasm in the process and conﬁdence in the outcome. Commitment unravels. You don't know what went wrong. Deadlocks and gaps abound-but that's normal for deals. What happened here? Momentum was lost. What Is Momentum? Momentum is the essence of deal making, giving impetus and generating action. It's what happens when the dead weight of inertia is overcome through the application of constant force. Momentum is exciting. Once started, it's hard to stop. Once stopped, it's hard to start. Deal-making momentum is the exhilarating sense of energized activity. The payoﬀ is twofold: (1) making the buy or closing the sale and (2) obtaining the personal pleasure of being a winner. Momentum is more attitude than action. When seeking momentum, never be satisﬁed with the status quo and always be on the lookout for new ideas-new methods to bridge gaps, new ways to break deadlocks, new approaches to solve problems. Momentum and Progress Momentum is movement. Progress is a step or steps toward an acceptable goal. Either can be present without the other. However, momentum without progress is too wild and progress without momentum is too tame. In deal making, momentum without progress runs the risk of running rampant and progress without momentum may falter short of the goal. Methods for Maintaining Momentum Momentum won't maintain itself. That's contrary to the laws of physics (friction depletes it). Momentum requires force, force needs energy, and energy demands eﬀort. It's no diﬀerent in deal making. Three elements for maintaining momentum follow. 416 The Art of Deal Making 1. Reach for Attainable Objectives. Two concepts reside here: reach for, meaning exceeding current grasp; and achievable, meaning within your capacity to get done. Nothing slows momentum more than objectives too easy or objectives too hard. If you do not stretch, over- conﬁdence sets in, or, worse, boredom. If you do not believe in the likelihood of success, discouragement sets in, or, worse, depression. Both suck out needed energy and momentum stops. 2. Always Keep Moving. Momentum has an odd cumulative quality. Once it begins to slow, it is hard to speed up. Just as a bicycler must begin pedaling faster when approaching a steep hill, deal-makers must work harder when approaching sticky situations. It is your job to keep the action going. Always have the next step planned before the last step ends. If you can't make progress on central issues, work on peripheral issues. If there are no easy problems to solve, look for odd ones or make some up. Sometimes the illusion of progress is enough to keep the deal rolling toward completion. Consider the old airline joke where the pilot announces, "I have good news and bad news. The good news is that we're making excellent time. The bad news is that we're lost." While making excellent-time-though-lost is not too cool for a pilot, it isn't so bad for a deal-maker. Maintaining the atmosphere of forward motion contributes to the problem-solving spirit needed to handle those knotty, axial issues. 3. Bypass Problems, then Circle Back. It is not easy to keep moving forward, especially when unexpected obstacles crop up. If a seemingly insoluble problem arises, don't despair. Go on to simpler matters instead. You can always return to the thorny one later. In fact, it is often easier to resolve an open issue when it is the last one remaining on the table. Furthermore, the bare passage of time solves many problems by making them irrelevant. Conveying Interest How to show the other side that you really want to move the deal along-without looking like a supplicant? The following subtle actions can sustain momentum. Roll Up Your Sleeves. Get to work. Dig into ﬁgures. As buyer, investigate what you'll receive. As seller, assist the buyer to make investigation. Go Kick the Tires. Get out of the oﬃce and into the ﬁeld. See the stuﬀ. Give Compromise Hints. Float trial balloons. Use pregnant questions. Oﬀer tentative suggestions. Go oﬀ-the-record. Use Informal Occasions. Invite the other side to more informal settings-meals, sporting events, or social activities. 417 The Art of Deal Making Deal Secret-33 Making The Close Closing Deals Is The Bottom Line Negotiating deals and not closing is like getting married and not mating. You can't be a good dealmaker unless you're a good deal closer. You can be weak in any of the other Skills or Secrets but not this one. You must be able to put that ﬁnal knot on the noose, that ﬁnal nail in the coﬃn (Ugh!-I like love-making analogies far better). Good deal closers focus on the desired outcomes. They see their goals clearly and keep them always in mind. Closing the deal takes a bit of bravado: You need guts to go for it-and the smarts to know when and how. You need not await a magical moment. You can end it all at any point. You can make the winning touchdown from any place on the playing ﬁeld. Smell the Close The best sign that a deal is ready to close is a suggested compromise on the critical outstanding issue. The oﬀer should be made on the most contentious problem, the one that was most resistant to solution. Furthermore, it doesn't matter whether there are other unresolved issues still outstanding. Other signs are certain telegraphic phrases, for example, “I think we can work this out. . .” in response to any oﬀer you make; or “We need to rock this baby to sleep.” Watch for a lower tension level. A signal can be a change in tone of voice. Even before the ﬁnal points are decided, conversation becomes more relaxed and informal, and humor picks up. Often, you can test the waters by initiating such relaxed conversation yourself. If you do not get back reciprocal relaxation, you know you're not ready to close. Even if you get a positive response, you must judge whether you're really ready to close or the other person is just being friendly. 418 The Art of Deal Making Isolate Final Points Closing deals means obtaining agreement on every issue. This is a formidable task. There are two general approaches: 1. Attack the major issues head on and leave the minor ones for later mop up 2. Solve all the minor issues ﬁrst and then confront the now-isolated majors. Which approach you choose depends on circumstances? When the deal looks relatively simple, or when the parties are not PERSON_NAME far apart on the primary issues (such as price), you can go for a quick close by negotiating the major issues up front. When the deal is more complex, or when the parties remain far apart on the primary issues, then it is smarter to surround the problem by resolving the minor issues ﬁrst. Who Makes the Push Making the ﬁrst move toward closure scares some dealmakers. They imagine it to be a sign of weakness. It isn't, although the possibilities of being rebuﬀed can be daunting. I like to take the initiative. If it fails to get proper results for whatever reason (timing, oﬀer, etc.), I make sure that the rejection does not aﬀect my own self-image. Knowing when to Stop There are two kinds of stops in deal making. Although they are opposite in intent, the same principle-sensing when to cease and desist-applies to both situations: 1. When to Stop Pushing for More. Work your tail oﬀ trying to maximize your value, but when you're ﬁnished, be ﬁnished. Some deal-makers never cease scheming. They're still negotiating as they sign the ﬁnal documents. The sure sign of PERSON_NAME the limit is an escalation of irritation on the other side. When you've gotten what you can get, call oﬀ the dogs. 2. When to Stop Trying to Close. Recognize that some deals never will be ready for signature. But some dealmakers press obliviously forward-annoying the other side and frustrating themselves. If at ﬁrst you don't succeed, sure, try again-but not again and again, at least not in the same way. Looking Good Human beings seek admiration in the eyes of their peers. There is no principle more fundamental in making deals. Remembering it makes you wise. Applying it makes you win. 419 The Art of Deal Making Always strive to give the other side something they can repeat with pride to others. Consider their reactions as you plan the close. Think how they'll explain the deal to superiors, subordinates, even friends and family. A small concession, especially a cosmetic one, can work wonders. Problem Types Lots of characters are dealmakers. Some give headaches by not being able to close. They always want to excise more ﬂesh, to perpetually nibble your hide. These characters keep grinding for gain. Nervous types are also unable to close deals. They are too scared to complete a transaction, worrying constantly about all the things that could go wrong. These characters keep looking for loopholes. How to handle problem types? Nibblers must be smacked on the snout. A hard shot, this they understand. Just tell them categorically that, "If you want to close, close; if you want more, kiss oﬀ." The frightened types are more diﬃcult to handle. Pressure will alienate, not coerce. You must give them room. After the Deal Closes Good dealmakers do more than pack up their briefcases after the deal is done. They look for ways to express their appreciation for both the deal and the people doing it. Maintain contact for a while. Consider giving some needed assistance that is not covered in the contract. The ﬁnal point is what not to do. Never boast about besting. Crowing is for the birds. Even if you did get the better of the deal, forget Never make the other side feel beaten. If anything, do the opposite-show the other side some additional beneﬁts of the transaction. These actions will boost your reputation. They will also encourage the next deal. Good dealmakers view every just-completed deal as the forerunner of a yet-to-be-started deal. 420 The Art of Deal Making Deal Secret-34 Employing The Pros They Work For You-Not You For Them Attorneys are trained to break deals. Like Pavlov's dogs they are conditioned to salivate when hearing the bell of bad news. This is not slur, it is just fact. Negative attitudes of lawyers is as much a natural law of commerce as parental love for children is a natural law of biology. I cast no blame. They can't help it. It's the way the system is designed. Attorneys, you see, don't proﬁt from deals that get done. But they sure take the heat for deals that get undone. Listening to lawyers can turn optimists into pessimists, pollyannas into cynics. There are problems behind every deal point; there is no issue without peril. No deal, it can seem, should ever be made. Deals, by deﬁnition, have risk. You accept risk in order to seek reward. The amount of reward must match the degree of risk, with the former well exceeding the latter. Attorneys and accountants explain the risk. Only you know the reward. Use Their Independent Judgment Don't get the wrong idea: You must push your professionals to their limit. Ask them to go over the deal from top to bottom. Maximize the full extent of their expertise. Encourage them to be rough and tough, vigorous and vicious. Throw them raw meat. Exhort them to exercise independent judgment, to disagree with you and your deal. If they do anything less, they're not doing their job. "I am counting on you," I inform my attorneys and accountants solemnly, "to un-earth all the issues I've missed. Excavate and exhume if you must, but ferret out those problems." Due Diligence Due diligence is the name given to the procedure that transpires between negotiating the deal and closing it. The process involves checking all books and records to determine if what has been represented to be true is indeed true. Normally, the buyer's team conducts due diligence on the seller's property. (The seller may conduct some due diligence if they are taking any of their consideration for the deal in buyer stock or notes.) Risk assessment-lurking dangers and potential threats-is the primary role of attorneys and accountants. The due diligence process searches for skeletons; for example: Undisclosed liabilities such as underfunded pension funds or contingent guarantees 421 The Art of Deal Making Overvalued assets such as inﬂated inventories or improperly reserved receivables Long-term contracts to sell goods and services priced below cost Potential legal insults such as product liability suits not covered by insurance Tax problems Finding the problems is ﬁne. But you should also ask the pros to suggest possible solutions. You do not want to change the deal more than once. Hidden Opportunities While your attorneys and accountants are conducting their due diligence, prompt them to keep an eye out for hidden opportunities. A few examples: Low-cost debt, such as industrial revenue bonds LIFO (last-in ﬁrst-out) inventories with a buried layer of low-cost raw materials Law suits against vendors, customers, or insurance companies with likelihood of collection Overfunded pension funds that can generate cash Fully depreciated assets that have signiﬁcant value Raw land carried on the books at minuscule, long-ago costs Investment assets such as minority ownership of other companies that have appreciated above book carrying costs. It's Your Deal After the professionals have found all the problems (and then some), it's your turn. Never forget the big picture-why you wanted to do the deal in the ﬁrst place. Although the deal may now look like a technical jungle-a thicket of legal thorns and tax bristles-don't despair. Instead, weigh the original beneﬁts of the deal against Just how problematic the issues are, Whether there are solutions to these problems, and Whether you think the deal is still worth doing. Balance the risks turned up by the pros against the rewards of the original idea. It is, after all, your deal and your decision. (If you decide to get out of the deal, the pros are your best resource. They can always ﬁnd convincing reasons to back out.) 422 The Art of Deal Making Using Consultants Consultants are freelance experts in a particular ﬁeld; they are well positioned to give an unbiased assessment of the deal. (Their only bias is to recommend, as part of the ﬁrst study, that you should continue with a second study.) Consultants, it is said, will ﬂy across the country to give a speech, but won't walk across the street to hear one. A less kind deﬁnition frames consultants as people who, having been ﬁred from a previous job, can't seem to ﬁnd a present one. My point is to be selective. There are numerous consultants around. Few are really good, but some are outstanding. In appraising a potential deal (normally an acquisition), consultants should bring three strengths to the table: experience and expertise in the speciﬁc industry or ﬁeld, a good nose for sniﬃng out opportunities and threats, and true independence of judgment. Getting the most out of consultants means using them for highly speciﬁc purposes. Consultants are excellent for: Technical analysis of products and markets Assessing distinctive competencies of companies Estimating competitive advantages of ﬁrms Formulating alternative strategies Evaluating diverse scenarios A good analysis of a business should include detailed information on every critical aspect from product technology to cost structure to distribution systems. The more general the assignment the more nebulous the product. If you are not satisﬁed with a consultant's work, the blame should often fall on those who structured the task. What to Do? How to overpay and get rich quick? Simple if you know what to buy and how to buy it. Mix ﬁnancial leverage, managerial ownership, and professional structure. It's called a leveraged buyout (LBO), and what it does is cure the healthy. Take a sound company strong with equity. Sell it. Make it sick, heavy with debt. Make it better by rebuilding equity. Sell it again. Reap your proﬁts. What to do? An LBO looks like it's done with mirrors. Recall the classic PERSON_NAME's $50+ million bonanza in a period so short he might have been caught for ordinary income, not capital gains. PERSON_NAME simply bought PERSON_NAME Greeting Cards from a tired RCA and then sold part of it back to a ravenous public. PERSON_NAME's timing was good, but his structure was better. What did the former Secretary of the 423 The Art of Deal Making Treasury put up? Only a few hundred thousand dollars, which, if you look closely, was hardly put up at all. That deal kicked oﬀ the LBO frenzy! How do LBOs work? Here's where you need attorneys. First, investors chip in a small amount of cash. This equity is then leveraged, 10, 20, even 50 times with debt. All senior funding-and this is the essential part-is secured by the acquired ﬁrm's own assets. Lending limits, for example, might be 80 percent of receivables, 50 percent of inventories, 25 percent of plant and equipment. The ﬁnancial institutions get a nice premium for their risk, several points over prime. Often there needs to be a middle layer of subordinate debt, taken back by the seller or bought by a third party. (If bought by a third party, this mezzanine money demands a piece of the equity, called a "kicker," in addition to a higher rate of return.) The touchstone of LBOs is cash ﬂow. Here's where you need accountants. Almost nothing else matters. Proﬁt and loss statements, surprisingly, are almost irrelevant. All that counts is whether, when, and with what safety you can meet interest coverage in the near term and can pay back principal in the long term. (Such payment schedules can be staged, with endless variation, to meet anticipated forecasts.) A nice feature in calculating cash ﬂow is tax payments, or, more accurately, the lack thereof. Paying an inﬂated price can thus present no problems. The acquirer could merely write up company assets and generate higher write-oﬀs for depreciation-in addition to already hefty interest deductions. Similarly, companies with tax losses have a competitive edge in LBO acquisitions. You only have to watch the windows. Downdrafts in this business cause quick pneumonia. Sensitivity analysis is critical. What If games are not games. You had better be awfully sure you can weather any storm. Default sits right overhead in those low-altitude rain clouds, especially during the ﬁrst few years. A slight change in market, pricing, margins, overheads, and especially interest rates, and in blow the banks with their liens in one hand and auction blocks ir, the other. (Or do they? When you owe small money, you have a creditor; when you owe big money, you have a partner!) LBOs work, notwithstanding the extraordinary debt, because of the structure. Assets not being properly employed, such as current inventory, are shrunk down making a more eﬃcient operation. Subsidiary businesses may be sold oﬀ for values far in excess of their cash-generating potential. But the key to successful LBOs is management. LBO ﬁnanciers insist that operating executives take part of the action. They require that management go at risk-making great gain on the upside and suﬀering serious loss on the downside. Savvy investors never do an LBO unless those who run target companies get a good hunk of the equity, at least 10 to 20 percent, and put up hard cash to buy it. 424 The Art of Deal Making The critical transition, then, occurs inside the heads of these executives. Previously employees, they are suddenly owners. Professional managers with company-paid perks change mystically into personal entrepreneurs who turn out every light. Participation and commitment grab the essence of motivation. It is a remarkable transformation. To be general manager of a conglomerate division managing public money is one thing. To be president of an independent company building private wealth is quite another. Take the decision- making process. Which will it be, a new corporate aircraft or an upgraded manufacturing facility? Think of the enhanced eﬀort and reduced costs. When management is galvanized, the company is rejuvenated. And the key to the deal is professional structure. 425 The Art of Deal Making Deal Secret-35 Coaching The Team Leverage Your People Leverage in mechanics is the ability of a small force to move a large object. Leverage in ﬁnance is the ability of a small amount of equity to control a large amount of assets (see Deal Secret 34). Leverage also applies to deal making. Here, it is the ability of good deal-makers to multiply themselves by working with a group of key individuals. Just like a good surgeon uses assistants to open and close a patient, a good dealmaker uses assistants to handle various matters. Roles on the Team Deal making has various parts, some of which should be delegated to members of your team. There is no sense having everyone do everything. There's no leverage in that. Always staﬀ for strength. Use each team member's talents for your advantage. Never allocate eﬀort to improve weaknesses. Team members will vary in ability, experience, and interest. Give each one what he or she likes and does best. For instance, some people excel at the initial scouting of possible deals, others enjoy the due diligence process, and still others like coordinating the ﬂow of activities. Seek balance in assignment structure. Make your tasks too loose and you lose focused motivation and personal commitment of the individuals. Make your tasks too rigid and you lose innovative interaction and brainstorming dynamism of the group. Deal making is both art and science, and you need both creative types and analytical types on the team. You also need someone who knows where each type belongs. Coordinating the Team One person should be responsible for assuring that all tasks are running in proper sequence and schedule. That person should be the principal dealmaker, or someone close to the key person. Progress should be monitored regularly. Few days should pass without communication. 426 The Art of Deal Making Ego and Attitude There is one cardinal rule for deal teams: Never air your diﬀerences in public. (Exception: when the overt diﬀerences are part of a planned strategy.) People who make deals have notoriously active egos. They think much of themselves, often more highly than they ought. They have strong opinions about things, and if those opinions are rejected, they may suﬀer or sulk. Caring for a deal-making team can require the temperament of an opera impresario. Prima donnas abound-you never know when they will go manic or depressive. Deal-making types may be pampered and protected, though they shouldn't be coddled or spoiled. PERSON_NAMEﬄing the Team Let's say you're in deal-making purgatory: Deadlocks can't be broken; gaps can't be bridged; momentum has stopped-and the deal has stalled. Worse, emotions have frayed on both sides and sparks are beginning to ﬂy. You need to do something fast. Try something diﬀerent: Rotate your team. Break the accustomed relationships. Make each member of your side work with a new member of the other side. Go as far as having non-attorneys work with attorneys. The change in perspective can only be beneﬁcial. After all, you have little left to lose. What to Do? Two large military companies are negotiating to bid an advanced ﬁghter aircraft. The contract will be worth billions. How to split the spoils is the issue. But these defense companies know that if they PERSON_NAME the deadline, neither gets anything. Furthermore, there's an enormous amount of preparatory work prior to bidding. What to do? Coaching the team also applies to negotiating joint ventures. Win-win structures focus on areas of responsibility for the joint venture partners. The best solution would have each side desiring a diﬀerent area (e.g., one might want the airframe construction and the other might like the electronic controls). If both want the same area, accommodations must be made. When a deadline is imposed by external circumstances, the two sides are on the same side. If an agreement can't be reached, new partners must be sought. 427 The Art of Deal Making Deal Secret-36 Figuring The Numbers Counting Counts-But Not Too Much Figures lie, it is said, and liars ﬁgure. Numbers often appear to be statements of absolute truth. This is illusion. In doing deals, you must understand where numbers come from and how they are calculated. Equally important-and often forgotten-are the numbers that aren't available. Fooling around with numbers is really rather easy. Proﬁts and Cash Many a bankrupt company had a stellar record of steady proﬁts until the day it ﬁled Chapter 11. There have been companies, for example, that booked sales as "revenues" even though all they ever received for their products were weak promises to pay-uncollectible accounts receivable that eventually had to be written oﬀ as worthless. The "proﬁts" were always on the books-but the cash was never in the bank. When evaluating companies, stock analysts have come to realize that cash is king, and that watching the statements of changes in ﬁnancial position, especially as they related to cash ﬂow, can be more important than tracking proﬁtability. This is often proven by LBOs which may never show proﬁts (due to high interest and depreciation)-but can eventually be sold for huge capital gains (see Deal Secret 34). Trends and How They Look Using the same ﬁnancial records, a company can be made to look either exceptionally desirable (if you're negotiating to sell it) or pitifully undesirable (if you're negotiating to buy it). Four principles come into play here: internal comparisons, external comparisons, choice of data, and choice of graphs. Buyers and sellers will view each diﬀerently. 428 The Art of Deal Making Internal Comparisons: Watch Your Base You want to make the company look as good as possible by showing high growth. High growth will justify a high multiple of earnings. No matter, go get a premium price for this blazing star. As a buyer, you want to make the company look as poor as possible. You want to show low growth, or, better yet, high volatility, in order to justify a low multiple of earnings. The general rule: The seller puts his or her best foot forward by choosing the base years carefully. The buyer must be sure to look at all the years. External Comparisons: Watch Your Competition If you are the buyer, compare the company to better-performing competitors. If you are the seller, look at poorer performers. If it is not obvious which companies are indeed competitors, the process gets tricky. Choice of Data: Watch Your Numbers Deciding which numbers to highlight, and which to hide, is also part of the show. Say a public company is growing by making acquisitions for stock. The absolute amount of sales and proﬁts might evince impressive growth, but if high prices were paid for the acquisitions (multiples of earnings for the acquired companies greater than that of the acquiring company), the earnings per share of the acquiring company would be declining and so might the stock price. Shareholders seeing the proﬁt increases might be perplexed as to why their value was eroding. 429 The Art of Deal Making Deal Secret-37 Crafting The Words Meaning Is More Than Words So you have a deal. Talking, you've done lots of. Writing, precious little. Now that you have an oral agreement, it's time to put the understanding into words on paper. It's amazing how diﬀerent the deal looks in black and white. Document Authorship Who prepares the documents? Which side takes the ﬁrst cut? There are two approaches here. Generally, when you draw up the ﬁrst draft, it's your outline and structure that controls the contract process. Thus, it is better to prepare the document and have the other side oﬀer suggestions for change. However, if there are still some ambiguities in the deal, you face a dilemma. If your side prepares the papers, you might antagonize the other side-or give away something unnecessary. In this case, it might be better to have the other side write the ﬁrst draft. Perhaps they'll state the ambiguity in your favor. If not, you can always discuss the matter. And, if you aren't happy with their draft, you can always rewrite it. If you do so, include at least some of their language to avoid a battle of wills among the lawyers. When to Start Writing Not Too Late Sometimes it is wise to write up the deal elements at various stages of negotiations. Doing so can prevent misunderstandings from solidifying. By spelling out the deal points, you uncover problems not resolved and even issues not discussed. 430 The Art of Deal Making Not Too Early Be aware, however, that a written document can highlight-even exacerbate-any real gaps between the parties. Sometimes it's better for such gaps to go unnoticed for a while. If focused on too soon, they may retard momentum and disrupt the deal. If ignored, these gaps might be narrowed through later discussions, or at least not interfere with the resolution of other issues. Types of Documents Term Sheets Term sheets are two-to-three-page summaries of deals. They are drawn up to conﬁrm an oral agreement and only stress the major issues. Term sheets are generally neither morally binding nor legally enforceable. Thus, they are rarely signed. I ﬁnd term sheets extremely useful in making deals-all parties can focus on each deal point without ambiguity or personality inﬂuence. Term sheets are so important that I write them myself not trusting them to attorneys. Often there are good vibes and strong momentum at this stage, and lawyers can slow the process and confound the issues. Don't misunderstand. Attorneys are essential for deals-but not for this function. The legal issues lawyers bring up are necessary and you'd be in thick soup if you ignored them-but term-sheet time is not the time to address these technicalities. Term sheets are tools for conﬁrming agreement on the cardinal issues, and you don't want minutia impeding progress. Memoranda of Understanding (Letters of Agreement) Memoranda of understanding (MOUs) are more oﬃcial statements of the agreement between the parties. MOUs, which can run more than 10 pages, describe all essential elements of the deal. They facilitate the preparation of contracts by exposing most of the issues. It is often stated explicitly that the MOU must be replaced by a formal contract to be binding. Nonetheless, MOUs are often signed and the parties can begin to act as if the deal were in eﬀect. Lawyers must prepare and critique MOUs. Formal Contracts Formal contracts are the last step. Good attorneys shelter the principals from the ritual and tedium, but they always report any business change or diﬀerence from the expected structure, no matter how small. Attorneys from both sides generally work together to smooth the logistics of closing. Pre-closings are often necessary to coordinate all the paperwork. Simply getting all of the signatures on all of the documents-some of which, we'd predict, will just have been changed-can take hours. 431 The Art of Deal Making Document Style Documents can be prepared in many ways. Your approach depends on what position you're in. If you feel that the deal is good for your side and should be done quickly, then go for documents that are straight, speciﬁc, simple, clear, and fast. If there are still some points that need to be resolved and delay is to your beneﬁt, then aim for documents that are tricky, general, complex, turgid, and slow. You can always trade oﬀ the ambiguity in a ﬁnal give and take. Keep in mind that turnaround time for documents is important in maintaining momentum. When you have an agreed deal, you must have a killer instinct to close it. More than one deal has died between lawyers' edits and choking word processors. You need an attorney who is the rarest of the breed, a maker not a breaker of deals. 432 The Art of Deal Making Deal Secret-38 Avoiding The Pitfalls One Fumble Spoils The Whole Game "Don't cough up the ball," coaches implore their teams. Football games are often determined by which side makes the fewer turnovers. The same is true in deal making: Whichever side makes the fewer mistakes is likely to achieve its objectives more easily. Some common pitfalls are summarized here. (Several have been discussed in prior chapters.) Your goal is to understand these deal-making traps, watch for them, recognize them, and avoid them. Faulty Information Errors of fact are an inexcusable gaﬀe. Any information used as a basis for a negotiating position should be both accurate and appropriate. Premature Threats Demands and ultimatums, whether blatant or subtle, are part of the deal-making process. But timing is critical. Shooting too soon looks ridiculous and has little eﬀect. Worse, it ruins the potential power of these tactics at a later stage. Unplanned Anger Showing anger without objective can adversely aﬀect both the deal and your reputation. All dealmakers get a little hot at times. Frankly, it's not necessarily bad to show some viscera-it warns the other side that this stuﬀ is important. But rage without reason does more harm than good. Personal Insults As for me, I never do it. I don't like to intimidate and I refuse to humiliate. No deal is that important. Also, it never works, not in the long run. Even if everything you say is true, you're building up resentment. What goes around, comes around. 433 The Art of Deal Making People Antagonisms Friction between the sides sets up barriers to making deals. The only people you dislike, if you think about it, are the people you know. With big stakes involved (ego above all), it's easy to project your frustrations on to the other side, to blame them for your faults. Control your personal feelings and get the job done. Cozy Relations Getting too friendly with the other side can lead to conﬂicts of interest. These may not be either immoral or illegal, but it still could be a detriment to doing good deals. Avoid even the appearance of potential conﬂict or compromise. Talking Too Much A big mouth can lead to big trouble. Never forget that the other side is the opposition and you must watch what you say to them. You can be forthright, sure, but don't be foolish. You should be friendly, you can be informal, but always control your tongue. Everything said should be planned. Fear of the Unknown Never worry your way into deals. Concern about speciﬁcs can be helpful, but general agitation is detrimental. Good preparation is the best antidote against fear. Showing Anxiety Exposing nervousness among dealmakers is like spilling blood among sharks. Neither is recommended for continued well-being. Such apparent weakness invites aggressiveness. Feeling Inferior This problem is more in the head than on the table. You may have less knowledge than the other side, or wield less power, but at the bargaining table all are equal. Everyone has the same ultimate weapon: The word is "no." Early PERSON_NAME It’s almost never good to show weakness in deal making, but it's disastrous at the outset. The emotional imprint for the entire negotiating process is formed up front. Even if your side has less power and control, hide it at ﬁrst. Throw in some confusing signs, some swagger and brag if you must. You might even threaten an early abort. 434 The Art of Deal Making Being Nibbled Giving up little by little can quickly turn into giving up more than you ever intended to concede. This salami technique of getting slivered by small slices must be avoided. State that all ideas and proposals will be considered, but simultaneously-not sequentially. PERSON_NAME When your head rules your heart, you can focus too much on facts and too little on feelings. People make deals for personal reasons. You can be right and still be wrong, winning battles while losing wars. Too much rational analysis of deals may slight the human factors. Too much numerical emphasis, too much quantitative decision making, can inhibit or destroy the insight and intuition needed to do deals. You can structure brilliantly, but if you don't also persuade pleasantly, you can lose what you should have won. Never forget, deal making is a people-intensive process. Excessive Emotion When your heart rules your head, you may ignore facts and make emotional deals. Getting too attached to deals can lead to volatile decisions. Too much emphasis on intuition can dissipate or negate the detailed examinations needed to do a good job. Never make an emotional deal without knowing the logic behind it. Overriding logic with gut feelings is ﬁne-as long as you remain fully aware of what you are doing. Never forget, deal making involves value and consideration measured in dollars and cents. Too Little Principle A good reputation takes many years to build and a few minutes to destroy. Think about that in every deal you do. Too Much Principle Too much principle can also thwart a deal. Can't be too principled, you say, just like you can't be too rich or too thin? Well, that depends on deﬁnitions. Having too much principle is a lot better than having too little. This is certain. Still, some people set standards that are spuriously high only because they seek to sustain their own lofty self-image. Ego, not morals, is the real stumbling block. Ego, remember, is the great killer of good deals. 435 The Art of Deal Making Deal Secret-39 Doing The Work Work Must Be Fun Work doesn't exist-not unless you would rather be doing something else. People do not suﬀer because of hard work; they break down due to worry, fear, tension, and anxiety. The work of good deal making is exhilarating. It invigorates the spirit while engaging the mind. But have no illusions. Good deal making is hard-rigorous, arduous, strenuous, demanding, exacting, enervating, and exhausting. It is concentrated and intense, requiring both mental eﬀort and social grace. It taxes all your resources, demanding people perception as well as technical precision. Doing deals is real work. Taking Stock We're almost ﬁnished now. We've been through the 10 Deal Skills and just about 40 Deal Secrets. We've said so much about deal making that you may be a little shell-shocked. How to pull it all together? Relax. You don't have to memorize everything I have said. Absorbing the ideas and experiencing the stories doesn't mean instant recall of every point. Your subconscious is getting it, even if you feel a bit overwhelmed. Perhaps it's like a ﬁrst lesson in golf or tennis. The instructor tells you how, where, and when to move each limb. You can't remember it all, much less coordinate it together. But with practice, the diverse movements all begin to fall into place. So take a deep breath and a step back. What follows is summary. If you remember and put these principles into practice, you'll be a good maker of deals. 436 The Art of Deal Making Be Committed and Focused You must be dedicated, persevering, and intense. Good dealmakers are single-minded in pursuit of their clear goals. They have a great desire to succeed and always seek new solutions to old problems. They make better deals because they focus on objectives. Keep Flexible with Multiple Options You must have various alternative deals from which you can select. Good dealmakers know that the most critical decision is often made up front, deciding in advance which deals are most doable. They know that maintaining other possible deals outside the current transaction improves negotiating strength. They are creative in devising innovative strategies, structures, and bargaining ideas. They make better deals because they have greater choices. Shoot Riﬂes, Not Shotguns You must hit the trunk of the tree, not fool with the branches. Good dealmakers go for the jugular, not to kill but to close. They know what issues are critical to resolve, what both sides need and want, what techniques bridge gaps and break deadlocks. They know where to ﬁnd regions of win- win arrangements. They aim straight and true. They make better deals because they select the right problems to solve. Seek Progress, Not Puﬀ You must concentrate on doing the deal, not building your image. Good dealmakers focus on resolving issues, not enhancing power. They are socially aware, keeping track of characters and personalities on both sides of the table. They make better deals because private ego is subservient to collective beneﬁt. Have Fun You must like the action, not just the results. Good dealmakers love what they do as well as appreciate what they get. They relish the deal-making process and look forward to every new occasion. They ﬁnd opportunities exciting and problems stimulating. They make better deals because they enjoy what they do. So, Enjoy! Deal-doing work, above all else, requires deal-doing fun. Doing the work means having the fun. 437 The Art of Deal Making What to Do? A private company was locked in severe strategic disputes that threatened to incite senior resignations and organizational fracture. The chief executive oﬃcer was maintaining an absolutely indefensible position. I was sitting with the top management group listening to the prime protector of current policy present a series of tortuously complex arguments that I was sure no one understood. Yet the older conservative executives, the keepers of the moribund status quo, reveled in watching the younger liberal executives, the proponents of constructive shift, ﬁnally being put down. "Well, that takes care of the rebel rousers," smirked a senior manager after the sinuous presentation. "We won't hear from that crowd again." I was furious. What to do? The subject cut to the core of company mission. To keep the old ways would invite organizational collapse. So, corralling my overactive emotions and restraining any sarcasm in my voice, I put a question to this smug senior manager, "Of all the excellent arguments defending our current strategy, which did you think was the very best?" The older manager, who couldn't possibly have understood what he had heard much less repeat any of it, fumbled a bit, then admitted, "You know, I never could follow anything that man ever said." Slinking away, he never discussed the matter again. Well-chosen words, even a few of them, can cut a sharp edge. 438 The Art of Deal Making Deal Secret-40 Having The Fun Fun Today Must Be Fun Tomorrow If work is whatever you need to get done, then fun is whatever you like to be doing. Deal making must be both fun and work: You should like to do whatever you need to do. A wealthy dealmaker was asked why he continued working so hard into his late 70s. "My friends play golf," he said, keeping his eyes glued to obscure ﬁnancial notes; "I make deals." He explained that he likes doing what he's PERSON_NAME good at doing-a category that did not include driving, chipping, or putting. Good dealmakers have fun doing their deals. What's to enjoy in deal making? How to have fun amidst the tension? The following attitudes should help. Relax Manner and demeanor are important. How you feel governs how you act. Don't allow pressures to overwhelm emotions. No deal is that vital. Cool beats hot. But the deal's getting away, you say? Don't be anxious. If a horse runs away, says a proverb, don't fret; if it's your horse, it will come back; if it's not yours, you don't want it back. Being relaxed doesn't contradict being focused and committed. You can still be dedicated to deal making and work with ferocious intensity. The key is not to take yourself too seriously. PERSON_NAME There's one special quality about doing deals that makes it exciting. Making deals is always new, always changing, always refreshing. Nothing is ever humdrum. Being bored never happens. So, savor the always-present novelty. When searching for new deals, look forward to each fresh possibility as if it were your ﬁrst. Be eager. Sense the uniqueness, the expectation of surprise. What will the next deal bring? From where will it come? How will you do it? 439 The Art of Deal Making When doing a particular deal, take pleasure in addressing each new problem. Problems have solutions. Solutions can be better or worse, and your task is to ﬁnd those that are better. Make the search scintillating, invigorating, rejuvenating. Psych yourself and expect results! Keep Score Whether your game is golf, tennis, chess, bridge, or Scrabble, keeping score keeps your interest. You need a benchmark against which to judge performance. Winning may not be the only thing, but constant improvement helps maintain momentum. You don't practice your strokes or study your moves without testing them in live action. Part of the fun is charting your progress. Enjoy the People To be a good dealmaker, you must like people. This is the ﬁrst half of the bottom line. Good dealmakers enjoy engaging diﬀerent personalities and handling diﬀerent characters. They appreciate constructing deals in which the other side is satisﬁed. Good dealmakers never build resentment. New friendships, these they build often. Enjoy the Process To be a good dealmaker, you must also like deal making. This is the second half of the bottom line. You must like what you do while you are doing it. The process should be pleasurable. Not just the result. Now you can't really relish everything-conﬂicting opinions and stalled progress do not spark your spirit, nor do personality conﬂicts and disruptive threats give you big belly laughs. But even the aggravation can be fun if you view obstacles as challenges and problems as opportunities. How to handle friction and strife? The trick is to see all action as part of a bigger picture. Keep end results in mind: Visualizing where you want to go facilitates how you are going to get there. Appreciate the quandaries and predicaments. Consider trouble the test of your mettle-the chance to devise creative solution. Do What You Want A favorite story involves an exchange between two high school friends meeting after many years. One has become an enormously successful businessperson, controlling a huge industrial empire. The other remains an economic basket-case, teaching part time in a small college, reading good books, philosophizing with friends, and generally enjoying life. 440 The Art of Deal Making “Why don't you get a real job?” asks the suave businessperson. “Why should I?” answers the disheveled professor. “Look, if you get a real job, you can make money.” “But why do I want to make money?” “Because with money you can buy a business.” “But why do I want to buy a business?” “So you can make even more money.” “But why do I want to make even more money?” “So you can buy a bigger business.” “But why do I want to buy a bigger business?” “So you can amass a huge amount of money.” “But why do I want to amass a huge amount of money?” “Because then you can retire and do what you want!” “But that's what I'm doing right now!” What I Want Now I get personal: What I want to do I am doing right now. I love doing deals, deals of all kinds, deals of all sizes. I've made deals from Wall Street megamergers to entrepreneurial start-ups. I've strategized, structured, and struggled under conditions most riveting and most unusual. Financing new ventures, mediating corporate conﬂicts, changing institutional directions, ﬁghting famous lawyers, I've done them all. Sometimes I was hot, burning with personal passion. Other times I was cool, working with studied precision. At all times I was committed: Dealmaking lights my ﬁre. When I'm called in to make deals to plan and put together novel transactions-I must quickly appraise what each side wants, needs, and can't live without. I'm under pressure-and I go for grit and gist. Although I don't like the analogy, having deal-making skill in today's world is like toting a fast gun in the Old West: "Have Skill, Will Travel" is the dealmaker's calling card. Yet you can't always win. I like recounting the skyrocketing winners, but I won't forget the ﬂame- out losers. I've agonized over deals hung up and second-guessed myself on deals gone sour. I've leaped for the stars and fallen in the dirt. But I always give it my best; some-times that's good 441 The Art of Deal Making enough, sometimes not quite. I have a deal-making life and that's what I share in this tome of deal skills. Best wishes, may all you deals work out splendidly! WWW. STERLNGCOOPER.INFO 442

mergers_acquisitionsadvisorym&amergers and acquisitionsvaluation

Mergers & Acquisitions E-book, 462 Pages (Part 4 of 5)

sci_adam_ma

The Art of Deal Making Deal Skill-6 How To Find The Ideas Multiple Options Means Higher Eﬃciency "Finding a new deal is like looking for my lunch," the street-smart cab driver informed me. "I know it's somewhere, maybe in the fridge maybe in the microwave-I'll spot it if I just keep moving." Some people assume that deal making is a black art, draped in secrecy and cloaked with mystery. Many novices, it seems, search for dark sayings, the one special incantation for wrapping up negotiations and ﬁnishing up deals. The quest for deal making's holy grail is, regrettably, a vain one. No Deal Is a Snap Never underestimate the diﬃculty of doing a deal. Closing a contract, even a small one, can be frightfully complex. Many things can misﬁre: Changing conditions can trigger valuation disputes; personality clashes can incite emotional conﬂict; new options can cause second thoughts. We have had many times a signed deal go badly when the seller balks after signing the Purchase and Sale Agrement. Always be on guard. Gremlins abound to muck up the works. Assume there are legions of deal-smashing demons lurking around. Most are not rational, but all are out to get you. Anything that can go wrong, says a famous lawmaker, probably will. Deals rupture with the slightest provocation. Busted transactions are more the rule than the exception. The window for completing a deal is often small and narrows quickly. (Note that I speak of a time before attorneys become involved, which, by the way, explains part of the high failure rate, LOL). I'm often amused to watch amateur dealmakers splitting the spoils of undone deals. They deplete energy, waste time, and strain ego arguing over who gets what percentage when the transaction hasn't a hope of actually working. Believe me, if you're ever tempted to call any deal easy, bite your tongue. 281 The Art of Deal Making The Critical Moment The most important part of deal making comes right up front, before any negotiations begin. When you start negotiating a speciﬁc deal, you've already made your biggest decision. Choosing which deals to try, and which to pass, determines the end result more than all other factors combined. How do you pick the best deals? The ﬁrst step is to procure more prospects. Eﬃciency in deal making means selecting the most doable deals. Such eﬃciency is increased by enjoying a large number of possible transactions. Expand opportunities. Augment alternatives. Multiply options. How to Find Deals Finding deals is fun. You always await the next lead with eager anticipation. It is also frustrating. You get to run, it seems, all the blind alleys. Generating ideas for new deals is not as important as recognizing them when they smack you in the face. It's easy to seek a certain deal, and not so easy to ﬁnd what you seek. And if you do, perchance, discover the end of your rainbow, what spate of arrogance makes you think you'll negotiate reasonable terms? Major investment banks, representing corporate clients, use sophisticated methods to screen merger and acquisition candidates. However, comprehensive computer searches often just generate paper, not to mention fees. Better, in our tightly wired world, is the grapevine. YOU WILL ALSO BE SPECIFICALLY TRAINED TO CREATE DEALS OUT OF THIN AIR USING OUR M & A TRAINING….HOW ABOUT THAT? Whenever you hear something that might have potential, don't hesitate-follow up. The worst you can get is a cold "no, thanks." But even a negative reply can lead to, "It's not for me, but I'll keep you in mind...." Or, better yet, "I'm not interested, but I'll tell you who is. We have often converted a SELLER who was turned down by a buyer into a client wanting to buy a business instead, and add to his present business. We made lemonade out of a lemon! The game is called networking; it really works and you should learn the rules. Networking is not just for big-time executives and lawyers on the one hand or for ex-hippies and swinging singles on the other, it is also looking simply at linkedin…for deals. It is a generic technique that simply makes sense. The more people you know, the more people who know you, the greater your chances for making something happen. 282 The Art of Deal Making Kinds of Ideas Generating fresh ideas is the key for multiplying options in deal making. The more alternatives from which you can choose, the greater your chances to make good choices. When jousting in the deal- making arena ﬂexibility means strength. Good deal makers are eﬀective and eﬃcient when: Choosing which deal to do Using skills and secrets to do the deal The key here is to provide real alternatives. Don't get caught with one deal being a critical necessity. Be independent and a bit remote. Such autonomy and distance is a spine stiﬀener and bully stopper, a bulwark against high-pressure shakedown. Whether Buy or Sell Side Buyers and sellers have diﬀerent attitudes about the sale. When selling something, whether a company asset such as a factory or a personal possession such as a house, the more potential buyers the merrier. After all, enlarging your net and extending its reach increases the odds of catching the biggest ﬁsh. But when sellers attract numerous proposals, how close in price are the oﬀers? Usually they fall within a tight range of one another. Almost inevitably, however, one or two bidders will ante up additional chips. Why do they stretch? For diverse reasons, from business necessity to personal interest-but motivation doesn't matter. What does matter is locating these premium players. As a seller, the more you listen the more you learn. There is no substitute for up-to-the-minute, in- the-trenches marketplace information. But there is a point of diminishing returns. Progressively more input produces progressively less output. Once you've learned what you can learn, eﬃciency craters. The same principles hold true on the buy side. Shopping around, kicking the tires of various deals and getting a feel for current conditions, is vital. Receptivity to New Ideas Original ideas have two purposes in deal making: 1. Discovering new deals 2. Discerning new ways to do old deals Fresh thinking enhances each element of the deal-making process. Always be ready to intervene with a new thought to break a dead-lock, bridge a gap, change an attitude, or shift the power. 283 The Art of Deal Making At this stage of deal making, it is important not to overanalyze or dismiss any notion too quickly. When multiplying options allow no negative thoughts. Admit no worry about working. If you don't devise some oﬀ-the-wall ideas now, you're shooting too low. New ideas mean nothing in themselves. What's the sense of coming up with novel thoughts if nobody will listen to them? Being receptive to new ideas sounds simple. It is not. Much of our social conditioning ﬁghts ﬂux and change. Old ideas have high inertia. It takes a strong force to put them in motion and an even stronger force to throw them out. We are brought up to fear being wrong. An error is an insult. Such defensiveness is devastating to creativity and counter-productive to deal making. Being wrong is the natural result of being creative. Being wrong is not bad. Being scared to be is. Improving receptivity to new ideas, then, is an important aspect of deal making. The following methods will help. They apply whether the new ideas are discussed on your side alone or with both sides together. Paraphrasing Paraphrasing is a method through which the listener uses his or her own words to repeat the new idea back to the original speaker. Stay faithful to the essence of the idea and the important speciﬁcs. Check your understanding with the speaker ("Let me see if I grasp your point..."). Keep the paraphrase free of evaluation or opinion. The task here is twofold: (1) to deﬁne a mutual starting place and (2) to keep the idea and its originator actively engaged. Developmental Response The development response technique guides the new, raw idea to-ward a more workable solution. First, state the pros of the idea-the elements you want to preserve. Next, explain how each pro is useful. Be speciﬁc and genuine, listing at least one pro more than comes easily. Often a valuable contribution comes from this last, hard-to-give pro. Then state the cons, phrasing each one to invite solution. As you consider and correct each con separately, the modiﬁcation process will transform the original idea. The ﬁnal solution may not even resemble the original suggestion. No matter what the outcome, give initial innovators credit, whichever side they're on. Expert Sessions Expert sessions, which were pioneered by Innotech, use specialists from widely divergent ﬁelds to brainstorm issues and problems. For example, a session searching for a painless blood sampling device included experts on mosquitos, acupuncture, magic, hypnosis, and electronics-medical doctors, pointedly, were invited out. 284 The Art of Deal Making The creative sessions ask developing questions about new ideas ("What's good about it?"). Generally, the most sparkling gems are not noticed or appreciated when they appear. The ideas generated must be sifted and weighed afterward like small nuggets of gold buried in heavy beds of mud. Non-expert Ideas We are all too quick to reject simple-sounding words from simple-sounding people. Listening to non-experts takes eﬀort. Why should we pay attention to inexperienced folk who don't know anything about the subject? The history of human knowledge tells a diﬀerent tale. Many radical breakthroughs were made by non-experts shattering tradition. Remember, a non-expert is not encumbered by years of entrenched thought patterns, nor burdened down with predictable approaches to obstinate issues. When a deal is stymied by technical problems, say inventory evaluation or ﬁnancial matters, a non-expert can sometimes ﬁnd a novel solution. Ideas Couched in Question Form This technique recognizes that people frequently ﬂoat queries as trial balloons. Questions are a comfortable way for introducing radical ideas that may sound absurd. The pattern occurs because people have been burned by harsh rejection of new thoughts. They are gun shy. You must draw out the ideas from behind these questions. By being sensitive to such suggestions, and by encouraging the questioner to develop the idea further, you can tap into creative gold. 285 The Art of Deal Making Deal Skill-7 How To Make The Choices The Right Deal Is An Easy Deal PERSON_NAME J. Cannell, creator and producer of The A Team and other television series, had to choose his deal. Universal Studios had oﬀered him a huge annual salary plus royalties to continue working for them. The alternative was to start his own studio, which, at best, would be ﬂedgling, undercapitalized, and cash ﬂow negative. Every logical argument cried out to play it safe-but Cannell chose to go it alone. Why did he do it? Why risk bankrolling an independent studio? Why chance disaster? Though Cannell points to the tremendous leverage of owning a hit series in syndication, one is not convinced by comic claims of avarice. Sure, monetary reward is part of the story, but it's probably not the best part. Cannell plunged for diﬀerent reasons. He made the choice because playing ball in the big leagues was his ambition, and Cannell bought his franchise with smarts, guts, and chutzpah. When Cannell could say that he had more hours on television than all but one major studio, or that his batting average for turning pilots into series was 1.000, these words meant more to him than the megabucks lining up for his bank account. ("Take away the money and I'll still be at my typewriter 6:30 tomorrow morning.") Skills for Choosing Deals How do you know whether a deal is likely to work? How can you develop your deal-making nose to sniﬀ out doable deals? There is only one answer: wisdom and insight undergirded by knowledge and experience. The key to selecting the best deals is rigorous evaluation-the tough, tight analysis of the deal ideas, alternatives, and options that were generated in Deal Skill 6. 286 The Art of Deal Making Evaluation Questions to Ask Eﬃciency in deal making means choosing those deals most doable. It's better to do the right deal wrong than the wrong deal right. This is the ﬁrst principle of good deal making. . The following series of test questions address the deal strictly from your side's viewpoint: Is the deal identiﬁable and clear, easily understood, and readily explainable? (Deals should be simple.) Does the deal seem workable and practical, able to be put into practice with minimum hurdles to jump? (Deals should begin un-complicated; even the plain ones become complex enough.) Does the deal take advantage of any competitive advantage? Does it maximize any distinctive competencies or play up any special capacities? (If not, where's your edge?) Is the deal internally consistent with your side's goals, strengths and weaknesses, functional capacities, ﬁnancial capital, human resources, and timing requirements? (Lack of internal consistency is the prime killer of deals.) Are the personal values and aspirations of your side's senior players being satisﬁed? Will the deal stimulate managerial eﬀort and engender corporate commitment? (Good deals light your ﬁre.) Does the deal consider the diverse participants of your side? (You don't need dissension when doing deals.) Can the deal be consummated and executed with the present organizational structure? If not, can the required alteration be handled? (You must assess the consequences of closing as well as how to get the deal closed.) How does the proposed deal aﬀect other deals currently being negotiated? What about any deals already consummated? (Deals that adversely aﬀect each other are a double negative.) What is the risk-reward trade-oﬀ ? Are the risks acceptable in economic and personal terms? (What are the consequences, for example, of a deal well bungled?) Can doing the deal trigger any unpleasant side eﬀects, say a price war from competing bidders? (Deals that can bite back need a long second look.) Can the deal be assessed up front? Can its viability be checked? Can you forecast the eﬀect of a closed deal before you actually close? Can you discern early indicators of results, such as market reaction? (Good deals reduce uncertainty.) Is the time sequencing of the deal elements realistic? (Good deals need clear deal-making paths.) Is the deal ﬂexible enough to adapt to changing conditions arising during negotiations? How tight are you locked in? (Good deals are malleable, able to meet new situations.) 287 The Art of Deal Making Are you betting the company-or your own career-on the success of the deal? (The rewards of good deals must far exceed their risks.) Evaluation Techniques to Use Consider a powerful rejection rule for deal evaluation: Any strategy or deal that does not either create or exploit an asymmetry in the environment constituting an advantage for the ﬁrm or the individual must be rejected. There are four tests in the evaluation procedure the Consistency test, the Importance test, the Structure test, and the Smell test. The Consistency Test Is the deal internally consistent? Any deal that contains any conﬂicting or contradictory goals, objectives, or implications must be rejected. Thus, deals that require more cash than the company can pay, or will change the direction of the company in undesirable directions, are not good choices. The Importance Test Does the deal concern areas of relevance? Any deal that does not involve major and meaningful goals must be rejected. The relevance test highlights the consequences of issues-not the solving of problems. One must be sure that the deal involves the right values and consideration. Discriminating between importance and unimportance is the essence of deal-making wisdom. Thus, deals that enhance a company's current market share are more important than those that develop totally new businesses. The Structure Test Is the deal properly organized to enable successful completion? Any deal that is too diﬀuse or too constrained must be rejected. Unless there's real potential for completing the deal to your liking, trying to force it is wishful thinking and wasting time. Deals hung out as bait should be avoided. The Smell Test Is the deal likely to work? Any deal that is not likely to close must be rejected. Use your nose. For example, deals oﬀered by dealmakers with reputations for obstinacy or disruption are smellier than those oﬀered by dealmakers known for their reasonableness. Take a deep breath before plunging into a deal opportunity. What to Do? A family that owns and operates a successful regional magazine group made an oﬀer to purchase a similar group in a diﬀerent area of the country. Although combining the two publishing companies 288 The Art of Deal Making is expected to yield substantial competitive strength, heavy ﬁnancing is required from an outside source. Since the company is their only source of wealth, some family members are arguing for a more conservative strategy. Suddenly another regional magazine group enters the bidding. What to do? Magazines are expensive properties and the limited capital here is stretched too thin. A bidding war is inconsistent with ﬁnancial resources and family harmony. Try forming an alliance with the other regional magazine group-if combining the two gives a competitive edge, combining the three might be better still. Such an alliance might take any of the following forms: (1) A joint venture between you and your competitor to buy and run the target group; (2) a full merger of the three groups under shared management; (3) an acquisition of your company by the third company. 289 The Art of Deal Making Deal Skill-8 How To Set The Goals Where To Go Determines How To Get There Goals are the most discussed and least understood part of making deals. When dealmakers plan their transactions, goals are often overlooked as obvious and simple and not worth worry or concern. Strategy and tactics are studied, but strategy and tactics to accomplish what? The setting of deal-making goals, not so obvious and not so simple, drives the deal-making process. What Are Goals Goals are planned positions. They are results to be achieved, desired situations to be attained. By deﬁnition or default, deal makers must have goals. If a dealmaker does not set formal goals, they are set nonetheless by neglect. A smart dealmaker always sets formal goals. Figure 8.1 lists some characteristics that distinguish good goals from Good Goals Are Bad Goals Are Clear Vague Speciﬁc General Focused Diﬀuse Contained Boundless Diﬃcult Easy Consistent Inconsistent Measurable Unmeasurable Achievable Unachievable bad goals. From a corporate viewpoint, goals serve several purposes at the same time. For example, they Serve as guidelines for directing strategy 290 The Art of Deal Making Function as guidelines for suggesting tactics Assign team players to speciﬁc tasks Focus the team on coordinating its eﬀorts Motivate the team and guide its behavior Act as yardsticks with which to measure results Provide the basis for feedback and control Deal Goals Dealmakers bring diverse goals into a negotiation. Some are more productive than others. 1. Satisfying Your Own Needs. This is a healthy, productive goal. You know your own bottom- line needs-the minimum requirements you demand and you seek to get them or better them. 2. Thwarting the Other Side's Needs. This goal is not so healthy or productive. Success is deﬁned in the negative-stopping the other side cold. Your mission is to prevent them from achieving their bottom-line needs. Sometimes, of course, you can't help it, such as in adversary proceedings (e.g., when creditors seek to liquidate bankrupt companies). 3. Maximizing Your Desires. A sound approach. Go for highest personal beneﬁt. Seek to exceed minimum requirements. Start by establishing hard-to-reach goals. 4. Optimizing the Other Side's Desires. The best approach. Go for highest mutual beneﬁt. Even in bankruptcies, both creditors and debtors gain from a successful turnaround. 5. Getting a Bargain. An emotional approach to goals. Few can resist a bargain-even when it's something you don't want and can't aﬀord. Some dealmakers will only buy a bargain. They will not close a transaction unless they believe they've gotten such a deal that they can't refuse. What's a bargain to these birds? Getting the lowest price around. Getting a hefty price reduction (forgetting where the price began.) Getting the last item (it must be good). Getting something else thrown in free (whether you want it or not). Finally, the comparative test: if someone else says you got a bargain then you got a bargain. Goal Components Consider the various parts of a goal. Being conscious of each element helps set good goals. Position. Where in the corporate or personal hierarchy does the goal ﬁt? Content. What is the nature of the goal? Measure. What is the criterion of the goal? Level. What is the amount of the goal? 291 The Art of Deal Making Period. What is the time constraint of the goal? The following example shows how this goal dissection works. Here, the situation is (1) a search for the right acquisition candidate and Deal 1 2 3 4 5 Component Research & Position Corporate Divisional Marketing Manufacturing Development Product Facility use Financial Absolute Innovation Content scope and and overhead Return Dollars synergy control absorption Return on Increase in Technology Contributional Increase in Measure equity market transfer of income utilization rate investment share new products $1 million 5 15% Level 20% 4 (increasing) (30-35%) (75-90% ) Period Year Year Season 18 Months 24 Months Figure 8.2. Goal Components of an Acquisition (2) the proper negotiation of the deal. The acquiring company is a large conglomerate that seeks to strengthen one of its divisions, a medium-sized manufacturer of telecommunications equipment. Figure 8.2 shows how each component contributes to, and deﬁnes, the whole goal. Observe how the goals guide which deal to do and how to structure each deal. The ﬁve goals are picked by position in the corporate hierarchy. 1. A corporate goal might be a ﬁnancial return of 20 percent per year on shareholders' investment. (This suggests a certain price limit, below a speciﬁc price/earnings multiple, and possibly a certain debt structure, allowing leverage of equity.) 2. A divisional goal might be an increasing amount of contribution income of $1 million every year. (This suggests certain revenue expansion and/or cost reduction opportunities.) 3. A marketing goal might be an increasing market share of 5 percent in the ﬁrst season by incorporating the new acquisition (raising total market share from 30 to 35 percent). (This suggests that new and old companies must not cannibalize each other's sales.) 4. A manufacturing goal might be increasing the utilization rate of current facilities 15 percent (from 75 to 90 percent) within 18 months, thereby absorbing additional overhead burden. (This suggests purchasing the target company's products and marketing resources, but not 292 The Art of Deal Making buying its manufacturing plants and equipment-an important, if diﬃcult, negotiating strategy.) 5. A research and development goal might be developing innovation synergy between the companies by technology transfer of four new products over 24 months. (This suggests that the research and development capabilities of the target company must be a vital part of the deal analysis.) By so dissecting your goals, you cut a clearer image of what you want to achieve. You may not get all you want, but you'll understand what you want, and thereby come closer to your ideal. Politics of Goal Setting Goals would seem to be logical statements. In the real world, this is not necessarily so. Gone is the ﬁction that goals are set rationally and logically. PERSON_NAME Good procedures include: general commitment, especially by principals; belief in the meaningfulness of the outcome; easy communication up and down the deal-team hierarchy; feedback of results: healthy and spirited competition among peers. But often, deal-making goals are set on the basis of power and position-just like other business decisions. The general rule is that each person or area seeks to maintain (or increase) his, her, or its relative strength and authority. Corporate politics (i.e., which individual or department will exercise control) is a major factor in set ting deal-making goals. Organizational Politics Whoever has the boss's ear has a good grip on the company soul. Jockeying position and maneuvering people is the corporate bargaining game, and it's played hard and tough in deal making where the stakes are high and the prestige is powerful. Individual Politics. Familiar with organizational politicians? We all know them. What makes them tick? At the top of the list, these people fancy themselves as dealmakers, inﬂuencing goal setting whenever possible. They have consummate knowledge of company systems and people-not how these systems and people work on paper but how they work in reality, the informal relationships. Organizational politicians track the opinions of superiors, senior managerial successors, even current sleeping arrangements. Their favorite position? Controlling the ﬂow of information. They are not too hot on authority; responsibility too soon can get them knocked out early. They are always seen with the right people (lunches are visible), and the "CEO-secretary game" is played well. They choose their tasks carefully, selecting only those that will work and win. 293 The Art of Deal Making Departmental Politics. Departments, too, are creatures of politics. They act as if animate. Mere boxes on organizational charts, they have an uncanny sense of their own existence. It doesn't matter who's operating the shop, managers can come and go, there is constant pressure to sustain power and position, to maintain the established routine, and to keep the status quo. Departments will do anything to maintain their mystical being. Deal making is both the greatest threat and the strongest ally of organizations. Deals are disruptive. They alter power and position, break up the established routine, and demolish the status quo. Organizations, or subgroups within organizations, will kill to control deals and the deal-making process. How Expectations Aﬀect Goals 1. Power of Expectations. What you expect will happen inﬂuences what in fact does happen. The strength of what you anticipate alters both your strategy and the commitment with which you carry it out. 2. Changing Expectations. When anticipations change, deal making becomes less sure. Conﬁdence in goals is shaken; strategy becomes unstable and enthusiasm is sapped. 3. When Expectations Diﬀer. A deal-making team with diﬀerent goals is both weaker and stronger. Weaker in that strategies may conﬂict and dissension overﬂow. Stronger in that there is spirited discussion of issues, and "group think" (when everyone supports the same wrong-headed policy) is less likely. 294 The Art of Deal Making Deal Skill-9 How To Plan The Strategies Strategy Is More Thinking Than Doing Strategy is an ancient term derived from warfare. It depicts the ﬁghting plans of battleﬁeld commanders. One can envision generals hunched over detailed relief maps, moving armies as if pawns. One can visualize wars being won and lost by subtle shifts of thrust parry, and feint. At Sterling Cooper, we always have a deal strategy, just like a battle map! In the DIGITS’s we were involved in many skirmishes in so called “hostile” takeovers. We had a strategy map drawn for our buyer as to what we would do and what could be counter move by the target. The target never knew what we had planned. For instance, in a courtroom battle for control of a public traded company, we went into Federal court every PERSON_NAME scheduling a motion to be heard and created a fear from the other side of not wanting to be in their oﬃces, so as not to be served with the papers on Fridays! Strategy in deal making is a directed plan. It deﬁnes the approach. It links overall goals with operational tactics. It has speciﬁc, clear-cut objectives and describes the actions and reactions of decision makers to the shifts and changes of conditions. The better your strategy, the better your deals. In this sense, strategy is the search for competitive advantage, for areas of relative strength that can coax, coddle, or coerce favorable outcomes. Competitive advantage seeks to capitalize on your distinctive competencies, those aspects of the deal-making process where your side excels or can excel compared with the other side. Assessing mutual strengths and weaknesses is the key to devising the best deal-making strategy. Compare your strengths and weaknesses to those of your opponent in the context of the deal issues. The result of this assessment is a series of alternative strategies. These various options for deal- making direction are then evaluated for probable outcomes, and the best are chosen to put into action. 295 The Art of Deal Making Creativity promotes strategy formulation. Consistency directs strategy evaluation. Structure controls strategy implementation. There is, however, a dark side to strategy. Its presence can fool dealmakers into thinking they've got a good grip on a situation when they haven't got a handle on anything. The more the strategic sophistication, at times the stronger the strategic illusion. The mirage of control is the problem of strategy. It has been said that corporate strategy is like a ritual rain dance. It has no eﬀect on the weather that follows, of course, but it makes those who do it feel they are in complete charge. Often when we use strategic planning, we are laboring to improve the dancing, not the weather. Ways of Thinking: Incremental versus Strategic Strategic planning is not sorcery; strategic hocus-pocus will not conjure up instant deal closing. Strategic planning is just a way of thinking about a transaction. It can be best understood in contrast to its opposite, incremental planning. The best dealmakers function well in both modes. While the strategic process leads to original thinking in devising alternative options, the incremental mode can be fertile soil for the spontaneous sprouting of "aha" insights. Incremental Thinking Operating in the incremental mode, the dealmaker begins reactively by recognizing an immediate problem, some unexpected shock whether opportunity or threat. The dealmaker then searches selectively through a restricted variety of potential solutions, making marginal movements from the status quo, evaluating each tiny step in order. Deviations from current policy are considered sequentially and widened progressively until the ﬁrst satisfactory solution is found. Such an agreeable answer is accepted immediately and all other alternatives, even if potentially better, are ignored. The idea of bounded rationality controls here. Dealmakers can't ever know everything; so if they want to do anything, they must replace optimizing, ﬁnding the best answer, with satisﬁcing, ﬁnding an acceptable answer. According to bounded rationality, problems in the real world need only be solved satisfactorily, no perfectly. PERSON_NAME Operating in the strategic mode, dealmakers begin proactively by deﬁning general goals and setting speciﬁc objectives. They scan the deal-making environment seeking opportunities and threats and 296 The Art of Deal Making analyze both sides for relative strengths and weaknesses. The key here is deal-making strengths and weaknesses in the light of the opportunities and threats in a search for competitive advantages. What emerges from this dynamic, creative process is a set of alternatives. Each is evaluated for probable consequences. Strategic choice is made with the guideline of internal consistency: Which set of strategies best matches goals and strengths? Implementation (including step and time sequencing), feedback, and review complete the process. It is a common misconception to judge incremental decision making bad, and strategic decision making good. Each is good, but in its own arena. One would not resolve an ugly personality clash in the strategic mode, just as one would not formulate a comprehensive plan in the incremental mode. Learn when to stay incremental and when to jump strategic. Strategy and Surprise Strategic thinking, to be truly strategic, must deal with surprise. The unanticipated must be anticipated; the unforeseen, seen. If everything is assumed to be known, if your deal-making future is expected to emulate your deal-making past, then the process is simple extension (trending), and strategy is playing no part. Strategic deal making must be concerned with radical change, discontinuity, sharp breaks with the past, even violent twists from current paths. Dealmakers must plan for the unplanned. Scope of Strategy Strategic thinking works for individuals as well as for companies. People can apply the thought processes for making personal decisions and planning personal deal making. For example, you can use the strategic method to resolve whether to push for a still higher salary at a prospective job or to negotiate a better position at your current job. An honest assessment of your strengths and weaknesses in light of the employment opportunities and threats (e.g., the prospective vs. current job) can be a critical part of the process. Careful consideration of diverse alternatives in light of overall lifetime goals is certainly worth the eﬀort. (One would not, of course, need strategic thinking to make the vast majority of daily deals. Lifetime goals are irrelevant for buying a car for instance. When Planning Strategy What to do ﬁrst when planning your strategy? When negotiating or structuring a deal, do not focus on conjuring up tricky tactics. Gimmicks do not achieve. Plots sicken as they thicken. 297 The Art of Deal Making Devising the plan must come ﬁrst. Where do you want to go, and how will each step of the process help get you there? See ends from beginnings. Have a clear vision of the proposed path-even though that path will twist and turn often. Keep ultimate results in current focus. After each step of the deal, try to reconstruct your objectives. Are you proceeding on target? Or have you drifted? If you've strayed oﬀ course, can you get back on? Or should you now consider altering your objectives to conform to the new reality? Negotiating deals is a continuous series of course corrections and target shifts. Strategic Attitudes There are three general kinds of strategic attitudes in deal making. They are: (1) simple and direct, (2) press and push, and (3) cool and aloof. Simple and Direct Come right to the point. Say what you mean. The straight-forward approach may be startlingly eﬀective, disarming the other side and driving to quick resolution. Go simple and direct when You've worked with the other side before-The deal is bogging down-Immediate closure is a goal Press and Push Here's where the shoving starts. Sensitive points are squeezed. To be eﬀective, the pressing and pushing should be subtle. If the other side thinks that you are twisting arms they will become resentful. Pressure is not some evil, alien torture. It is often the mechanism to get a deal closed. Press and push when Your side is stronger. The other side needs a quick close. You want to assess limits. We bought one of our largest and best deals, (with 300 locations and 12,500 employees), when the Seller needed to close before the New Year, and it was already PERSON_NAME. Who else could have been ready to close that quickly? We knew and the seller knew-NOBODY ELSE! Cool and Aloof This approach uses reverse psychology. Play hard to get. Let the other side sell themselves. It can be marvelously eﬀective. If you give points too quickly, if you're too compromise minded, the other side may worry that they've undershot their potential. (I've been there, kicking myself when the positive response came a mite too easily.) Avoid tempting your opponents: Awakening latent greed 298 The Art of Deal Making is not smart. The key here is making the other side work when exacting the concession. Be cool and aloof when The other side is stronger Your side is under time pressure You have other alternative deals Tactics to Consider Attitudes and approaches to negotiating vary. In some situations, the "drip" is preferred, letting out demands little by little so as not to scare oﬀ the other side. In diﬀerent situations, the "drop" is preferred, with the whole load being dumped at once. The following 12 tactics are used commonly in negotiations. They give ﬂavor for the 40 Deal Secrets in Part II. If you choose to use them, know how to thrust. If they're used against you, know how to parry. Consistency is vital here: Tactics must be matched to strategy. 1. Patience. You wait. However anxious, you don't show it. Patience is a devastating weapon when the other side is highly volatile. When you set the pace, you control the deal. 2. Slow Agony. The deal moves at a crawl. Every issue takes inordinate amounts of time. Delays are frequent. Slow agony never says "no"; the deal never actually stalls. This is an interesting defense against high pressure. 3. Apathy. Overt concern is minimal. Whether the deal goes or blows appears immaterial. You request without energy and respond without passion. Apathy defends against high pressure. 4. Empathy/Sympathy. Concern is shown for the other side. This is a powerful tactic for breaking deadlocks and bridging gaps. Such feelings should be genuine. Do not feign personal concern; compassion as a ruse is oﬀ limits. Use empathy/sympathy when you mean it. 5. Sudden Shifts. Whim and PERSON_NAME do not build solid reputation. Consistency is important, but sometimes it equals sluggishness, even obstinacy. When talks are turgid and momentum has dissipated, unexpected changes can dislodge blockage and overcome obstacles. You have nothing to lose by shaking the tree. 6. Faking. Dealmakers are like football halfbacks, able to feint one way and run the other. Faking is more trading than lying. Fake when you want to protect a particular point. For example, you might insist on all cash in selling your home (or business) just to be able to maintain your price when you ﬁnally "concede" some seller ﬁnancing-which you planned to concede all along. 7. Walking. Closing your briefcase and leaving the room. A dead deal. This tactic is less extreme than it looks. After all, you can always reopen negotiations (though some of your credibility 299 The Art of Deal Making is lost). Walking works when the other side has more basic power and has pushed too hard too long. Quitting is the ultimate leveler. 8. Fait Accompli. The threat to take unilateral action. The deal, or something about it, would be irrevocably changed. For example, when a ﬁnancially troubled company negotiates with creditors, each side can threaten to ﬁle bankruptcy proceedings-which would put all decisions in the hands of the court. Use fait accompli when you control a critical issue-but use it cautiously. 9. Salami. Cut a little here, a little there, and soon the salami is all gone. Some negotiators grind for small gain-but they never stop. The deal's never done. You must stop these people. Strict limits are the antidote for salami tactics. 10. Limits. Allow the other side to go so far but no farther. Setting boundaries can be imposing, even riveting. Don't do it often, but always make it count. Set your limits once and stick to them. Use this tactic when the other side keeps pushing. 11. Deadlines. Countdowns are contentious. Calendar pressure is troublesome. One must never make a hasty decision under time constraint. Try to force yourself to go even a bit slower than normal. If the deal evaporates, it evaporates. It's far better to pass a dozen good deals than to make one bad one. 12. Antagonism. Not a good tactic. More is accomplished by seeking personal harmony even during professional disputes. Nonetheless people are antagonistic, some deliberately as a technique, others because that's just the way they are. Disarm the antagonism by side-steps, not body blocks, by leveraged angles not frontal assaults. Direct confrontation rarely works. Try gentle correction, tinged with humor. "I see the new day hasn't brought forth a new attitude." "I can't toughen my position because you can't get more upset." What to Do? You are a buyer negotiating to buy a new home. You currently rent an apartment and have no pressure to move quickly. The sellers, however, have serious concerns. They have moved to a new city and have already bought another home. What to do? Time is a strength to you and a weakness to them. Draw up a series of alternatives related to time. You might give a short deadline for your oﬀer if you feel pressure is the right tactic. Conversely, you might grant extra time to the sellers. Evaluating the diﬀerent options requires careful analysis of the personalities of the people. The high-pressure strategy might be more eﬀective if the sellers are unable to maintain two mortgages or cannot be bothered with unﬁnished business in their old city. The sympathetic strategy would be more eﬀective if the sellers show appreciation by making an easier agreement. It is also possible to hedge your bets: Try one approach, and if it doesn't work, shift to the other. (Think carefully about the order.) 300 The Art of Deal Making Deal Skill-10 How To Build The Structures Your Price, My Terms You've been a grand potentate setting glorious goals (Deal Skill 8). You've been a ﬁeld marshal plotting dynamic strategies (Deal Skill 9). Feeling pretty powerful? Well, now comes the hard part: Making those strategies work and PERSON_NAME those goals. This is the moment of truth when words and papers are transformed into deeds and action. This is when machinery gets rolling and hands get dirty. I trust you're ready. Structure in both process and content is needed to make the deal work. Thus, in deal making, structure has two meanings: It is the mechanism for putting the strategy into action during negotiations (process). It is the actual way the deal is put together, the terms and conditions as they ultimately turn out (content). Structuring Your Strategy Structure is to strategy as form is to function. Each is dependent on the other. Each can cause the other. Start with a speciﬁc strategy and the structure needed to implement it is deﬁned. And if you start with a speciﬁc structure the proper strategy is described. Watch for strategy-structure relationships in deal making. For example, if a seller’s strategy calls for an exceptionally high purchase price, then the deal's structure will probably have to include some noncash consideration (e.g., contingent future payments or seller ﬁnancing). If, however, the deal's structure demands all cash, then the strategy must allow for a lower price. The principles are parallel for personal deal making. Take salary negotiations. If your strategy is to absolutely maximize the amount of money you could conceivably put in your pocket, your structure might require a lower base salary coupled with a higher incentive bonus. If your structure requires a higher guaranteed amount, your strategy would have to accept a lower ceiling. 301 The Art of Deal Making Structuring Your Negotiations The stages of negotiation are important. Though seemingly static, stages modulate pace and control direction. Good dealmakers understand stages; they recognize when they occur and what they should do in each. The boundaries between these periods can be indistinct. Nevertheless, any negotiation can be dissected into ﬁve independent stages. 1. Deciding. Don't jump into the middle of a battle without choosing the right war. Too many people forget the preliminaries and lose the game before it begins. Determining whether and what to negotiate usually controls more of the outcome than all the strategies and tactics combined together (Deal Skills 6 and 7). What are your long-term goals and short-term objectives? Verbalizing what seems to be obvious may reveal elements that are not so obvious. 2. Preparing. Good lawyers write detailed briefs. Good scientists plan careful experiments. Doing your homework is essential. Maximum data should be accumulated early on, condensed down into concise information, and then transformed into critical knowledge-all before actual negotiating sessions are begun. Understand the other side's positions and postures. Separate superﬁcial stances from fundamental necessities. Get your hands on all possible information-numbers, public reports and statements, press clippings, even private opinions. Do a self-analysis as if from your opponent's point of view. Note the distinction between data (raw facts), information (facts that are organized and categorized), and knowledge (facts that have meaning and implications). The problem in organizations is often too much data, not too little. The need is for better data reduction, not more data collection. 3. Initiating. At the beginning of negotiations, positions are presented and images are portrayed. Healthy self-interest demands proper mutual respect. Good dealmakers put priority on establishing good rapport at the outset. Power plays of meeting location, seating arrangements, ﬁrst proposals, and instant deadlines are common. These opening gambits are generally more irritating than eﬀective. What you want to establish is common ground. 4. Continuing. Keep going and don't despair. Persistence and patience are assets in protracted deal- making discussions. Progress will never zip along in straight lines, so don't expect the impossible. Watch out for emotional ploys, gambits of sudden disruption (or sympathy-attracting weakness), and trumped-up issues. Remember, neither high speed nor straight direction is in the cards. Be satisﬁed with minor movement. Good dealmakers can overcome frustration. Obstacles can be circled, hurdles can be jumped. Go back to the beginning and ask why you are there. Reiterate your initial objectives. Sticking points are often the result of artiﬁcial ego hindrances. Saving face often means losing deals. Novelty is an 302 The Art of Deal Making eﬀective win-win tactic. Try generating fresh sets of alternatives to overcome inertia, especially when negotiations stall. 5. Concluding. Have the good sense ﬁnalize when ﬁnished. Many deals have been ruptured after having been made because one side did not stop pressing for advantage (which is often more cosmetic than substantial). What is your attitude when seeing your opponent fulﬁll needs and achieve goals? This is a marvelous test for the professional deal-maker. If you can kick yourself for not asking more, you're still in the amateur ranks. If you feel genuine satisfaction, you're well on your way to making it in the pros. Structuring Your Deals "Your price, my terms," is a classic phrase attributed to various legendary dealmakers. Essentially, this saying sums up an entire philosophy about structure in four easy words. It speaks volumes about deal making. The Other Side's Price As a seasoned buyer, you like to give people their price. Why? Not good-heartedness, though compassion is no vice. By delivering their price, you know you can beat competition and make your deal-and that's surely a virtue. Price is a solid number, easily remembered and simply repeated. When getting their price (or close to it), people feel good about themselves because they achieved their goal. The fact that terms of payment weren't exactly as anticipated is no major matter- especially when the story is recounted to friends over drinks at the club. Your Side's Terms Also, as a seasoned buyer, you want to provide substantial margins of safety. You like to maintain maximum ﬂexibility-time to work in the new operation and room to maneuver should things go awry. Good dealmakers are usually willing to pay more in exchange for postponed payments. If sellers wait, they get more; if they can't (or won't), they get less-this is the rule of the deal-making jungle. The buyer is happy to pay interest. Where else can you get a non-asset-supported, nonguaranteed loan on a risky business? And it is especially true when the future payments are contingent on performance. Good dealmakers will always give up a good portion of the upside to gain real protection on the downside. Proportion is not the issue here. It's worth much to a buyer to make a deal less likely to explode. The diﬀerence between major success and modest success is small compared to the vast diﬀerence between minor success and major failure. A dealmaker likes to sleep at nights. 303 The Art of Deal Making Mutual Victory Structuring deals is the best route to win-win resolution. It is the mechanism by which opposing interests have a chance at harmony. When I'm asked to structure a deal, I focus on how or where I can get more for my side without taking away a similar amount from the other side. My opponent's hide is the last place I look to gouge (or slice). Improving the deal is inﬁnitely easier when both sides gain, even if one side (my side) gains a little more. 304 The Art of Deal Making Part II Deal-Doing Secrets How to Play the Deal-Making Game 305 The Art of Deal Making Deal Secret-1 Balancing The Power Power Skews Deals In physics, power is the energy needed to do work. In deal making, power is the force needed to shift odds and skew results. Skew-it's what you want to do; it means weighting outcomes in your favor. Everyone wants advantage. No one wants equality-not unless starting out behind. Power gives capacity to create advantage, or if behind, to catch up quickly. Power is the essence of deal making. It is strength; it is control. It establishes the opening positions, and determines the end game. Power means winning. How do you assess power in deal making? Not easily. Strength and control are not simple judgments. Much lurks beneath the surface. The bigger, brawnier side may not have all the marbles. Power Is Relative Power is determined by balance, how much on one side versus how much on the other. Negotiations between corporations over terms of a joint venture has similar power structure to discussions between children over which movie to see. When assessing power, the critical issue is which side has more. Absolute levels of power mean nothing. Relative power is all that counts. If your side's got it, exploit it (but, as we'll see, carefully). If your side doesn't have it, ﬁgure out how to foul up your opponent. Real power players don't put on parades. Show-oﬀs show out. Crass displays of power bristles backs, stiﬀening, not softening, resolve. Real power players get their way quietly before anyone realizes what's happening. Symbols of Power People look to assert power-over things, events, and other people. Power is a primary human motive. To some, the substance of power is all that matters. To others, the appearance is the shining 306 The Art of Deal Making crown. Power symbols are more appearance than substance. It's fun to consider power dressing, power eating, power puﬃng, power living, and power talking-but they really have minimum impact. Pieces of the Power Puzzle Power in deal making is not calculated without complication. There are at least 15 pieces of the power puzzle. Identifying which are most important and assessing their relative strength is tricky. Traditional factors alone can be misleading. For example, a bankrupt company may threaten a ﬁre- sale liquidation in negotiating with creditors and thus tip the balance of power. In the same way, an employee can threaten to quit a vital job-and gain the upper hand in dealing with a boss. To assess power in deal making, pay attention to the following power pieces. Be subtle when applying power: When you've got it, use it; when you haven't, hide it. Power in deals promotes your side and retards the other side. It is always being weighed and balanced, tested and shifted. Power, remember, skews deals. Size Power Which side is bigger? The larger side has more power, if only psychologically, since size is always a threat. Size is the clearest indicator of potential force, whether that size be ﬁnancial, legal, market, or the like. If you're on the bigger side, don't ﬂaunt your girth. Size power looms larger if veiled-the most powerful arrow is the one still in the quiver. If you're on the smaller side, exploit the slowness, sloth or stodginess of your opponents. Try quick changes to rattle their cage. (A ﬂea can make life more diﬃcult for a dog than a dog can for a ﬂea.) Need Power Which side requires the deal more? The party that has greater necessity to do the deal is weaker throughout the process. A small vendor supplying a critical part to a large manufacturer can demand and receive a healthy premium. We did that when we bought a defense department supplier/manufacturer who supplied a critical part to the Trident Nuclear submarine and several other critical systems, without which all the “systems” could not communicate with each other! Priority Power Which side considers the deal more important? The party that puts higher emphasis on doing the deal is stronger, especially in competitive situations. When doing deals, put a premium on the top of the list. lf doing multiple deals, think like a computer and "time share" each deal gets your full, undivided attention, as if it were the only deal your plate, for short bursts of time. 307 The Art of Deal Making Focus Power Which side is concentrating more on the deal? The party that zeros in more intently on this one deal is stronger. Dispersed, fragmented interests sap deal-making strength. Passion Power Which side likes the deal more? The party that has more desire to make the transaction is weaker. When an acquiring company's chief executive oﬃcer (CEO) is enamored with your business (or your industry), hold out for more goodies. When the CEO buys by the numbers, and has wide selection of acquisition candidates, get what you can-take the money and run. Resource Power Which side has greater muscle? The party that can throw more dollars, people, and lawyers at the deal is stronger. When confronted by greater resources, strive for straightforward simplicity and sure- footed speed. "Let's keep these eggs unscrambled." is your line. When the greater resources are in your pocket, don't mind some foot dragging and omelet eating. Sunk Power Which side has made the larger investment? The party that has sunk more costs into the deal-time, money, eﬀort, ego, and image-is weaker. If you are a private company and your opponent is public, a premature press release describing the deal, especially if glowing, puts more pressure on them. In some cases, sunk power can be used to encourage the other side to invest in the deal-making process by holding meetings, analyzing data, visiting factories, retaining accountants, and cranking up lawyers. (Note: Sunk power and focus power can pull in opposite directions. This illustrates the complexity of power analysis.) Flexibility Power Which side has more options? The party that can shift and move in more directions is stronger. A dealmaker with only one way to work is forever running uphill. Unity Power Which side is more together? The party that has greater internal agreement is stronger. There is nothing more disrupting than lack of unity among a deal-making team. 308 The Art of Deal Making Personal Power Which side has the better people and personalities? The team that has more knowledgeable players is stronger. Knowledge in deal making includes: content data, legal technologies, tax expertise, negotiating techniques, and the like. Political Power Which side wields more inﬂuence? The party that can bring greater external forces to bear on the deal is stronger. If a negotiator on one side knows the boss of the negotiator on the other side, he or she has implicit political power. (This type of power is there even if never used especially if never used, since it's probably more perceived than real.) Reward Power Which side can help the other more? The party that can aid the other to a greater degree in aﬀairs beyond this one deal is stronger. If your company can provide additional business to the company with which you're negotiating, whether directly through additional orders or in-directly through recommendations, you've got a leg up. Punishment Power Which side can hurt the other more? The party that can inﬂict higher relative damage-be it economic injury or insult to prestige-is the stronger. When one side is a heavy customer of the other side, there is an implicit commercial threat of general cancellation. Even a weak company can command high ground by supplying a diﬃcult-to-replace product or service. If your opponent can tarnish your reputation more than you can blacken theirs, they are stronger. Poison, sadly, is easy to spread. Knowledge Power Which side has more information and understanding? The party that has more relevant data and deal- speciﬁc comprehension is stronger. If you've got it, use it. Knowledge is a powerful intimidator. Logic Power Which side has more sensible arguments? The party whose points are more defensible is stronger. The careful, concentrated use of good reasoning, without a cocky, know-it-all attitude, can eﬀectively control deals. 309 The Art of Deal Making What to Do? An old business friend, an early acquirer of businesses and top-rate dealer with people, had been eyeing an interesting chess set in a store window for some time. He liked the overly large pieces and the simple, modern design. He watched while the sticker price was reduced over several months from $DIGITS to $DIGITS. He didn't want to pay an exorbitant price, but he also didn't want to lose the set. What to do? When the price was marked down to $DIGITS, he could stand it no longer. He wrote out a check for $800, gave it to his secretary, and told her to tell the store owner that he was out of town and that the $800 was "take it or leave it." Well, the owner took the $800 fast. Need power, sunk power, and resource power were all working against the store owner, with only mild passion power working against my friend. But the owner took the check so fast that he, although proud to own the set and pleased that he paid $800, not $DIGITS, couldn't help but wonder, what if he had written out a check for $600 ?. 310 The Art of Deal Making Deal Secret-2 Pegging The Parties Diﬀerent Parties Make Diﬀerent Deals The parties to the deal are the entities making it. Good dealmakers understand who and what they are up against. They know how to classify the other side of the deal. They can distinguish among diverse parties-who they each are, what they are each about, what they each want and how they each act. The objective is how best to handle each type, how to match strategy choice to party type. We consider three ways to classify the other side of the deal, to peg the parties: identifying the entity, assessing the need, and locating the key decision maker. Identifying the Entity What parties are participating in the transaction? Their nature and composition can suggest purposes to fulfill and hot buttons to push. 1. Individuals. Solitary people have complex motives. They are driven by various factors: mission, wealth, ego, and power. When individuals are party to the deal, be sensitive to the relative strength of their driving motives. 2. Groups. Groups are individuals who band together to achieve speciﬁc objectives. Motivation can become less complex as the group grows larger. When working with groups, either close the deal by targeting the central objectives or confuse the deal by appealing to fragmentary issues. 3. Companies. Companies are proﬁt-making entities whose goals are to increase earnings and equity. Yet, though the principal in the transaction is a company, never forget that you deal only with people and people think as individuals. When negotiating with companies, understand proﬁt objectives, but don't ignore people purposes. For example, assume you are purchasing several products from a distributor. You can probably lower your overall costs by buying some slower-moving items in exchange for additional discounts on your primary products. The salesperson becomes a hero and you save some bucks. 311 The Art of Deal Making 4. Institutions. Not-for-proﬁt organizations strive to accomplish speciﬁc missions. When dealing with such institutions-whether religious (churches), humanitarian (charities), or cultural (museums)-any hint of goal agreement can facilitate your deal making. But don't be overly sweet: Too much sugar is sickening. 5. Governments. These bureaucratic organizations seek survival and status quo. When dealing with public sector agencies or entities, assume they are risk averse, protective of the current state, and upset by disruptions. There is high inertia to change; lots of force is needed to alter the existing way of doing things. Government employees, remember, can fail more easily than they can succeed. Assessing the Need As we've seen, need power is a critical power piece. The relative strength of each party's need should be assessed. 1. Anxious parties are what you like to see sitting across the table. They want the deal done more than you do. They are desperate fearing failure. Any reasonable costs are acceptable. But you can only push anxious opponents so far. Be careful, these types can be volatile; push them over the edge and they'll blow oﬀ. 2. Interested parties want to do the deal-but not at any cost. You have to use more logic than pressure to coax the deal to closure. These people can walk without worry. 3. Indiﬀerent parties can take it or leave it. They have other alternatives and will spring only for a good deal. Patience is a virtue here. You can't be overly aggressive with “indiﬀerent”. Try playing hard to get to induce them to do the chasing. 4. Browsing parties are time eaters-the worst of the bunch. They are lookers, professional tire kickers, deal-making hobbyists who might check out 100 situations and not do a one of them. Browsers are the bane of a dealmaker's life. They sap energy and destroy eﬃciency. Locating the Key Decision Maker Deals are closed when some person or group from each side gives a ﬁnal thumbs up. You know the key person or persons on your side. The trick is to ﬁnd him, her, or them on the other side. It's always helpful to ﬁnd the desk on which the buck stops. 1. Table Person. When the key decision maker is active and visible in the negotiations, assessment is simple. You look the decision maker in the eye, make your moves, and see who blinks. 2. Closet Person. Here the dealmaker is not present. He or she is hiding, as it were, in the closet, never present but always there. Sometimes you know who the person is and sometimes you do not. The people at the table are basically messengers. How to handle this situation? 312 The Art of Deal Making Smoking out a closet person may be helpful, though it may be better to allow the other side comfort in their little secret. Don't knock the ploy of leaving the decision maker in the closet. Since it is an eﬀective way to avoid making instant decisions, it may be a good strategy for your side. This is why a president and a chairman should rarely be in the same deal-making meeting at the same time. Each provides the other with a convenient reentry. When both are present, each is on the spot. 3. Heavenly PERSON_NAME. In this decision-making structure, only a high-level group, such as an executive committee or a board of directors, can give ﬁnal approval. Life is diﬃcult for dealmakers on both sides. The people with whom you are negotiating are not in control of the deal content or process. Be sensitive to their frustrations. 4. Amorphous Group. This is the worst case. Disasterville. No one is responsible and no one can take responsibility. This situation is characteristic of government bureaucracies and commercial companies in organizational transition. What are the signs of amorphous decision making? Watch for uncertainty in response time, vacillation in response content, mixed signals on deal points, contradictions in terms, and open disagreement among same- side participants. If you are faced with an amorphous group, try to determine if diﬀerent or disputing forces are involved. Then play directly to those who seek the deal more avidly. PERSON_NAME example, if one signal demands a higher price, and the other requires complex conditions, try countering with an upgraded price and even simpler conditions. What to Do? A group of investors were considering helping two entrepreneurs start a new business. The investors would not only do the seed funding, they would also promote an early public oﬀering to raise substantial sums. The two founders were distinguished investment bankers earning very large incomes. For them to forsake their established careers, they had to see very substantial rewards. There was good compatibility between investors and entrepreneurs, except for one thing. The investors thought that the money should get 80 percent of the equity, and the entrepreneurs would not consider less than 60 percent for themselves. How to bridge the 80 to 20 percent versus 40 to 60 percent gap? What to do? These parties were interested, not anxious, and had strong individual motivation. The key to the deal was not the initial funding by the investors, but their ability to ﬂoat the public oﬀering. I therefore recommended that we reduce greatly the initial funding levels, so that the entrepreneurs themselves could co-invest with the investors, and in this manner build their share up to 60 percent. (Money was still getting 80 percent, but now half the dough was coming from the entrepreneurs). The investors, under this scenario, would be putting in little cash. However, if they were unable to 313 The Art of Deal Making raise the additional sums through the public oﬀering, they would lose their cheaply purchased shares. 314 The Art of Deal Making Deal Secret-3 Psyching The Characters Character Traits Suggest Strategic Posture Personalities of dealmakers vary dramatically and inﬂuence how they make deals. Learn to recognize the traits and types of deal-making characters and thus plan your strategies. Even when parties to transactions are large organizations, particular (and sometimes peculiar) human beings make those deals happen. How to assess personality traits of dealmakers? How to match strategic response to personality types? Eﬀective dealmakers must be good judges of character. They are quick studies of people. Getting a good sense of personality helps the proper planning of strategy. How to classify the people with whom you deal? Categorize each character according to a basic understanding of makeup and manner. Use the character scales discussed in the following sections. Most people fall somewhere in the middle of each category. Don't take this rating system too seriously. Try it a few times, just to get the hang of it. Normally, your assessments will be rather informal. Top Banana or Errand Boy/Girl What kinds of decisions can the person make on his or her own? How much independence does an individual have? In other words, are you dealing with a principal who can make decisions or an agent who can only transmit them? Good dealmakers play principals and agents diﬀerently. For example, irritation or outrage is only rarely expressed to a principal. It's just not done unless circumstances are extreme. Hitting an agent hard, however, is perfectly acceptable (as long as social decorum is maintained). You know full well that the message will be reported back to the boss accurately and quickly. Hot buttons of top bananas, the ones you push to get results, are normally greased with vanity. 315 The Art of Deal Making Veteran or Virgin How experienced is the person? Does he or she have a long track record of making deals or are you initiating a greenhorn? Is your opposite a grizzled-old buzzard or a fuzzy-faced ﬂedgling? With veterans, you play it straight-and you watch for tricks. They are usually either forthright and direct or cunning and crafty. Novices are noisome, virgins the pits. Both hide their inexperience behind a facade of awkward toughness. They think “ﬂintheadedness”, even rudeness to older people, portrays fortitude and conﬁdence. They are wrong, but you must still deal with these upstarts. With virgins, there are two approaches. The ﬁrst allows them to bolster their weak self-image through bluster; they may calm down into good dealmakers. The second approach is to pull them up short. Let them know that you know the script and can read their lines. Tell them that bravado is not bravura. Show them the carrot and the stick. They can either make or break the deal, and bask in the former or give account for the latter. Egotistical or Action Centered What's the person's primary objective? Is it accomplishing the task of puﬃng the self ? Egotists who fancy themselves consummate deal-makers can be spotted in a microsecond. Some telltale signs: the number of "I's" in their conversations and the ring of constant condescension in their tone. Check how they speak in meetings, act in front of others, handle subordinates, even write their names or answer the phone. How to deal with egotists? Direct confrontation is a last resort. It can always be tried but if it ﬂubs all other eﬀorts end. Instead, you can deﬂect the egotist by appealing to his or her baser instincts. Give the braggart something to crow about. Skew part of the deal to puﬀ the person, as long as it costs you nothing. For example, trade away public recognition (with no authority), additional features thrown in (cosmetics only), and inﬂated purchase price (watered way down with extended payments and little interest), or a hefty special payment (subtracted from the real purchase price). Action-centered people are fulﬁlled by closing good deals; they seek the straightest and clearest route to success, irrespective of personal prestige. Don't be fooled by their pleasant manner. They work hard and tough and can be smooth and slippery. You can give away more than you should and feel good about it. Deal making is not philanthropy. Be on guard here. 316 The Art of Deal Making Self-Willed or Team Player Does the person play ball with a group, or is he or she a loner? Can he or she share responsibility, authority, and credit? Self-willed principals should be handled one-on-one. Don't worry about alienating the team; they don't count, anyway. Self-willed agents are messy for both sides, and are likely to cause confusion. If you've got an uncontrollable ego representing the decision maker, communicate directly with the principals. (But don't antagonize the overblown messenger.) Team-playing principals tend to rely on one or two special associates. Determine the favorite counselors and ﬁnd their soft spots. It's a mistake to assume that team players are all good news and self-willed types are all bad. Self- willed principals can make fast decisions, even ones to your liking, and not wait around for others to critique them. Team players may be indecisive, and waste everyone's time while they grope with their group. Intense or Relaxed Is the person uptight or at ease in the deal-making setting? Intense people show little patience and drive linearly for clear objectives. They are less ﬂexible in thought and deed. Relaxed people are apt to ﬁnd more creative solutions. They tend to take themselves less seriously and don't mind looking a little foolish as they search for new answers. Your task, in general, is to induce a more unruﬄed easygoing atmosphere, to encourage a calm, positive posture in the deal-making process. Innovative problem solving is nurtured when parties are less high strung. Humor is a good technique, especially good-natured kidding of opponents combined with light deprecation of oneself. Try comments like, "We're acting like this deal's important. A million years from now, who'll care?" Or, "Nothing kills a good deal like hard heads on stiﬀ necks-on both sides." Objective or Subjective Is the person inﬂuenced more by logic or emotion? Will he or she conform to the traditional solutions or seek the unusual? Which appeals more, converging to a solution or diverging with more options. Objective types are more analytical, rational, and focused. They generally conform to traditional ways of thinking and behaving. They like to converge ever closer to stark solutions. Proceed step- by-step with these folks. 317 The Art of Deal Making Subjective types are more passionate, abstract, and daring. They are generally more nontraditional and iconoclastic. They seek to explore new areas even if confusing and risky. This type of personality is often more ﬂexible in deal making. Subjective types are great at bridging gaps and breaking deadlocks. They are not great, however, at closing deals. It's hard for them to come to a ﬁnal agreement because they can always ﬁnd something else novel or better. In order to consummate a deal, objective types should be in control. To do good deals, especially if they're complex, have both objectives and subjectives on your team. Consistent or Capricious Is the person reliable in both promise and practice? Can he or she be trusted to follow a predictable path? You can deal directly with consistent thinkers. Moves can be planned well ahead. When dealing with capricious characters, you must focus more on the present. Nail down agreements in detail, even on small points, before moving on to new subjects. With unpredictable personalities, sit lightly and never rest. Always expect change. When there's a real impasse in a deal, however, roles may reverse. Capricious types are often better at unblocking problems. They can jump higher hurdles, though you can never predict how, where, or when they will land. Consistent types, those who think step-by-step, have a harder time overcoming obstacles. Likers or Haters How does the person see people-as individuals to know or as objects to exploit? Likers see the good in people and forgive their faults. Haters see the bad and carry grudges. Likers enjoy doing deals with friends. Haters prefer getting even with foes. Likers and haters are polar opposites, and the look on their faces is often a dead give-away. Doing business with haters is no fun. You never know when you've tripped their tightly strung wires. Disarming a hater is like defusing a bomb. Confrontation, while tempting, is the technique of desperation. First, try showing that you do not take yourself, or the deal, too seriously. It's hard to hate someone who just doesn't care. Make small talk. Try to establish a relationship. Friendliness can be contagious. Normal or Strange Once in a while you come across a head case. Be careful. Normal rules of the road don't apply. PERSON_NAME making as a profession attracts diverse characters. A few are real oddballs. You expect to contest large egos, and you learn to handle them (if not like them). But occasionally you'll meet an ego so 318 The Art of Deal Making massive that it's almost comical. You never know when that mental mass is going to explode. An innocent remark taken wrong, an inadvertent slight blown out of proportion, and we have a ﬁreball. It's hard to prescribe a proper response, short of a graduate degree in abnormal psychology. Your primary task is to recognize what you are dealing with and to take care not to react strongly to any provocation. If you are patient, it may be possible to make your deal. But if it works it will probably come in an unexpected manner. What to Do? You are the principal negotiator in a critical deal for your company. Suddenly, the principal negotiator on the other side becomes caustic in her personal attacks. You are being belittled and insulted publicly. Your team members are waiting. What to do? You must make a rapid judgment call based on a character assessment. If the individual is only capricious, her rudeness is a tactic-confront the boor and thwart the trick (see Deal Secrets 26, 27, and 28). If, however, she is a hater or is strange, you must say nothing and await developments. Your relaxed, slightly bored countenance will be most aggravating. If she calms down, you will have gained ground. If she continues her tirade, just disengage. There is no way to win against such irrationality. Your quiet withdrawal from the maelstrom-and the deal-throws the ball directly into her court. 319 The Art of Deal Making Deal Secret-4 Surveying The Turf The Medium Is Part Of The Message How do settings of deals aﬀect their substance? How does environment inﬂuence the way deals get done? In deal making, signals are always being sent. Your side sends them; the other side sends them; even the setting sends them. Telltale signs abound. Conscious awareness may or may not be involved. You may not recognize these hidden communications. Like infrared and ultraviolet light, unseen at both ends of the spectrum, they are always there. Metamessages Signals are "metamessages": nonverbal feelings, projections, impressions, connotations, and inﬂuences. They bias the actual messages with their subliminal tugs and pulls. Consider the following examples: When a principal will not speak without an attorney beside him, you begin to wonder. The literal message is that your opponent is one careful person. The metamessage may be that your opponent is uncertain, unsure, nervous, worried, or frightened. (Ask yourself what he is so afraid of.) When one side of the deal volunteers to take a crack at writing a ﬁrst draft of an agreement, the literal message is, "We'll do the work and cover the expense." The metamessage is, "We know the deal better than you do," or "we will control procedure from now on." The subsequent sections are metamessages regarding "turf," subliminal signals about the setting of deals. Watch for these subtleties in your deals. Home Court Advantage There are two general rules of thumb regarding meeting place. The ﬁrst describes relative power: Home court gives control (meeting location indicates positional strength). The second describes relative desire: The one who wants, walks; the beseecher travels to the PERSON_NAME of the beseechee. 320 The Art of Deal Making Often, the meeting venue is a matter of mutual convenience, not game-playing tricks. However, be aware that some dealmakers deliberately use the home court advantage. I prefer to concede the place of meeting and have the other side assume that I come in a weaker position. (I like defying convention when it comes to power.) I also like to see the home grounds of my opponents. You never know what you can learn. For example, if there are lots of vacated oﬃces, this could mean that business may not be as rosy as it's being pictured. Seating Arrangements Remember how long it took just to decide the shape of the negotiating table at the Vietnam Peace Conference? In your deals, does the primary principal take the head seat? If not, does that indicate real dominance and high conﬁdence? If the principal is not present, who takes the chief spot-and does that person take the lead? Either way you gain insight about the power behind the throne. A curious thing happens in organizations. You sometimes ﬁnd that meeting rooms ﬁll up in reverse, from the rear forward, so that the last one in must take the uppermost seat. Such an external show of meekness can be more artiﬁcial pretense than true humility. It can also mask political conﬂict boiling below the surface. Telephone Where would we be without telephones, and now of course-smartphones? I am fascinated by their power. You can get to "see" people by phone or Zoom, whose oﬃces you could never even approach. An urgent meeting with a person who might have traveled across the country can be interrupted by a casual call from across the street. When asked whether I like to travel, my snappy answer is, "Sure, by telephone." Phone calls especially conference calls are highly eﬃcient. They compress time and promote a get-down-to- business attitude. Actual geography is becoming less relevant for business. When I'm staying on the West Coast, I can often do my East Coast business better. My day starts earlier, 20-minute phone calls replace two-hour meetings, and eﬃciency is improved. Telephone talk doesn't work in all situations. For example, it's too easy for the other party to say no to the mouthpiece; the impersonality makes for an easier turndown. The medium also promotes rapid-ﬁre response, not a positive if you want the other side to reﬂect on your ideas or proposals. There is no slighting direct contact in deal making. You often need to see reactions and expressions. This factor is especially important when making and responding to proposals. Use the Zoom or Teams visual meeting to assess the players. Deal making on the telephone/or Zoom has special character. For example, advantage is achieved, however slight, by the one who makes the call. Readiness is key. The caller is obviously ready; the 321 The Art of Deal Making one who receives the call is obviously not. Some people just do not take many calls, preferring to return calls at their discretion. Secretaries and answering PERSON_NAME, voice mail are good ﬁlters. If, after a secretary asks your name and says "Just a moment," you are told that the person you are calling is "unavailable," become suspicious. But you always learn something, even the fact that your opponent is not ready to speak with you. As another example, facts are more literal on the phone. The speciﬁc details of oﬀers and counteroﬀers are uncolored by atmosphere and aura. Sometimes this is good for your side, sometimes not. It depends on your current position and intended strategy. Telephone tricks are common. Lawyers like to bill out a minimum of seven to 12 minutes of their time for each call made for clients, irrespective of whether the call was much shorter or even whether the person was actually there. Since these calls can average well under a minute, such a lawyer can rack up several hours-worth of billings in less than 60 real minutes. (Some would call this system eﬃcient, others would use a less kind word.) Ducking calls is a required skill; to some it's a new art form. Let's say you want to avoid giving a ﬁnal answer to a prospective buyer because you'd rather test some other oﬀers ﬁrst. But you don't want to turn them oﬀ, since they might be making the best deal. If you talk, and if they catch you before you're ready, you're in Trouble City. It's like the proverbial mouthful of scalding soup: The next thing you do must be wrong. You don't want to say yes (you want to check those other oﬀers); you can't say no (theirs may prove to be the best oﬀer), and any hesitation will betray your fence-sitting. The situation is a delicate one. Calling back during low likelihood oﬃce hours-such as lunch time or early evening is a favorite technique for slipping people without making it too obvious. Using secretaries to leave messages is another. Ducking can't work for long, of course, but it might buy a few precious days. Informal Settings While deals get concluded in more formal settings, they usually get started in more informal ones. Business meals are a favorite. Watch protocol here. Signals are sent by what restaurant is chosen and who picks up the bill. It is inappropriate, for example, for a start-up entrepreneur to cavort with investors at an expensive nightspot. Likewise it doesn't sit well for a struggling company to entertain its bankers at a swanky watering hole. Sporting events, and golfs are spectator and participatory, are good catalysts for building relationships. People get to know each other as individuals instead of objects. Emotions are less inhibited by social convention and you get a glimpse of the real person hiding beneath the hand- tailored suit. 322 The Art of Deal Making Such personal knowledge is invaluable in understanding the characters in the deal-making process, and it is essential if the deal involves a continuing relationship. The golf course is a legendary place for making deals. The relaxed atmosphere stimulates expansive thinking. (You also get to see how the other fellow functions in the rough, in the traps, and when four-putting a short green.) 323 The Art of Deal Making Deal Secret-5 Gauging The Size Size In Deals Means More Than Size Of Deals How Size Inﬂuences Deals Why is size important? What aspects of the deal-making process are aﬀected by the amplitude, volume, and weight of transactions? No doubt the number of dollars exchanged is critical-size is surely measured in green. But there are other colors to the deal-making rainbow-size counts in more ways than one. Size can sway the intensity of negotiations, the length of discussions, and the diﬃculty of agreement. It can slant the visibility of outcomes, the public image of results, and the reputation of participants. It can determine the level of management doing the negotiating, the attention paid by senior executives, and the orchids or onions reserved for the dealmakers. Relativity Size, as most things in business, must be judged by comparison. Relative balance is more important than absolute standard. 1. Deal Size Relates to the Size of the Parties Making the Deal. It is non-sense to speak of $20 million as a large deal. To General Motors, it's microscopic. To PERSON_NAME's Chevy dealership, it's mammoth. 2. Deal Size Also Relates to Other Options Available to the Parties. A $50 million deal would have been small to PERSON_NAME Icahn when he was contemplating taking over Trans World Airlines. Similarly, a $100 million suit against Texaco would not have made much of a ripple when they were busy appealing the $10 billion judgment for Pennzoil. Factors of Size What parts of a deal determine its size? Dollar value is the obvious answer. But must a $10 million deal always be 10 times larger than a $1 million deal? Not necessarily. The fact is that the latter, 324 The Art of Deal Making even in the same company, can be even bigger than the former. Remember, there is more to size than numbers. Positive Kick A small deal with a large customer may be a test case. Upside potential can be enormous; the future can dwarf the present. Do a good job on this one and the sky's the limit. In some industries, for example, where expertise is hard to judge up front, smaller contracts are generally given before larger ones. Negative Kick Mess up a smaller deal with a current customer and you foul up an ongoing relationship. Downside danger can be serious; the present can disrupt the future. A $10,000 order from a $500,000-a-year customer deserves more attention than a $20,000 order from a $50,000-a-year customer. Visibility The public presence of a transaction, inside or outside the company, inﬂuences its magnitude. A special $50,000 corporate image project for a company chief executive may be more important to an advertising agency than a $500,000 media buy from that same company. Similarly, a contract to dispose of dangerous chemicals, no matter how small, risks a nasty public relations spill if not handled correctly. PERSON_NAME A small deal that helps achieve your longer-term objectives can exceed in size a larger deal not so relevant. A $2 million research and development (R&D) contract for a technology company may be larger than a $20 million production order. Sure, the $20 million means higher proﬁts-but that may be a one-shot deal. The R&D contract may build expertise that could produce continuous proﬁts. (Give a hungry man a ﬁsh and you feed him for a day; teach him how to ﬁsh and you feed him forever.) Symbolic Value What a deal means aﬀects how it is perceived. A small matter with large implications can be a big deal. A company that talks innovation and funds tradition digs credibility gaps. Nothing speaks louder than the movement of money, and a pilot project in a risky new area looms large in the corporate consciousness. 325 The Art of Deal Making Strategies of Size So you can gauge the size of your deal-big deal! Now what? How does such knowledge help make better deals? Certain strategies work better under diﬀerent size conditions. Several follow. What to Do when the Deal Is Large The following should be done when the transaction is big: Put your best people on the case. Focus on the deal-don't be distracted by trivia. Provide proper resources; recognize that investment is necessary and don't skimp on legal, accounting, and consulting fees. Pay attention to details; small points in large deals can cost bundles. Build human relationships; a light touch can ease protracted negotiations with heavy stakes. The high tension in huge mergers and acquisitions is reduced when opposing sides eat pepperoni pizzas together in all night sessions. What to Do when the Deal Is Small The following should be done when the transaction is little: Prime your negotiating team-it's easy to go into small deals unprepared. Be sure your people do not consider the job beneath them; look for ways to show your team the importance of the deal. Stay alert even if you aren't excited. Give credit to your dealmakers; it's often just as hard to pull oﬀ a small deal as a large one. What to Do when a Corporate Deal Is Mismatched Consider a situation where a large public corporation is negotiating to buy a small private company. When you're the larger corporation, don't bully or condescend; treat your potential deal partners with dignity-after all, you want what they've got. When you're the smaller company, don't cower or show anxiety; handle your suitors with equality- after all, you've got what they want. 326 The Art of Deal Making What to Do when a Personal Deal Is Mismatched Consider the relationship when superiors and subordinates make deals in the workplace, for example, the negotiation of salary or position. Each side must maintain its mutual dignity. The superior's tactics must not intimidate or humiliate, and the subordinate's tactics must not embarrass or beguile. When you're the superior, use questions to draw out ideas, showing real interest in your subordinate's opinions. When you're the subordinate, oﬀer ideas and information, asserting conﬁdence in your convictions. Be careful that criticism is always constructive; the superior should not feel compelled to pull rank, the subordinate should not fear to be ﬁrm. Each side should lead through proper example. What to Do? You are the head of marketing and sales for a consumer product in a large manufacturing company. Your product broke all sales records this year but bonuses will be severely curtailed because the company as a whole had minimal proﬁts. Furthermore, the prospects for next year look grim. Morale is starting to suﬀer. Your boss, the divisional vice president, states that while your department will not receive bonuses, you will be rewarded handsomely. What to do? Incentive compensation is important for most employees, but it is critical for marketing and sales personnel. Without bonuses, your department could be decimated. Plan a twofold attack. 1. Suggest to your superior that your people will take lower base PERSON_NAME next year if they can exceed even their normal bonuses with exceptional performance. The proviso is that the department's bonuses will be determined by its own performance, not the company's. 2. Take a chance. Distribute part of your personal bonus this year to your people. The size of the bonus will exceed its dollars. It will inspire employees and build personal loyalty. The combination will make waves and perhaps shake up senior management. 327 The Art of Deal Making Deal Secret-6 Valuing The Stuﬀ Worth Is In The Wallet Of The Holder PERSON_NAME van Gogh produced over 800 paintings, but during his life-time he could only sell one-for $50. Recently, one of those unsold paintings sold for $40 million. So much for absolute value. "Stuﬀ" is the value and consideration being traded in a transaction. Stuﬀ is all kinds of things; in fact, it's anything changing hands in a deal. How you value stuﬀ is important. If beauty is in the eye of the beholder, then worth is in the wallet of the holder. Cash is about the only thing with a ﬁxed value. The value of virtually everything else depends on who is the owner or potential owner, what are the conditions, and who is the judge. Absolute value is a myth. Principles of Relative Value Value is a moving target-subjective and ever changing. When, as well as who, aﬀects outcome. Scarcity, need, and social values all contribute to the perception of worth. I like to deﬁne value relatively, in comparison with other things. In this sense, the real value of your stuﬀ can be deﬁned by the value of the other side's stuﬀ. "How much is some X worth?" is not the best question. I prefer, "Which would you rather have, the stuﬀ you're giving or the stuﬀ you're getting?" A good technique for valuing stuﬀ is to ask yourself constantly which side of the trade you like better. Ask the question every time the deal changes. Another objective is to discover your indiﬀerence point-that special place where it doesn't matter whether you do the deal. Relative value aﬀects each side diﬀerently. One side may look simply at ﬁnancial data-the generally accepted market value-while the other side may consider what business advantages it can gain by ownership. 328 The Art of Deal Making Your task is to assess relative value on both sides. Get at underlying motivations. First, understand how your side values the stuﬀ. Then, perceive how the other side does its valuing. Polarity of Value In general, there are two categories for assigning value: 1. The positive beneﬁts to be achieved by having or owning this stuﬀ. (Obvious.) 2. The negative costs that can be avoided by not having or owning this stuﬀ. (Less obvious.) Each category has its own subtleties. Positive value means that you want to do the deal because, if you do, the stuﬀ will increase your worth or wealth. A company whose high-growth division could command a massive multiple of earnings would sell for a premium price. Negative value means that you want to do the deal because, if you do not, the stuﬀ will decrease your worth or wealth. A company whose cash-hungry division could drive it into bankruptcy would sell for a discounted price. Desire, greed, and lust diﬀer from fear, anxiety, and dread. Would you do a deal if you had 9 chances in 10 to make 20 times your annual salary but had 1 chance in 10 to lose your right arm? Most people would refuse (even lefties). What about 50 times your salary? A hundred times? A thousand times? Most people are risk averse; that is, they would rather play it safer than mere odds would suggest. Avoiding negative threat, therefore, carries heavy weight in valuations. Valuation Under Competition Bidding in auctions can be dangerous to your ﬁnancial health. When a joint venture between PERSON_NAME Petroleum and Chevron won oﬀshore drilling rights in DIGITS they were shocked to discover that they paid more than double the next highest bid. The four other bids ranged from under $1 million to $161 million. These pros paid $333.6 million $170 million more than necessary-and suﬀered what has become known as the winners curse among oil lease auction victors. Research has shown that bidders are usually overconﬁdent about their ability to assess value, often generating a huge gap between the highest and next highest bids. The phenomenon is strongest when involving unproven values (e.g., defense contracts for new technologies, leases in new shopping malls, and mineral rights). Factors aﬀecting price, in addition to true value, include the number of bidders and the structure of the auction. Sealed bids with many bidders induce the wildest frenzy. (See Deal Secret 9.) Appraisal Process 329 The Art of Deal Making Few things have an unconditionally fair value. Lots of values may be fair, although some may be more fair than others. It depends on whom you are asking and why you are asking them. In general, beware the appraisal process. Appraisers have notorious reputations for skewing valuations according to their client's objectives. Purposes aﬀect outcomes. Whether the appraisal is for sale purposes (on the upper hand) or tax purposes (on the lower hand) will inﬂuence how a real estate appraiser values a piece of property. When the government appropriates forest lands from a company, appraisers for each side make their best case. You can be sure the government's appraisers assign a far lower worth per acre than do the company's, even though both appraisers may be expert and honest. (Reverse the clients and watch those appraisals ﬂip.) You get, it seems, what you pay for. We had a situation on an acquisition whereby our CEO, who is not an appraiser, valued 13 pieces of real estate at $84.5 million for the lender in the space of 30 minutes. Then we hired PERSON_NAME & Stevens, the well-regarded appraisal ﬁrm, paid big bucks for it, and they valued it after three weeks, and produced a thick report, at $85.5 million! What to Do: Corporate Example I know a company that wanted to sell. How much should they ask? How should they establish the right purchase price? What to do? We analyzed the business and categorized ﬁve kinds of buyers who would be interested in an acquisition-each would have a diﬀerent number; each would use a diﬀerent method. 1. The cash-ﬂow buyer would look at the proﬁts generated, targeting the net free cash; they wouldn't care one about the products, process, or people. They might oﬀer $40 million for the steady stream of dollars. 2. The asset-based buyer would assess the fair market value for the company's net assets-the dollar amount of all assets sold oﬀ in orderly fashion minus all liabilities. They could oﬀer $25 million for the liquidation rights. 3. The replacement-value buyer would consider what it would cost them to set up an equivalent facility, the production plants and marketing organization they needed. They could oﬀer $50 million for fast and cheap entry into the business. 4. The synergy-value buyer would view what they could do with the company by integrating it into their own company, how the new entity would enjoy increased market share and lower average costs. They might oﬀer $55 million for the increased eﬀectiveness, eﬃciency, and market dominance. 330 The Art of Deal Making 5. The defensive-value buyer would envision what their rivals might do with the new business, controlling the market and driving others out. They could oﬀer $60 million to keep competitors at bay. (Need I say which one we accepted?) What to Do: Personal Example Let's go close-to-home-setting your salary at your job. Consider the ﬁve following methods of valuation. (Compare these categories with those in the corporate example.) 1. A net-dollar-value salary is pegged to the incremental gross proﬁt-the fresh bottom-line dollars-that you bring into the company. A salesperson who could generate $3 million in new business might be worth $100,000+. 2. A market-value salary is a collective valuation of what people with your general skills and experience could expect to command in your ﬁeld or industry. This valuation is not individual. 3. A replacement-value salary is the company's total cost of ﬁnding and paying someone else to do your job if you were no longer working. Job interruption costs (downtime on your tasks), job disruption costs (interference with the tasks of others), search expenses, and subsequent salary must be included. 4. A synergy-value salary is what a company would pay you considering the added beneﬁts that other aspects of the company could derive from your talents and participation. For example, a salesperson who covers Illinois for the shirt division of a large company might also be able to represent the suit division of the same company in the same region. 5. A competitive-value salary is what a competitor might pay you to join their ﬁrm. Your presence would not only help the new ﬁrm, your absence would also hurt the old one. 331 The Art of Deal Making Deal Secret-7 Appraising The Stakes Stakes Very High Or Stakes Very Low Make Deals Very Tricky Everything you do in deals is colored by relative signiﬁcance. When stakes are high you act one way, when low another way. The gravity dictates attitudes and approaches. Stakes are high when deal success would contribute dramatically to company progress or personal career. Stakes are also high when failure would severely undermine organizational viability or professional path. Anxiety and Stakes Anxiety is a good indicator of stress and stakes. The degree of apprehension can signal the level of the deal's importance. Anxiety is a general sense of foreboding, an unspeciﬁc fear of the future. You are afraid, but you are not sure of what. Anxious behavior includes overeager reactions, exaggerated responses, and inappropriate demeanor. People function best with moderate levels of anxiety, and worse with very high or very low levels. High levels of anxiety disturb and distract. Low levels allow ramble and roam. Moderate anxiety is ideal. It is enough to maintain and preserve interest but not enough to sabotage and subvert attention. Stakeholder Analysis Stakeholder analysis is a technique that helps analyze how each side views the deal. Uniformity is out. Neither side is considered homogenous; the parties are not all cut from the same cloth. Instead, each side is seen to be composed of individuals with special motives and interests. Thus, each person has his or her own private agenda, a committed interest (or stake) that each group member maintains (or holds). Your task is to discern the special stake of each individual in order to determine the group's overall thrust. Organizational behaviorists believe that stakeholder analysis-getting at personal motivations-is vital for understanding why groups act the way they do. 332 The Art of Deal Making How to Judge the Stakes Certain signals help in evaluating the stakes in deal making. Knowing these signs can give your side an advantage: Level of Key Person. How high in the organization is the prime negotiator? The higher the person the higher the stakes. Focus of Key Person. How much attention does the prime negotiator give the deal? The greater the focus the higher the stakes. Level of Activity. How responsive is the other side? Are your phone calls returned quickly? Are requests for information fulﬁlled promptly? Frequency of Meetings. How often are meetings scheduled? When are the next steps planned? Do days ﬂoat by without concrete progress? Degree of Pushiness. Which side is setting the time schedules and deadlines? The active party generally has higher stakes. Conscious Behavior. Are there any obvious signs of stress and anxiety, such as exaggerated reactions, hair-trigger tempers that are out of character, or wide (and wild) swings of moods? Unconscious Behavior. Are there any telltale signs of stress and anxiety? Fidgety, nervous habits and rapid, high-pitched speech suggest very high or low stakes. (By the way, don't forget to monitor-and mask-your own reactions. The other side might have read this book, too.) When the Stakes Are High When you play "bet the company" or "wager the career" on a particular deal, mental attitudes are complex. You are tough because the deal is important; you are soft because you fear the deal won't happen. Your posture can be volatile, with violent shifts in moods and positions. As a result, you are likely to react quickly and simplistically to tricks and trades by the other side. Cool is hard to be when your feet are on ﬁre. When negotiating a high-stakes deal, concentrate on reducing your levels of stress and anxiety (if only their outward show.) Slow down your speech Do physical exercise to soak up that awkward energy Use breathing exercises to induce relaxation Try faking calmness; artiﬁcial serenity can induce real serenity 333 The Art of Deal Making Stakes in a deal can be reduced by ﬁnding another option outside the deal. Assume the deal is broken and consider what to do next. Don't actually do anything, but think of alternative action. If you can develop independent choices, stakes lower, anxiety drops, and deal-making behavior improves. When the Stakes Are Low When you do not care about a deal, you get sloppy. Lack of attention breeds mistakes of fact and errors of judgment. Control slips away and advantage is lost. When deals degenerate, deals disrupt. Sometimes, in a belated attempt to salvage a decaying deal, the negotiator will make a sudden shift in position. Unfortunately, the surprise move may trigger out-right rupture. When negotiating a deal where the stakes are low, concentrate on raising your levels of stress and anxiety (if only their outward show). Speed up lazy speech Force yourself to pay strict attention to details Don't dawdle over issues Try faking fervor; artiﬁcial intensity can induce real intensity If, however, you ﬁnd it impossible to generate even modest anxiety, you may be the wrong person for the job. Find another person to negotiate the deal and ﬁnd another deal for you to negotiate. What to Do? How about playing some high-stakes corporate poker? At the table we ﬁnd Pennzoil and Texaco squaring oﬀ. Our CEO hired the winning attorney, PERSON_NAME Jamail (known as the King of Torts, who won the case here for Pennzoil) to “bluﬀ” and settle a large case relating to a failed sale agreement that was also verbal. We used the notoriety of the attorney who won here to “scare” our adversary to settle. Pennzoil's legal judgment against Texaco for interrupting its deal with PERSON_NAME is about $10 billion in claims and damages, the largest verdict in corporate history. Tough talk of huge security demands blasts forth from Pennzoil. Dark threats of bankruptcy ﬁlings PERSON_NAME from Texaco. Relativity plays a role here, and the game is an artful one. For Pennzoil, it's a bonanza; the issue is how big. For Texaco, it's life and death; the issue is survival. What to do? 334 The Art of Deal Making Strangely, the interests of both companies should suggest settling the suit. Both sides have too much to lose by not agreeing out of court. Texaco is not without resources nor is Pennzoil without fear. Let's see why. If Pennzoil does not settle, one of two things could happen: (1) Texaco could declare bankruptcy and Pennzoil would become just one of many creditors embroiled in a legal miasma or (2) a subsequent judicial appeal could overturn the verdict and Pennzoil would wind up with nothing. Furthermore, it is unlikely that Pennzoil would ever get everything. So, Pennzoil should be highly motivated to settle, not gamble. If Texaco does not settle, Pennzoil could win the appeal and exact the full $10 billion plus accumulated interest, virtually gobbling up Texaco in the process. Even if this worst-case scenario does not happen, it is likely that Pennzoil would get more through the courts than in a settlement. Thus Texaco, too, should be highly motivated to settle, not gamble. The end result was a $3 billion settlement…everyone lived for another day. 335 The Art of Deal Making Deal Secret-8 Establishing The Positions Initial Positions Set Constant Tone Most positions are predictable. An athlete coming oﬀ a brilliant sea-son makes noises about contract problems. TASS, the Soviet Union's news service, reports the U.S. position to be "reactionary and imperialistic." The White House considers the Soviet position to be "propaganda and nothing new." Establishing position is the opening engagement in a negotiating campaign. First posture is like an imprint, a permanent pattern of behavior. It sets the stage for subsequent conduct. Relationships are formed early. Once imprints are stamped, they are diﬃcult to alter. Establishing deal-making positions for humans is akin to securing territorial control for animals. Consider a dominion battle between two male chimpanzees for regional rule (the area being marked oﬀ by urine). Who will take the lead? Who will mate the females? Once dominance and recessiveness are set, each chimp maintains its assigned role. (Now I do not mean to imply that dealmakers are apes, but those not-too-infrequent "pissing contests" among lawyers make one wonder). Positioning the Other Side Establishing proper initial position is critical. It sets a mood that generally does not change during the rest of the negotiations. Initial positions are not set in the dark. Deals are not blind dates. Each side considers the other before going into the ﬁrst meeting. It is important to know your opponents, understand their relationship to you, and have a general sense of how you are going to act with them. 1. When Dealing with Equals. Be open and direct. Build subtle dominance by aggressive concern for mutual interests (such as schedule, procedure, etc.). Control is achieved more easily by process assistance (e.g., setting the agenda) than by position assertion (e.g. insisting on your price). 336 The Art of Deal Making 2. When Dealing with Superiors. Conﬁdent respect is the key here. Your power is inferior and, face facts, it will remain so. A forced aggressiveness is at best shallow and at worst silly. A strong, friendly attitude is what you want to project. 3. When Dealing with Subordinates. Be respectful and listen seriously. Draw them out when they are not communicating forthrightly. Avoid haughty disdain or put-on deference. Maximize your superior position by not making it obvious. 4. When Dealing with Buyers, Clients, and Customers. Here's heresy: The power of buyers is overrated. The buyers' job is to buy. If they don't buy, they lose their job. After all, their ﬁrm needs what your ﬁrm has. Your relationship with buyers should be viewed this way: You enable buyers to keep their jobs. 5. When Dealing with Sellers, Vendors, and Suppliers. Now you write the check. You wield the Big Pencil that fabled instrument of order-writing fame. You need to know your relative power versus that of other customers. However strong you are, never bully. A hand on the shoulder always beats a twist of the arm. Show your vendor the importance of the relationship. Dangling this carrot-conﬁdence in continuing business-will improve your position. Remember, personality colors deals. Friendly, personable stances usually work better. Memorize ﬁrst names. Eﬀective dealmakers don't take themselves too seriously. Attitude is especially important when setting forth initial positions. Our CEO, likes to keep things friendly with jokes and stories of successful deals. After You, Please A prime rule of deal making is, "Always let the other side move ﬁrst." Maybe, if you're the buyer, the seller will set an initial price lower than what you would have oﬀered. Maybe, if you're the seller, the buyer will oﬀer an initial price higher than you would have set. You'll never know if you go ﬁrst. You can't lose by not going ﬁrst. If the other side's number is ludicrously out of line, you can always dismiss it with a laugh. This ﬂips the question back to them. A second rule is, "Never bid against yourself." Anxious buyers often get caught in the trap of increasing their oﬀers when there are no other serious players in the game. The best antidote for this poison is patience. Wait a while before responding to a rejection of your last bid. Don't be quick to modify and change. Good sellers make an art of encouraging qualiﬁed buyers to up their oﬀers. Aim for the Best PERSON_NAME You can't get across the street without walking across the road. Words of wisdom. The deal-making philosopher is PERSON_NAME Grassgreen, president of Kindercare, Inc., the country's largest operator of daycare centers. He states that when he sends naive employees out to negotiate rental of a new location, they sometimes can get a better price than the experts. "They didn't know what they 337 The Art of Deal Making couldn’t do. And they weren't afraid to ask." Asking is easy, it's cheap-and you can always say you were kidding. Too many people forget to ask. There's another side to this tactic. If you take too aggressive an initial position, you run the risk of scaring oﬀ the other side. Sometimes buyers bid so far from reality that sellers think that the buyers are either (1) incapable of evaluating the situation and therefore not worth wasting time with or (2) downright insulting and not worth doing business with. Business brokers often take this failed approach as they want to show oﬀ their skills to the client, who is then the loser, when the buyer walks! There are two ways of balancing these extreme positions. 1. Know the other side-the characters, their desire for the deal, and their other alternatives. 2. Ask high, but do it with a twinkle. Make that an enigmatic twinkle. Put a pixieish sparkle in your eyes, a PERSON_NAME smile on your lips. A quixotic grin can mean either "Don't take me too seriously" (if the oﬀer is outrageous) or "You can really hit this pitch" (if the oﬀer is in the ballpark). When You Must Go First Sometimes you can't avoid making the ﬁrst oﬀer. So, maximize the positive beneﬁts of going ﬁrst. You control the opening issues and attitudes. It is in your power to decide what matters will be discussed and where initial negotiations will focus. For example, if you make an oﬀer that allows something other than full cash payment up front, it makes a statement. If standard terms in your industry are "net 30 days," and your initial oﬀer is "net 90 days," you make terms and dating a real issue. If you make such an oﬀer as the vendor, you may couple it with a higher-than-normal price. You are constructing a deal responsive to your customer's current cash bind, and the increased purchase price reﬂects not only the payment delay but also the inherent risk. When You Can Go Second Counterpunching is always easier than throwing the ﬁrst blow. You can see the speciﬁc interests of the other side. You now have great insight into their approach. If, for example, they play lowball, you have a choice of responses: highball (an equal and opposite reaction), a mild laugh (as if to say, "That's funny, now let's get serious"), or a more formal dismissal ("There's no sense in countering"). If their ﬁrst oﬀer is reasonable, you again have a choice: 338 The Art of Deal Making You can play hardball and pretend that the oﬀer is lowball, choose from the above responses, and await further developments. Maybe they'll go up. You can respond in kind. This is a better tactic. You want to make many deals, not exact every last cent from one deal. After all, you might be back for another bite. When You're Exploring Boundaries Making deal proposals that push limits must be done with care. You must avoid antagonism and quick rupture of relationships. A good approach is to vary one part of the deal at a time, while holding all other parts constant. Try to frame your oﬀer in the context of honest inquiry. For example, after discussing a complex deal that has many elements of consideration to be paid over long periods of time, switch to all cash: "Let's say we could pay everything in hard dollars. How much could you reduce the price if we snap all greenbacks at closing?" This gives insight into the importance of cash and the lowest possible price within reason. Conversely, a seller might switch from insistence on all cash at closing to very favorable terms. How much could the seller raise prices by giving such advantageous conditions? If the buyer can and will give acceptable guarantees, and if the seller does not need as much cash, such a deal could be better for both buyer and seller. When in Competition As Buyer Buyers have two simple objectives: Not getting knocked out early Smoking out competitors' oﬀers When you're a buyer competing with others, oﬀer a fat price-but with the open understanding that your numbers are subject to further analysis and checking. The seller has nothing to worry about because if everything turns out as claimed the higher price will be justiﬁed. (In reality, you can always ﬁnd something wrong). Your juicy oﬀer will keep you actively in the game, and may even scare oﬀ some competitors. As Seller Sellers, too, have two simple objectives: Keeping as many bidders as active as possible Discovering the hottest candidates 339 The Art of Deal Making Sellers might consider proposing a slightly lower price and then observing the reactions of potential buyers. If the price is like chum before sharks, and buyers start swirling around you in a craze, then you know you can really land a big one-and at an inﬂated price. Again, do not deceive. Put out your oﬀer in a contingent manner. "Suppose we set a price of X; what would be your reaction?" You can then inform buyers that, on further reﬂection, your trial price was low. You hope that the blood- dazed predators hardly notice the diﬀerence. (See Deal Secret 28.) When You Really PERSON_NAME Have no illusions: No one is going to believe that your ﬁrst oﬀer is your ﬁnal oﬀer. It's like bluﬃng in poker. You must go all the way a few times before anyone will take you seriously. Once in a while, you must stick to your guns. Assume you have no ﬂexibility whatsoever on a particular deal point. How do you build credibility if you've already modiﬁed other deal points? One strategy might be to tackle another, rather minor issue ﬁrst and prove to the other side that you really mean it when you say that your ﬁrst oﬀer is "all she wrote." What to Do? You are up against a real character. She is capricious and testy and her only consistency in deal making is making constant changes. She never actually lies, though she comes awfully close, and you can never seem to get a straight answer out of her. Unfortunately, her oﬀer is the best you've got going. How to cage this bird? What to do? A formal approach is the remedy here. Precision is necessary. Set strict ground rules at (or before) the ﬁrst session. Insist that all oﬀers be communicated in writing. React forthrightly to anything in print, but do not respond seriously to anything verbal. Allow trial balloons to ﬂoat harmlessly into the wind, dismissed with mild humor. Suppose she says, "What would you do if we reduced our notes a bit, but made up for it by increasing the interest rate?" Your response might be. "I would look forward to reading a memo on the subject, with all the blanks ﬁlled in fully and fairly." 340 The Art of Deal Making Deal Secret-9 Getting The Price Getting Your Price Means Making Your Deal When asked why he was making more money than the president of the United States, Babe PERSON_NAME replied, "I had a better year." Price is the crux of all deals. It is the way we keep score. Although price seems simple, straightforward, and easy to evaluate, it is not. How to Get Your Price as Seller How to Determine Price The market generally sets the prices, but you do not have to be straitjacketed by the market. (Sure, if you're selling a commodity, the exact same stuﬀ everyone else is selling, the market governs.) First, determine the selling price for products like yours. Next, you must position your speciﬁc stuﬀ. Some aspects that boost the price are: brand recognition, special features, quality, custom design, and the like. Perceived value (e.g., PERSON_NAME 928 vs. Ford Mustang) makes for higher pricing. How to Diﬀerentiate Your Product Your goal is to sustain maximum market share within a limited market. Seek control of a niche. In other words, be a big ﬁsh in a little pond. The way to do this is by making your stuﬀ diﬀerent. If you're the same, you get the same price. If your product is recognizably diﬀerent, you can get a better price. The key to making your products diﬀerent is segmentation-carving out a particular area where you can claim uniqueness. Any uniqueness. It doesn't matter whether you diﬀerentiate by size, category, distribution system, varieties, quality, or customer. It doesn't matter which you choose. Any diﬀerence, if perceived to be important to the buyer, can command a higher price. Products must be tailored tightly to the market. 341 The Art of Deal Making Assume you make furniture. There are lots of furniture manufacturers around. How to diﬀerentiate? Specialize. There are a thousand ways. Maybe you can serve a particular industry, such as banking. Maybe you can import from Scandinavia. How to Stimulate Bids Shopping around without revealing your game is the best way to stimulate bids. Don't give the impression of handling picked-over merchandise. When it becomes known in Hollywood that a script is making the rounds of the studios no one will touch it-after all, who wants to be last in line? The same is true when selling a business. Pick your targets carefully. When working with interested parties, get a bid-any bid. The only way to ﬁnd the market is with real numbers. Your objective is to get the highest number on the table. Thus, prospective buyers should be told that their bids should assume "everything presented is perfectly true." These bids are not morally or legally binding. Buyers can do their detailed analysis later and make any changes they want. How to Raise Prices A positive change in your product should be made at the same time you raise the price. The change doesn't have to be big, but customers and prospective buyers should feel they are getting something for their extra cash. For example, 2 percent of a 7 percent price increase should be plowed back into the product in a visible way (e.g. a slight redesign, some fresh colors, or a little extra service). How to Use Terms Is it worth trading oﬀ better terms for the buyer in exchange for a higher price for the seller? For example, if a buyer is allowed to extend dating from "net 30 days" to "net 90 days," the seller can up the price. The seller must be compensated for the cost of money and the additional burden of carrying the longer receivable. How to Get Your Price as Buyer How to Determine Price Shop around. The market is key. Compare all aspects of the products, not just the price. The cheapest products are not always the ones with the lowest price tags. For instance, the cost of ﬁnancing the deal as well as any warranties and service responsibility should be ﬁgured into your price comparisons. 342 The Art of Deal Making How to Make Your Bids Make an oﬀer that you would love to be accepted. Judge the situation. If you're hot for the deal, make a reasonable ﬁrst oﬀer. If you're unsure, throw out a red herring. You never know who may bite. Don't be afraid to discuss your oﬀer over and over again. The more you talk the more you learn. How to Adjust Prices Every oﬀer is made subject to appropriate due diligence. Deals should be bid as if everything presented is absolutely correct. Thus, a fat ﬁrst oﬀer encourages the seller that the bidder is a prime candidate. The process may even drive out some competitors. Then, after making a detailed analysis, you can always change your mind ("take a haircut" or "move South" in deal-making parlance). How to Improve Terms As discussed in Deal Skill 10, "your price, my terms" is a deal-maker's maxim. Deal terms are as important as price to the buyer.* The opposite is often true (at least psychologically) for the seller. Sellers like to brag about the price they got. Cater to this tendency: Trade oﬀ higher prices for better terms. When Parties Compete Competition is great when you're a seller, not so when you're a buyer. The same tricks, I'm pleased to report, work in both situations. When Buying As a buyer, never bid against yourself. Many buyers have upped their oﬀers when no other parties were even in the running. Look for situations where the sellers will acknowledge that your party is the only bidder. "Let's do a negotiated deal," you would say. "Let's proceed in good faith. If we can't reach a good deal for both of us, we'll back oﬀ with nothing lost." If necessary, agree to a time limit. Stretch as far as possible to eliminate competition. When Selling As seller, try to deal with several interested (or, better yet, anxious) suitors simultaneously. PERSON_NAME other options around makes you a more conﬁdent negotiator. Alternatives stiﬀen backbones. Furthermore, there's a strange phenomenon in the buying and selling game. The great majority of 343 The Art of Deal Making oﬀers cluster, as you'd expect, within a tight range. But then there are usually one or two outliers, parties who for their own reasons bid signiﬁcantly higher. Your task is to ﬁnd these ﬁne folks. Buying and Selling in Auctions (LIKE MOST DEALS) Bidding Theory Recent research has conﬁrmed what canny traders have known for some time: Most bidders in auctions harbor inﬂated opinions of their own judgment of value. Though they may do detailed analyses, the bottom line is that they generally go with their intuitions. Instincts lead the charge, and more often than not, it's a slaughter for the buyer (and a windfall for the seller). New theory in bidding psychology shows that the structure of auctions molds strategies and inﬂuences behavior. Major companies are monitoring the progress. How to Handle Auctions as Sellers When to Auction Deals. When you have an especially hot property, the rules change. Now you're in the driver's seat. Make wide contacts. Establish a date for bids to be submitted. Seller's Auction Strategy. The optimal strategy for soliciting bids includes the following steps: Encourage the maximum number of bidders; the greater the number of participants the higher the winning bid. Make available before the auction as much information as possible about the object or asset to be auctioned. Trust the marketplace to squeeze out any windfall proﬁts-but only if all relevant data is widely distributed to all potential bidders. Do not give away any information about the bidders before the auction. Avoid all actions that will reveal the number, nature, or strategies of the rival bidders (e.g., use no prequaliﬁcation procedures; keep your bidders totally blind). Do not give away any information after the auction. Avoid giving bidders any hint of their competitors' strategies. (This applies both to second-round bids or future auctions.) Consider a second round. This is delicate. Allow those bidders that came close to sweeten their oﬀers. Since the ﬁrst-round winner would scream like hell, don't announce who won. Do not disclose the winning bid, either. However, a new ﬂoor for the ﬁnal round should be established. How to Handle Auctions as Buyers When to Participate in Auctions? Auctions should be avoided when-ever possible. Only bid when you have speciﬁc competitive advantage. For example, an operating company that knows it 344 The Art of Deal Making can bring substantial new business to the ﬁrm being auctioned has an edge over an investment company looking purely at that ﬁrm's current cash ﬂow. The operating company can aﬀord to make a higher oﬀer and still generate a similar return. Buyer's Auction Strategy. The optimal strategy for making bids includes the following steps: Only participate when the number of bidders is relatively small. Some companies will not even enter auctions with more than ﬁve hats in the ring. Seek some competitive edge in the bidding. For example, look for synergies with your current operations. Or try to get special information about the object or asset to be auctioned. If you cannot go into the auction with some sort of comparative advantage, for-get it. Learn as much as possible before the auction about the number, nature, or strategies of the rival bidders. Put yourself in their shoes and plan alternative scenarios. Learn as much as possible after the auction about your competitors' strategies. This will prove useful when bidding against the same rivals again, and it will be a benchmark against which to judge your own pre-auction evaluation techniques. Making Sure Buyers and Sellers Can Deliver The most frustrating experience is to cut a good deal with a party that can't produce. You must establish conﬁdence in the other side's credibility. Sometimes, the parties with the lowest credibility oﬀer the best deals. This is logical, since weaker buyers must oﬀer sellers something special to compensate for the uncertainty. Don't dismiss these ﬂakes too quickly. They may be hungry enough to belly up to the table. You always want to know how much the buyer can pay. It's like children selling candy to each other. "How much does the Mars Bar cost?" asked the wide-eyed six-year-old. "How much do you have in your pocket?" answered the street-smart eight-year-old. What to Do? PERSON_NAME Morgenstern, president of Defense Software and Systems Inc., is a remarkable man. An ordained rabbi in the Orthodox tradition, he has been a leading computer consultant for major U.S. military contractors for 25 years. Morgenstern is largely credited with introducing Talmudic scholars to computer programming as a profession, both in the United States and in PERSON_NAME. ("There are three things similar between Talmudic learning and software programming," says Morgenstern. "One, you need to have a keen, analytical mind. Two, you need to be able to put up with some oﬀ- the-wall ideas. Three, you need to be able to sit on your rear end for a dozen hours straight.") 345 The Art of Deal Making The story of how Morgenstern established his company in PERSON_NAME (Decision Systems), perhaps that country's leading defense-oriented software ﬁrm, is a story of price. It seems that after several years of consulting for the Israeli government, largely for no remuneration, Morgenstern was asked to set up a more formal operation to handle a speciﬁc aerospace contract. Now this was diﬀerent. He would have to pay employees and carry overheads. So, for the ﬁrst time, he would have to present a price for the contract. But how much to charge? What to do? Morgenstern bid the contract essentially at cost. He was not a wealthy man, but this was his way of contributing to the homeland of his people. However, his proposal was rejected by the government oﬃcials. Why? It was not too high, they said, but too low. One wise man counseled: PERSON_NAME, you must make a proﬁt. Not for your sake but for ours. We need you to work on these projects. And while we can't be sure that your Zionism will remain as fervent in the future, we can be very sure that your interest in proﬁts won't change. 346 The Art of Deal Making Deal Secret-10 Learning The Opening Game There Is No Substitute For Preparation What marvelous analogies come from chess! "Chess is life" expound the grandmasters, who speak of the "essence of a bishop" and the "elegance of a sacriﬁce." No grandmaster, it is said, has ever lost a game when feeling well. Chess games are divided into three parts: the opening game, the middle game, and the end game. Each part, with its special attributes, teaches speciﬁc lessons about deal making. 1. The opening game is the ﬁrst few moves in which all the pieces are put into play. Good opening-game strategy is characterized by well-prepared themes and variations. 2. The middle game is the play with the major pieces on the board. Good middle-game strategy is characterized by plans projected out many moves deep, positional strength, combinations, sacriﬁces, and mating attacks. 3. The end game begins when the major pieces come oﬀ the board. Here, through the promotion of pawns to queens, small advantages are transformed into winning positions. Good end- game strategy is characterized by precise calculations of tempo and timing. Kinds of Chess Openings In chess, openings are patterns of moves. There are dozens of diﬀerent openings with wonderfully colorful names. There are also hundreds of variations which sport their own personalities. Each of these patterns of moves has clear advantages and disadvantages-with the boundary between brilliance and blunder often being subtle. The same is true of deal making. Gambits are important in both chess and deal making. A gambit gives up something, such as a pawn (in essence a fetal queen), to gain position and mobility. A gambit is a risk, trading something tangible for something intangible. If there's little compensation, if your opponent's pawn advantage is maintained to the end, you face a lost position. 347 The Art of Deal Making Surprise is an important opening ploy. Shock can often overwhelm a superior system. Say your opponent chooses an older, inferior opening. If you haven't prepared for it and your opponent has, you could be in trouble. See an analogy to deal making? Principles of the Opening Game There are certain ideas behind good chess openings. These principles correspond directly to deal making. 1. Develop Pieces Eﬃciently. Each move should bring out a new piece. Developing your pieces by attacking your opponent's pieces is eﬃcient. If the other side must defend after each move, he or she is less likely to develop an attack. Good dealmakers optimize their resources. 2. Put Pieces on Good Squares. Positioning of pieces is vital. Maximize move-making mobility. Know the value of each piece in your arsenal. Good dealmakers understand how best to take advantage of their capabilities. 3. Pieces Should Work Together. Synergy is important. Good deal-makers appreciate how their resources combine for maximum eﬀectiveness. 4. Control the Center. Center control is the most important early principle. The greater your control of the center, the greater space for your pieces, and the more constricted the space for your opponent's. An oﬀensive posture is always more desirable. Good deal-makers know that control of central issues is a critical factor for success. 5. Protect the King. The king is your vital piece. Lose it and you lose the game. What cannot be lost must be constantly protected. Good dealmakers never neglect their bottom-line vulnerability. Kinds of Deal Openings Try the following openings of the deal-making game. (I've had some fun with these.) PERSON_NAME Center Game. Friendly and compelling. Moves are made for show and image, not content and substance. PERSON_NAME Grant Suave Game. Cultured and urbane. Moves are made to exude graciousness and charm. PERSON_NAME Onassis System. Elegant and reﬁned. Moves are made for polished manners and social standing. PERSON_NAME Sagan System. Erudite and understandable. Moves are made to make hard concepts easy to digest. Don Rickles Attack. Insulting and cutting. Moves are made to irritate and oﬀend. PERSON_NAME Attack. Brutal and solitary. Moves are made to blow you away. 348 The Art of Deal Making Mr. T. Attack. Intimidating and coercive. Moves are made to bounce you around. J.R. PERSON_NAME Gambit. Tough and sneaky. Moves are made behind your back. Muammar Khaddafy Gambit. Wild and dangerous. Moves are made without concern for consequences. PERSON_NAME Stallone Gambit. Powerful but superﬁcial. Moves are made to accomplish simple purposes. Yogi Berra Countergambit. Odd and wise. Moves are made that appear silly but contain real insight. Woody PERSON_NAME Countergambit. Witty and wise. Moves are made to convey profound truth in a lighthearted manner. PERSON_NAME Defense. Light and easy. Moves are made to put you asleep. Leonid Brezhnev Defense. Stoic and blunt. Moves are made to maintain an iron curtain. PERSON_NAME Khrushchev Defense. Boorish and uncouth. Moves are made to irritate and aﬀront. PERSON_NAME Dangerﬁeld Defense. Hesitant and self-conscious. Moves are made with worry and uncertainty-sure not to get any respect. What to Do? "You're in trouble, kid," said the high-pressure lawyer, barely concealing his glee. It was my ﬁrst big business deal, certainly my ﬁrst exposure to the tortuous maze of tax-loss law. I was sitting, by myself, in a large conference room of a major New York law ﬁrm, surrounded, it seemed, by all the attorneys infesting Park Avenue. I felt instant empathy with the gladiators of ancient PERSON_NAME, alone in the arena encompassed by wild beasts. My naiveté was as evident as an open zipper and I was being hustled by real pros. If I didn't virtually give my company away, I was warned, I could lose it all. (I didn't and I didn't, but that's another story.) If making me worry was the theme of their show, it was a smashing success. Their carrot- and-stick negotiating posture skewed well more to witches than to rabbits. What to do? My problem was preparation, or more precisely, the lack of it. I like learning from others, but not, I quickly realized, from a dozen hostile lawyers smelling blood. The solution was to plan ahead of time, be prepped in the topic, and bring along expert counsel to even up the odds. 349 The Art of Deal Making Deal Secret-11 Imaging The Middle Game Always Check, It May Be Mate Let's start with a surprise: The trick in good deal making is often not what tactic you use but how well you use it. Speciﬁc strategy sometimes doesn't matter. Making that strategy work is what counts. It's like the middle game in chess where there are numerous strategies from which to choose. How well you execute the strategy is more important than which one you pick. Implementation, in other words, is more critical than formulation. The world champion of chess, Gari Kasparov of the Soviet Union, was a dynamic player known for explosive attacks that border on the reckless. The former world champion, Anatoly PERSON_NAME, also of the Soviet Union, is a positional player known for a suﬀocating style that has been likened to that of a boa constrictor. Kasparov is electrifying but erratic. Karpov is dull but consistent. The Super Ks are, without doubt, the two best players in the world. Their strategies diﬀer widely, yet both are world class. Likewise in deal making: First-rate dealmakers evince diversity of strategy but commonality of excellence. Strategies for the Middle Game The following strategic ideas ﬁt the middle game. The general idea is to meld consistency and creativity in driving toward success. Most of these strategies can work together. 1. Complete Development. Finish the process begun in the opening. Get all your pieces activated; get all your issues on the table; get all your resources working as a unit. Be sure all moves support a clear plan. 2. Plan an Attack. Determine the best approach for mounting an oﬀensive, whether a direct assault against the opponent's primary sticking point (such as price) or an indirect foray on an opposing ﬂank (such as timing). In chess, the strategic decision is when to go after the king. In deal making, it's whether to go after vital or peripheral issues ﬁrst. 3. Combinations. Look for ways and means to combine your resources. Moves must be thought through carefully. In chess, take advantage of the particular attribute of each piece. In deal 350 The Art of Deal Making making, it's the special character of each issue. Discover how several separate issues might be solved in one overall solution. 4. Sacriﬁces. In chess, watch for unique opportunities where giving up a valuable piece can produce quick victory, normally by exposing the king's defensive position. The victory needs to be swift, since you are now down substantial material and would eventually lose if the position becomes simpliﬁed. In deal making, sacriﬁces are strategic concessions. Watch for unique opportunities where giving something up can induce swift closure on favorable terms. Maybe a sudden swing on price can cut through a morass of tangled problems. 5. Develop Complications. If you have the superior position, seek ways to increase complexity. In chess, a superior position is better placed pieces, more focused resources, and more board control. In deal making, it's less necessity to make the deal, larger size, and lower stakes. Here, for example, you should add additional issues and factors. Do not allow simpliﬁcation. 6. Simplify the Position. If you have the inferior position, seek ways to decrease complexity. In chess, an inferior position is poorly placed pieces, dispersed resources, and less board control. In deal making, it's greater necessity to make the deal, smaller size, and higher stakes. Here, for example, you should eliminate current issues by exchanging or trading them oﬀ. Do not allow complications. 7. Prepare for the End Game. Few grandmaster matches end in the middle game. Few deals are consummated at this point, either. A concluding handshake with a room full of issues is rare. Instead, the preparations that begin in the middle of negotiations are what win the close. The key is to think out where you want to end up. Imaging the future is vital. Deal Tactics of the Middle Game 1. Relative Value of Pieces. Understand the comparative value of your issues and resources, strengths and weaknesses, so that you can trade them to your advantage. In deal making, however, there is no nice point system to count on your ﬁngers. However, if you think in terms of relative value of issues, it can guide the trading process. 2. Patterns and Positions. Familiarity with various deal positions is vital. Develop (1) a sense of circumstance and (2) limits around critical problems. Avoid being suckered by high pressure. 3. Deep Calculations. Determining moves in deals is much the same as in cheese. You consider (1) a move, (2) your opponent's possible replies, and (3) your possible answers to each of those replies, and so on. You must learn to weed out the least likely scenarios quickly and concentrate on the most likely. 4. Active People. You want your people to be hard workers, doing all the things of which they are capable. Each element of deal making, should be used where it works best: ﬂexibility in the opening to build rapport, complexity in the middle game to add opportunity, and ﬁrmness in the end game to close the deal. 351 The Art of Deal Making 5. Multiple Attacks. Applying multiple attacks to deal making can stimulate creativity. Two examples: "Pins," ﬁnding issues that your opponent can't be tough on for fear of uncovering a worse situation (e.g., a selling company might readily agree to pay extra money to eliminate a liability exposure for fear that the actual liability may be far more extensive); double attacks, simultaneously addressing more than one issue (e.g., giving your kids a weekly allowance can eliminate all disputes over ﬁnancing their movies, new clothes, parties, etc.). Stress the strategy: Whenever you ﬁnd a pinned issue, attack it! Whenever you can handle two issues at once, do it! What to Do? A small company is willing to pay an excellent price for a group of businesses that would give them vital synergies, but they don't have the ﬁnancial horsepower to pull the whole thing oﬀ. The seller likes the buyer's valuation and enthusiasm. What to do? Appreciate the common position, especially the relative power of the pieces in play. The seller should consider breaking up the businesses. The buyer should consider down-scaling objectives to purchase several but not all of the divisions. This is a deal that should be made: The price is too good for the seller, and the need too strong for the buyer. 352 The Art of Deal Making Deal Secret-12 Calculating The End Game Tempo, Not Temper In deal making, closing is what counts. You can be brilliant in ﬁnding, selecting, and structuring deals–but none of that matters if you can't ﬁnish them oﬀ. In chess, the end game begins when all the heavy pieces (queens and rooks) are oﬀ the board. In deal making, the end game begins when most major issues are resolved. End game play takes on a diﬀerent character. It must be very precise. Ideas for the End Game 1. Wins occur when you have clear superiority in material or position. At this point, it's all a matter of technique. In chess, exchange pieces–since the fewer pieces on the board the larger your advantage becomes. In deal making, trade out all remaining issues quickly. Press your advantage with care. In deals, winning positions can be blown by high-handed manner. 2. Forced wins occur when you totally control the situation no matter what the other side does. In chess, it's just a matter of demonstrating your checkmate. In deal making, such occurrences are exceedingly rare, and ﬂaunting your position can ruin it. 3. Draws are when the game is ended even. In chess, draws are declared when one side oﬀers and the other accepts. (Protocol dictates that the side with the slight advantage should oﬀer the draw.) Draws are usually duds in chess, though important when needed to clinch match victory. In deal making, draws occur when negotiations end in a tie. Draws are not duds in deals: If they mean closure, they are good; however, you may be disappointed if you sought more gain than you got. 4. Forced draws occur when any of the following happen: (a) all issues are resolved, (b) positions are repeated continuously without compromise or movement, (c) neither side can alter its position without conceding basic points, (d) a long period of time elapses without progress. 353 The Art of Deal Making 5. Zugzwang is a German word meaning move compulsion. It occurs when one side cannot make a move without giving away something important. In chess, you have to move. In deals, you do not. Deal Strategies for the End Game 1. Precise calculations are needed to determine the exact sequence and timing of your ﬁnal moves in negotiations. In chess, victory or loss is often measured in the tempo of a single move: Whoever would make the next move would win (generally by the promotion of a pawn to a queen). In deal making, completion or disruption is often calculated in terms of the resolution of a single issue. 2. Mobility is critical. In chess, it's position and timing: The king needs to shepherd its pawns down the board to become a queen. In deal making, it's attitudes and issues: Dealmakers need to shepherd their ﬁnal points down to closing. 3. Sacriﬁce in the end game is more apparent than real, since you know exactly what you are getting for what you are giving. In chess, the beneﬁts of an end-game sacriﬁce must happen in short order. In deal making, the reason for the sacriﬁce is usually a quick trade to reach ﬁnal agreement. How to Become an Expert Developing world-class expertise is exceedingly diﬃcult. One prominent management researcher– who did much of his work with chess grandmasters–believes that such expertise requires 10 years of concentrated experience and some 50,000 chunks of information." What's a chunk? A good bit more than a byte. A chunk is an integrated concept of knowledge– whole experiences–complete patterns of awareness that become the foundation for evaluating new situations. A chess example is a repeatable position of pieces. A deal example is handling an irritating personal aﬀront. Chess Lingo I am fascinated by the jargon of chess players. The talk sounds violent, yet has a whimsical touch. Hopelessly PERSON_NAME In chess, the winner is identiﬁed by default. If a player is winning, she is not declared a sure victor; rather her opponent is described as being hopelessly lost. In deal making, it's when one side just gives up the ﬁght. 354 The Art of Deal Making Blunders Clear mistakes–very bad moves made by very good players. A blunder to a grandmaster might be a decent move for normal mortals. We all blunder, even in deal making. Examples of the latter in- dude giving away too much too soon and not compromising for ego's sake. Think about what chess players say about blunders: It's not the ﬁrst mistake that kills you, but the second–the fatal ﬂaw is often made while worrying over that initial, often minor, error. The message is clear: Don't fret about past failures; just concentrate on current issues. Stalemate A forced draw–and a wonderful word. In chess, it's a would-be, should-be checkmate that has gone stale. Stalemates often occur when one side has a winning advantage and gets sloppy. Dealmakers who have negotiated a good deal must maintain full focus and not allow a minor issue to disrupt the transaction. Perpetual Check In chess, when one side can continuously check the other side but never actually pull the mate. In deal making, when one side can keep the other side constantly oﬀ balance, say by harping on a sensitive subject. Perpetual check, in chess and in deals, is done by the weaker side and draws by repetition of moves. Adjournments In chess, after 40 moves are made without victory, the players may take a recess to the next day– and all the strict rules of the game evaporate. Players are expected to work hard analyzing the numerous variations of the adjourned position. This is not like a take-home examination in college. There is no honor code to uphold. You may consult every expert, use every tool, and boot up every computer. Similarly in deal making, when negotiations are adjourned, it is vital to rethink strategy and plan your next moves carefully. PERSON_NAME, It May Be Mate This is my favorite chess maxim. There are two points here: (1) you never know the impact of a strategy until you try it, and (2) you should always give luck a chance to weave its serendipitous magic. 355 The Art of Deal Making What to Do: When to Take Risks? In both personal and business deal making, as in chess, you take risks when your position is either very good or very poor. In either position, a gamble can result in a proﬁtable payoﬀ. In chess, whether in the middle game or end game, you take risks under two opposite conditions: When you have a superior position with greater control of board space or better mobility for your pieces. Risk here may assure a quick victory. When your position is desperate and you have little to lose by trying something daring. Risk here may salvage a lost position. Superior Corporate Position Assume you are discussing a promotion with your boss. You have just created a successful sales campaign (which gives you superior position) and have personally opened up several major accounts (which gives you greater control of space). As a result, several competitors are making attractive bids for your services (which gives you better mobility). What to do? Now is the time to go for that promotion: The game is stacked in your favor. Inferior Corporate Position If you are in a poor position, you can aﬀord to take the same kind of risk because things couldn't get much worse. Suppose, for example, your department was decimated by budget cuts. Your boss has been ﬁred and it is rumored that you are next. What to do? It can't hurt to take an aggressive posture. March right into the division head's oﬃce, assert your positive contribution to the company, and state with conﬁdence that you would like to be transferred to another department. At worst, you may be ﬁred today instead of PERSON_NAME. At best, you may be viewed as a take-charge person and a loyal employee. Superior Personal Position Your mother-in-law has been bugging you for years. Not much of a provider, she laments. Not good enough for her daughter, she carps. Finally, you get a healthy raise. What to do? Time to take a risk and put the lady linebacker in her place. Inferior Personal Position Your marriage is falling apart; ﬁghting is on the increase and divorce is in the winds. What to do? Time to take a risk and put more adventure in the bedroom. LOL? 356 The Art of Deal Making Deal Secret-13 Stressing The Strengths When You’ve Got It, Use It (Don’t Flaunt it) Build strengths; avoid weaknesses–a good balance I like to avoid. The arena for doing deals is ﬁercely combative. Dealmakers must show their best stuﬀ or be thrown out on their rears. It is better to be great at some things and poor at others than average at everything. Mediocrity just doesn't hold tough in competitive deal making. Strength and Weakness Assessment Good dealmakers must know their own strengths and weaknesses, aptitudes and limitations. Check your personal balance sheet: What are your assets and liabilities? The self-assessment process is tricky because it is so biased. Thus the deﬁnition of one's strengths and weaknesses cannot be divorced from one's position and responsibility. Objective analysis is diﬃcult and one should never assume otherwise. However, performing the assessment in a comparative context can help. Inside Analysis First, go internal. Compare your various departments or attributes among one another. For a company example, which is your ﬁrm's stronger division, marketing or manufacturing? For a personal example, which is your own better talent, technical or people skills? Outside Analysis Next, go external. Compare your various departments or attributes to those of competitors. For a company example, how does your ﬁrm's distribution system compare to those of marketplace opponents? For a personal example, how good are you at outselling your rivals? Techniques for Maximizing Strengths 357 The Art of Deal Making The following areas of deal-making strengths are matched with appropriate tactics to take advantage of these strengths. 1. Size. When your side is larger (and has more resources), take your time, strive for complexity, and allow no pressure. However, above all, treat the other side as equals. Do not condescend. Do not chance antagonism. 2. Power. When your side has more force (see Deal Secret 1), be slow to change on demand, quick to press agreement on your terms, and willing to allow face-saving concessions. 3. Flexibility. When your side is more adaptable, add complexities, alter issues, change agendas, move schedules, postpone meetings. 4. Needs. When your side has less demand for the deal, go slower, avoid pressure, be meticulous. 5. Expertise. When your side is more knowledgeable, use the impact of your advantage quietly. The less overt your content superiority, the stronger your inﬂuence. 6. People. When your side has stronger negotiators, have more face-to-face contact. Encourage larger, more frequent meetings. Discourage written communications. 7. Time. When your side has less schedule pressure, proceed properly. Do not slow the pace deliberately or you may infuriate the other side. 8. Insight. Sometimes you just know what to do; other times you just take a chance. Deal- making wisdom is the product of experience, natural gift, and trusting your own judgment. Intuition can contradict logic. When you feel it, use it; when you believe it, do it. What to Do? Assume that you are a group president in a large conglomerate. You have become embroiled in a competitive bidding battle to purchase a spin-oﬀ division of another conglomerate. The purchase is critical for one of your divisions. You've already reached the price limit set by the board's executive committee. You cannot go higher and you cannot win at this price. How can the oﬀer be sweetened without violating the corporate rules? What to do? Go with your strengths. Both conglomerates consist of large corporate groups with many diverse subsidiaries. In all likelihood, one of your company's other divisions can do business with one of the seller's other divisions. It may be worth a substantial amount to the selling corporation to secure a large, multiyear contract for its products. It may even be enough to give your group the acquisition as part of a larger deal. 358 The Art of Deal Making Deal Secret-14 Skirting the Weaknesses When You Haven't Got It, Hide It (Don't Improve It) Improve your strengths–not your weaknesses. Deal making is not school. Bury those wobbly areas; never give in to them. (Why not strengthen your weaknesses? It's too expensive!) Techniques for Minimizing Weaknesses The following areas of deal-making weaknesses are matched with appropriate tactics to downplay these weaknesses. 1. Size. When your side is smaller (and has less resources), propel the process, strive for simplicity, appeal to fairness. Above all, treat the other side as equals. Do not fawn. 2. Power. When your side has less force (see Deal Secret 1), be careful when conceding points. Be sure every concession really counts and that your concessions become progressively smaller. Try toughness as a surprise. 3. Flexibility. When your side is less adaptable, strive to simplify, contain issues, maintain agendas, keep to schedules. 4. Needs. When your side needs the deal more, try not to show it. Move the deal along without evincing nervousness. Showing anxiety is a serious lapse. 5. Expertise. When your side is less knowledgeable, try to learn quickly. Use your lack of information or experience as a negotiating ploy. "Now you can't expect me to understand you 'city boys' right away… " 6. People. When your side has weaker negotiators, have less face-to-face contact. Encourage smaller, less frequent meetings. Communicate more in writing. 7. Time. When your side has more schedule pressure, move the deal along without showing anxiety. (Express nervous concern and you will be attacked like a wounded animal.) 8. Insight. When your side has less understanding of the deal, you can either let the other side lead and learn as you go or boldly suggest naive ideas and see what happens. 359 The Art of Deal Making Attitudes when Weak Never succumb to weakness. Never evince resignation. A sullen, depressed demeanor invites stagnation; and rudeness, surliness, and sarcasm induce disruption. Consider the following: Be hopeful, in outward attitude if not inward spirit. Speak clearly and directly, not muﬄed and askance. Sit erect and look well-pulled-together. Don't give yourself away with slumping, dejected posture–a slithering body conveys feebleness. Eye contact is important. Don't fear eyeballs colliding across the table. Indeed, search out your opponents' pupils. You'll feel awkward at ﬁrst, then good. Weakness Can Be a Strength Used circumspectly, a help me posture can evoke concessions. Most dealmakers can fall prey to compassion. The key is to appeal to your opponents' human nature–not to their competitive instincts. (Naturally, when you're on the stronger side, beware of this tactic.) Some people, sadly, have a sadistic bent, and any sign of weakness will just encourage their rapacious behavior. Finally, recall President PERSON_NAME's words: "Let us never negotiate out of fear. But let us never fear to negotiate." We tend to overlook what he said beforehand: "So let us begin anew–remembering on both sides that civility is not a sign of weakness, and sincerity is always subject to proof." What to Do? We joint-venture store liquidations and operations clients (see Deal Secret 30), and are is in the business of resuscitating troubled companies. We charge a ﬁxed fee based on retail sales. However, what happens when a prospective client is unable to pay normal commissions because of cash ﬂow diﬃculty? What to do? Seek an alternative form of payment. One approach is to use the disputed diﬀerence to buy equity in the client company. This accomplishes several things at once. We maintain our standard commissions and build an equity position which we can sell later. The client preserves its cash and gains a strong partner. 360 The Art of Deal Making Deal Secret-15 Driving the Oﬀense Doing The Deal Means Moving The Process Forward movement is vital for deal success. Stalling is as dangerous in making deals as it is in ﬂPERSON_NAME aircraft. Your object is to drive the oﬀense without being oﬀensive. Be a killer for the cause. Killer Instinct A deal is never over, in Yogi Berra's immortal words, till it's over. Never be satisﬁed with good movement and proper direction. Never rest until papers are signed, money changes hands, and the deal is closed. Never be complacent. Deals can stall because of inattention. Everyone, especially attorneys, pays more attention to those who complain. So growl, grumble, and grouse. Wail, lament, and moan. Talk to your people every day. Keep things hopping. If squeaky wheels get greased, then squawk, don't just squeak. Tips for Breaking Crises There is a critical moment in most deals. It occurs when initial enthusiasm meets contentious disagreement. Progress slows, discouragement grows, and many deals abort. The problem has two solutions: (1) break through the crisis by resolving the issues or (2) close the deal before it reaches the crisis point. Following are techniques for achieving crisis breakthrough. Multiplying Options Advancing is easiest when you have a choice of direction and method. The more alternatives you have, the more likely you'll ﬁnd one that will work. Multiplying options is one of my major themes. The constant assessment of situations and the frequent search for new ideas facilitates breakthrough. 361 The Art of Deal Making Using the Team It is not desirable for principals to confront each other too often. The top brass should get together only to resolve ﬁnal issues. Other members of the negotiating team should be used for the nitty- gritty. Divide up duties–this technique allows communication to proceed at all levels. Going Oﬀ-the-Record In oﬀ-the-record conversations, ideas can be suggested and opinions expressed without commitment. Don't misunderstand–there's no deception here; rarely are such discussions really oﬀ- the-record. Each side knows the technique, and both sides like using it. Oﬀ-the-record discussions give all parties a low-pressure opportunity to explore alternatives and fresh approaches. Setting Time Limits There comes a moment when you know the deal is not happening. At that certain point you must crank up the heat. For example, if your oﬀer as buyer is being shopped around or if your oﬀer as seller is being delayed, you must increase pressure. Let the other side know your displeasure that you're up to their tricks, that you have other options, and that you're prepared to take a walk. Using Written Communications No matter what the circumstances or relationships, the agreement should always be put in writing. (See Deal Secret 37.) This puts the issues into clear view and reveals any hidden problems that must be resolved before the deal can get done. Timing is important here. If the problems emerge too soon, they can kill the deal. For example, introducing technical diﬃculties early on might slow down momentum and cut oﬀ progress. The intrusions can divert energy and fragment focus. The solution is to reach agreement on the broad business matters before getting down to the details. Which Side Should Go First? Generally the side that wants to control the deal will draw up the document. Then, any changes go on that side's original form (and word processor). However, if there are some points of uncertainty, you might let the other side prepare the ﬁrst draft. Perhaps they recollect the questionable areas in ways more favorable to you (see Deal Secret 37). Another approach is to draw up the memo or letter with blanks left for the key deal numbers. 362 The Art of Deal Making Types of Written Communications Memoranda of understanding highlight all the primary deal points and are excellent instruments for moving a deal from talk to action. These memos are designed to conﬁrm mutual understanding, and are often composed by the parties involved–not their attorneys (however, an attorney should probably read over the memo). Since such memos are not legally binding, they enable both sides to express their thinking. Clear disclaimers are included and they need not be signed. Letters of intent are more serious. They are signed instruments typically drawn up by attorneys. We have a sample template Agreement to use as a starter. Both sides now aﬃrm that they are committed to go ahead with the transactions according to the speciﬁed terms and conditions. You can still back out, but it's getting harder-and it might cost you something. Doing Nothing Doing nothing is the hardest thing to do well. But often, there is no stronger oﬀense. Going silent puts pressure on the other side, especially if they've invested time and eﬀort in the deal (sunk costs) and need to get it done. Furthermore, as you may recall, silence protects your side from talking too much–a disease that can cause you to bid against yourself when there's no one else in the running. Wooing and Wowing Time for your charm. Don't laugh. Everyone likes to be complimented, even ﬂattered. If you're a buyer, tell the other side how well they've done with their business; if you're a seller, explain why they'll be satisﬁed owners. Also everyone likes to associate with a winner. If the deal involves any continuing relationship between the parties, you should build your side's image in the eyes of the other side. You want to show, without being overt, that the association will be good for them. What to Do? In negotiating to buy an equity interest in a small private ﬁrm, your terms and conditions remain inferior to competitive oﬀers. What to do? Take the oﬀensive. Stress the increased likelihood of substantial as set appreciation for the remaining shares. The current owners would gain greater wealth, even though their percentage of ownership would be smaller, if your group brings more incremental value than would competitors. Such incremental value can take the form of additional business, better management, or stronger ﬁnancial backup. For example, when such acquisitions are made by well-known investors, an initial public oﬀering becomes more likely and valued higher. 363 The Art of Deal Making Deal Secret-16 Buttressing the Defense Doing The Deal Means Changing The Process "The best defense is a good oﬀense" sounds great. When it works, it's nice. When your weak spot is attacked, don't defend, attack back. For example: If the other side demands that certain guarantees must be strengthened, tell them you are considering cutting them down. If your boss claims you are not spending enough time traveling to see customers, say, "What about those additional expense allowances you promised?" Sounds like good strategy? Sure. The problem is that oﬀense doesn't always work. The following are some ideas for counteracting adverse negotiating conditions. Counterpunching Let the other side make the ﬁrst proposals. It is easier to respond than to oﬀer when defending a position. According to military theory, an attacking army needs far more soldiers than does a defending army. When you are the proposee, you have time for considered response. You learn more, too. Tag-Teaming Substitute Players Put in some new folks. They may help, even if only slowing the process and shifting the momentum. This tactic is like calling a time-out to make a substitution in basketball-often used to break the other team's hot streak. 364 The Art of Deal Making Good-Guy-Bad-Guy Routine Playing good-guy-bad-guy is always worth a shot. In deal making, this is also known as the black- hat-white-hat ritual. Note that taking the bad guy/black hat role means disagreeing-not being disagreeable. Creating a bad guy is often valuable because it makes the good guy stand out by contrast. He or she is someone with whom the other side can talk and in whom they can conﬁde. Good guys can sometimes perform magic. This technique can be eﬀective even if the other side is fully aware of your ruse. Stonewalling Just say no. However much the facts demand change in your position, simply refuse to budge. Be obstinate. Keep a straight face and be stubborn and inﬂexible–mulish and bullheaded. Obviously, the strength of your stone and the height of your wall depends on the relative power of the parties. (See Deal Secret 1.) If your side is the more powerful, stonewalling is easy to implement (though not necessarily good strategy). If your side is the less powerful, stonewalling adds a touch of the irrational, which isn't all bad. Perhaps the most positive beneﬁt of stonewalling is its impact. It can't be ignored. Furthermore, when you ﬁnally do make a change, however modest, the importance of the concession becomes exaggerated. Your eﬀorts are much appreciated. The key is timing and relativity: People assess current events by comparing them with recent events. (See Deal Skill 2.) The Art of Bluﬃng Bluﬃng is a common business practice. It is easy to do, but hard to do well. It's also dangerous, especially if the parties involved know your style; repeatable patterns are sensed quickly. If you bluﬀ, you must be prepared to carry through with your threats. When Fighting Time Take charge of the process. Schedule meetings. Set agendas. Energize attorneys. Produce paperwork. In other words, you assume responsibility for movement. If the other side continues to delay, they either don't want to make a fair deal (in which case you'd rather know it sooner than later) or their eﬀort to use time as a weapon is exposed. Consider this less traditional approach. If the other side thinks it has you in a time squeeze, perhaps you should shock them by slowing negotiations yourself. It can disrupt their strategy and work to your advantage. 365 The Art of Deal Making When Fighting Bullies Handling toughs and tyrants is risky because all options hold dangers. Pushing back hard can expose their cowardliness–but it may also trigger a blowout. Playing meek and defenseless can disarm the other side–but it may also invite mayhem. The best tactic is to sidestep ruﬃans. Allow their abuse to bounce oﬀ harmlessly, like a hot laser oﬀ a shiny mirror. If you don't react, their assaults don't penetrate. When Fighting Authority Understand the character of the command structure you face and make your appeal accordingly. If the authority is based on merit and achievement, use logic and fact. If the authority is based on politics and gamesmanship, use ego and emotion. The critical factor for manipulating authority is to show that taking your suggestions will enhance their leadership control, while not doing so will undermine their personal position. When Fighting Coercion When the other side keeps trying to muscle you into making concessions, it is a mistake to assume they will stop. They won't stop until you stop them. So stop them! When Doing Nothing Is the Best PERSON_NAME Fickleness frustrates. Indecision can blunt the strongest attack. So be wishy washy. Force your opponents to try cornering you. Become loose like Jell-o–attempting to nail Jell-o to the wall can be nerve racking. Doing nothing is sometimes the most aggressive move you can make. Consider a protracted negotiating session where the other side, at the end of a long day, throws their ﬁnal proposal at you. If that proposal is still well oﬀ the mark, perhaps you should do nothing. Be unable to schedule the next meeting; be unavailable for personal chats; be polite but vague during phone calls. The contrast will be sharp and the pressure maddening. Generally, you don't have to do nothing for long to make your point. Nothing, please note, is not nothing. Personal Attacks Threats, dares, insults, and the like are not good tactics. Little is gained from desperate acts of a personal nature. Deals are made because people want to make them, and if you antagonize the other side you lose more than you gain, 366 The Art of Deal Making What to Do? I admit I was rather panicked at the prospect of losing an important acquisition. The potential purchase could catapult a small company I had put together. The target ﬁrm was a spin-oﬀ of a large corporation, and management of the subsidiary held the key to the deal. All we could oﬀer management was 20 percent of the stock, whereas they sought 50 percent, a number that competing bidders would approach. What to do? Preparing for my visit with management, I was rehearsing the role of salesperson, articulating all the ways in which their company would beneﬁt in coming with us (other than that stock percentage). The president of our company advised a diﬀerent tack. He counseled me not to push. "Sometimes, oversell triggers an opposite eﬀect," he advised. "The other side thinks, 'Why should he have to sell so hard? Better to undersell and allow them to convince themselves." I agreed with the approach–we had a strong story to tell. And then I saw the irony: I couldn't help but note the timing of the admonition–just as I, "the dealmaker," was struggling with this chapter. (The purchase, by the way, didn't work out for other reasons, though the undersell attitude was clearly correct. 367 The Art of Deal Making Deal Secret-17 Surmounting the Setbacks The First Fall Hurts, The Second One Kills So you've had a setback. You're down. You're ﬂat on your back. A setback is not the end of the world–or the deal. Maybe you've had to make some concessions. You're discouraged. The other side is pressing for more give. Your tendency is to let up, resign, and stay ﬂat on your back. Don't! Don't give in and don't succumb. Above all, don't make hasty decisions that can compound your ﬁrst error. Recall the chess maxim about the second mistake, the one you make when lamenting the ﬁrst mistake? Happens all the time in deal making. Containing the Problem The ﬁrst step is containment. Conﬁne your losses to one location Isolate the issue. Treat the setback as if it were an independent, watertight compartment on a ship. The ship won't sink if one compartment ruptures." Circling the Problem The next step is having ﬂipping the focus away from the problem. Once having isolated the illness, you must move away from it. Change directions. Break stride. Make alterations of any kind. Pick yourself up and scout the lay of the land. Shift the theater of operations. You have several good options. For example: Put new players on your negotiating team. Their freshness pro vides a convenient excuse to retard the pace or change the pattern of current negotiations. Set a strange meeting time, perhaps later in the day. Such a switch suggests that you have more important activities earlier in the day. Invite the other side out to a nice restaurant to continue talking. This shows conﬁdence in your position. 368 The Art of Deal Making Start talking about other issues. Pick an area where the other side is weak, or one that has not yet been discussed, or one in which the other side has a keen interest (e.g., if they've wanted to get a hands-on look at your plants, arrange the trip). Ultimatums Declaring ultimatums is never an easy tactic to use or face. Too much self-image is involved and logic is often overrun by emotion. Yet few deals get done without a bit of brinkmanship. Try this tactic right after a setback. It's the most unexpected moment. The threat may seem irrational, but not idle. It may scare the other side into worrying whether you'll trash the deal. That's not so bad. Let them trade their iron mallet for kid gloves. Turning Lemons into Lemonade No matter what happens, you can always improve the situation. Often, the embryo of a vital, new approach is buried within the carcass of the old approach. Being a little naive never hurts. If you don't know something can't be done, you might go out and do it. 369 The Art of Deal Making Deal Secret-18 Breaking the Deadlocks Crack the Tension, Not Your Head Every deal reaches an impasse somewhere along the line. Breaking through that impasse is what you have to do. Stopping the standoff is what turns good dealmakers into great ones. Tips for Breaking Deadlocks The following list describes various deadlock-breaking techniques: Change the Pace. Switch topics, shift agendas, move meetings, or take a break. (Remember the time-out in basketball.) One-on-one Meetings. Interrupt a larger meeting and go head-to-head with the other side's principal. Get the old, cynical attorneys and young, intense MBAs out of the room. Maybe out of the building. Play Mediator. Take the good-guy role and put yourself in the middle. Try seeing the deal from both sides. (Play PERSON_NAME without the crown.) Bring in New Factors. Generate fresh ideas. Introduce new concerns, matters, points, and problems. Reduce the importance of deadlocked issues by surrounding it with other issues. Substitute people. Bring in new people (someone off-the-bench-that substitute in basketball.) Go Senior. A last resort. If you're not already dealing with the most senior person, reach up. Recognize that you are antagonizing your peers. Now they can't look good, no matter the outcome. If the deal works, the boss gets the credit; if the deal doesn't work, your peers get the blame. Do Nothing. Often, the safest solution is to stand still. Be patient. When in doubt, don't do the wrong thing. Something can always be done tomorrow. You only lose your options when you use them. 370 The Art of Deal Making Art of Compromise If you think compromise is splitting the diﬀerence–dividing negotiating positions evenly-you think wrong. Carving issues down the middle do not make the best deals. Compromise is a complex and surprisingly precarious process. Used properly, it closes deals. Used improperly, it causes disaster. Compromise is the art of getting both sides to agree to a resolution that neither side likes. As long as everybody is unhappy, goes one adage, the deal is a fair one. The following principles should be used in making compromises. 1. Don't Be the First to Concede a Major Issue. Being the ﬁrst to accept a substantial compromise is a sign of weakness. It can induce aggressive behavior across the table. The more you give, if given in the wrong way, the more they want. Feeding greed only breeds greater appetite. 2. Suggest Only PERSON_NAME. Oﬀering minor compromises ﬁrst is ﬁne. It is a good way to encourage a reasonable solution. This tactic does not bring out the shark in your opponent. 3. Don't Compromise Near Deadlines. Don't give the impression of caving in to pressure. Compromise should always be combined with conﬁdence. Oﬀering a concession when a deadline approaches smacks of concern and collapse. Instead, you might inform the other side that you are ready to oﬀer some new ideas–after their deadline has expired. 4. Concede the Right Way. It is vital that the other side interpret your concessions properly. You must communicate, in fact more than in statement, that your oﬀers are minor and getting smaller. If your opposites think they can get more, they will push for more. That's the nature of negotiations. (Sometimes, being human means playing by jungle rules.) 5. Milk Concessions. When you've made a concession, no matter how small, make the most of it. Use your compromise to show your willingness to get the deal done. Use it to show what nice people you are. Talk about it seriously and with good humor. ("Now look how much you've squeezed out of us!") 6. Skewing the Split. Splitting the diﬀerence, please note, does not necessarily mean hacking the issue in half, nor must it always relate to price. Deals can be split, even though skewed to one side. A critical criterion is the test of mutually and relatively equal unhappiness. All issues are subject to such compromises, from features of product to terms of payment. Finding the Right Angles If we assume that the two sides are 180 degrees opposed on out-standing issues, a 90 degree switch for both sides–each one moving half way toward the other side–sounds ideal. This would be true if we were limited to two dimensions. Since we aren't limited, the best solution might lie in three dimensions. 371 The Art of Deal Making For example, if Company A (the seller) insists that it must receive $10 million for a certain division, whereas Company B (the buyer) asserts that it will only pay $8 million, they must negotiate. Assume the diﬀerence lies in disputed forecasts of next year's earnings. An even, split-the-diﬀerence compromise, which both side will like and either may reject, is to pay $9 million. However, there is a better way. A three-dimensional solution would involve: (1) paying $8 million on closing and (2) an additional $2 million based on future earnings. A formula tied directly to those earnings will allocate the additional payments plus interest. Both sides should be happy. If the earnings will materialize, as the seller maintains, the buyer will be pleased to pay the full $10 million. If the earnings are not there. $8 million was the right price and the seller has no beef. Careful Concessions Be cautious with concessions; they can cut both ways. 1. When to Oﬀer Concessions. It is best to oﬀer a concession when you are strong. Concessions should be well-chosen and restrained not arbitrary and unbounded. If the deal can be consummated with a ﬁnal concession, go for it. A desperate concession to keep a deal alive generally has little value (but if you are desperate to do the deal....) 2. How to Oﬀer Concessions. Proper style depends on underlying motivation. If you pull back your position out of strength, make a big deal of it. If out of weakness, underplay it. If you make a move that ﬁnalizes the deal, make it obvious that your oﬀer beneﬁts both sides. 3. When to Accept Concessions. It rarely hurts to accept concessions, unless some return action is expected or implied. 4. How to Accept Concessions. Don't gloat about them. Don't dwell on them. No one likes to give ground and the other side may be harboring second thoughts. It's a mistake to rub your opponent's nose in his or her weakness. Treat concessions as creative contribution rather than as erosions of strength. 372 The Art of Deal Making Deal Secret-19 Bridging the Gaps Bridges Are Man-Made Links What's the diﬀerence between Breaking the Deadlocks (Deal Secret 18) and Bridging the Gaps (Deal Secret 19)? The former concerns process, the means to get deals done, while the latter concerns content, the matter and substance of deals. Give Both Sides Something A bridge must have two sides; you can't cross a river without being anchored on both banks. It is surprising how many negotiators ignore the importance of giving something to the other side. Ignore? They avoid it like a disease. To give is to fail, some deal makers mistakenly believe, Concession is sacrilege, heresy, the un-pardonable sin against the deal-making god. Such twisted thinking is nothing but the triumph of ego over action. In deal-making terms, you get more when you give a little. Always try to couple what your side wants to get with something the other side can receive in return. Seek Fresh Ideas Even the appearance of newness is important. If nothing else, innovation is a face-saving device. If you attempt to exact concessions through brute force, you will breed resistance. No one wants to cave in. However, if you convince the other side that your approach is original, it will be easier for them to concede. Critical Issues Critical issues make or break deals. They either build up or break up blockage. What you do with them depends on circumstances. 373 The Art of Deal Making When to Address Critical Issues Sometimes you go right for the jugular. The deal is made or missed right here. You must have high conﬁdence in the likelihood of success–or be under extreme pressure–to take this tactic. When to Avoid Critical Issues It is more likely that you will skirt the major problems for a while. Get the other side into the habit of agreeing. Resolve the light issues ﬁrst, then lay into the heavies. Eliminate Misunderstandings Opposing sides view complex issues from opposite perspectives. Take, for example, the evaluation of inventory, a crucial part of most business acquisitions. A buyer may consider the downside scenario what happens if the company goes out of business–and arrive at the low value. The seller, of course, takes inventory at full value. How to resolve the dispute? If the seller can demonstrate ﬁrm orders for most of the inventory, that would clear up the problem. When to eliminate misunderstandings is a judgment call. You shouldn't do it too soon. Trying to mitigate a problem often exacerbates it. Attempting to cool down smoldering altercation can actually ﬂame it up. Open debate allows events to take their own course –actions and reactions become neither predictable nor controllable. Better let sleeping dogs lie, at least while working on other issues. When a major misconception stops a deal cold, you must handle it. Other times, take care. Postpone the Problem When dealing with explosive situations, never slam the door shut. The risk is too high, the reward too low. For example, when negotiating ground rules for a hostile press interview, the attorney for a controversial organization was careful never to be the one actually stopping the interview, which was exactly what he wanted to do. By engaging in elaborate discussions, primarily by written correspondence, he was able to get the reporter to tire of the process and drop the story. A directly belligerent approach would have invoked wrath and assured a real hatchet job. (See Deal Secret 27.) Use a Contingency Formula When a problem just cannot be solved, a contingent formula can give both sides what they seek. The unpleasant side eﬀect of this strategy is the added complexity. For example, when the buyers of a business insist that $12 million is the maximum they will pay, and the sellers of that business insist that $15 million is the minimum they will accept, a compromise must be reached. Perhaps a 374 The Art of Deal Making deal can be structured as follows: a $12 million ﬂoor, a $15 million ceiling, and the $3 million diﬀerence contingent on something (e.g., collection of the seller's receivables). The formulas, procedures, and policing methods needed to structure a contingent-based deal must be established. This is easier said than done. Often the contingent proposal bridges the gap during the negotiations, but is ultimately eliminated in the ﬁnal agreement as being too complicated. Use Options Try to give the other side alternatives. Allow them ﬂexibility to choose from among various possibilities. As long as all of the available choices are good for you, you have nothing to lose and much to gain. Array various options. The intent you show is more important than the speciﬁcs you oﬀer. You evince serious interest to ﬁnd solutions, to meet the other side's needs. This attitude creates an atmosphere conducive for making deals. Change Criteria Whenever possible, reconsider the way you evaluate issues and problems. Can you reexamine your major needs? Have any shifted since the start of negotiations? Sometimes, resolution of one issue can help resolve another issue. For example, establishing an escrow account to cover any inventory shortfalls (which may be a minor concern) may be the solution to a heated dispute about the quality of receivables. Change Value or Consideration Reconsider the material being transferred in the deal. If the sides are very far apart, try changing some basic assumptions. Altering the deal stuﬀ–modifying what is being sold and/or how it is being bought–may give each side a fresh perspective. What to Do? As a seller of some unusual personal property, you have been negotiating with one buyer for weeks. Price is the only issue to resolve, but it seems an insurmountable one. A wide gulf remains between the maximum he will oﬀer and the minimum you will accept. Your problem is that the property is so specialized that it will be diﬃcult to attract other buyers. What to do? Make a valiant attempt to traverse the gulf between you and the buyer through a combination of fresh ideas. Give the buyer a choice of novel alternatives for bridging the price gap. For example: Paying the disputed amount over time 375 The Art of Deal Making Paying the disputed amount with assets other than cash Binding arbitration with third-party appraisers Appraising the property at some later date to determine today's fair market value with hindsight The key is the choice: You allow the buyer to pick the option he prefers. At best, he will select one of your alternatives. At worst, he will come back with a new oﬀer. Perhaps his oﬀer will be more complicated. So what, it will get negotiations moving again. 376 The Art of Deal Making Deal Secret-20 Taking the Control Managing How Things Happen Means Mastering What Things Happen Leadership is vital for deal making. The process is both fascinating and subtle. What's going on over the table may mask what's going on below it. Regulate how a deal gets made and you inﬂuence what deal gets done. In other words, the deal- making process controls the deal-doing content. Control is not a simple function of power, however. Even though the most powerful player starts out with greater control, the control can shift with subsequent events. Control is elusive and hard to pin down. Following are various techniques for asserting leadership of deals, for taking the control. Eﬀect a Compromise The point here is progress and process. Substance doesn't matter–the issue may be major or minor. It is vital for your side to initiate and eﬀect some sort of compromise. You must be the catalyst– that’s how you take charge. (Strangely, it is often better to eﬀect a compromise than to receive a concession. The latter is a single event, the former a recurring attitude.) Get a Concession Getting or giving a concession impacts other issues. Movement in your direction is great, and you should strive to achieve such positive action irrespective of the issue or its importance. Better to get a agreement minor concession during negotiations than to start out with a major agreement. However, if the other side has greater power, minimal largess, and only one concession to grant, don't squander the opportunity. Forget false pride and take what you can get. 377 The Art of Deal Making Set or Reject an Ultimatum Ultimatums take charge. Little else is relevant once deal-busting conditions enter the scene. Setting an ultimatum is a powerful tactic. A typical case is declaring a time limit for concluding the deal. "Gentlemen: We have 48 hours to reach a conclusion–or we walk!" Refusing to succumb to an ultimatum is just as powerful. When confronted with a buyer reducing his price, a wily seller deadpanned, "May I assume your lower oﬀer voids my moral commitment not to speak with other buyers?" Sustain the Momentum Having momentum means having control. If you've got it, preserve it. Keep doing what you're doing. Avoid disruption. Go with the ﬂow. If you've lost it, the other side probably got it. If that's the case, get it back. Try disruption–any break in the action. Break their rhythm and reverse momentum. Change the Schedule It's amazing how deal schedules control deal momentum. Changing the schedule can be as simple as postponing a meeting for a day to as serious as recommending a week's hiatus. It can also include requesting a shift from verbal discussions to written communications. Change the Deal Changing deal terms is never pleasant. But retrading is always expected. It establishes control at the same time it risks rupture. The other side is ticked oﬀ: They thought they had an agreement– suddenly they don't. Altering prices is the obvious move. More often, price changes are couched in other terms. A buyer may delay payments or demand more features, while a seller may require faster payments or give fewer features. Bring in New Troops In most deal-making situations, the participants become too familiar with one another. Sometimes you can break stride and take control by changing the players. For example: 1. Bringing in an unknown senior person with full decision-making authority can be quite disrupting. New relationships need to be formed. In some ways, it's as if negotiations must be reset and started afresh. 2. Trotting in new professionals (e.g., your attorneys) accomplishes the same thing. The cozy negotiating group is suddenly invaded by aliens. Everyone has to back up in order to bring the new people up to date. As a result, the entire process slows to your speed. 378 The Art of Deal Making Request New Information A call for additional data does more than give you further knowledge. It subtly communicates your lack of conﬁdence in current direction and your need for veriﬁcation. Since your side is doing the asking, the other side is put under pressure. (Calling for something substantial, like an in-depth audit, is a much more serious request and risks problems.) If the information you request turns out to be unavailable or diﬃcult to get, do not slough it oﬀ as unimportant. Doing so will send the wrong message. Not only will it imply that the request was frivolous, but also that you are shaky and unsure. Criticize Constructively Constructive criticism of the other side can be eﬀective. Before voicing the criticism, however, try to recognize a positive contribution they made, such as an insightful observation or a thoughtful suggestion. This creates the proper atmosphere. Good dealmakers make points when they oﬀer helpful critique. The action demonstrates a commitment to truth and a sincere desire to get the deal done. Made in the proper manner, criticism can build the other side's conﬁdence in your personal integrity. "Do not reprove a scorner, lest he hate you; rebuke a wise man, and he will love you." What to Do? You are representing a ﬁnancial institution that wants to coinvest with a venture partner in a leveraged buyout. Negotiations have stalled over several issues. Your required equity investment seems well secured. A primary problem is that although ﬁnancial returns should be excellent over the life of the investment, you cannot aﬀord to have assets deployed that do not generate income in the short run. But your venture partner maintains that cash cannot be paid by the debt-laden leveraged buyout for several years. How to make the investment? What to do? Eﬀect a compromise, giving both sides something. Since cash is not as important to your side as reported income, you make your investment as a zero-coupon note, which generates income for your proﬁt and loss statement but does not pay cash until the note matures in several years. At that time you have the option of converting your note to the appropriate amount of stock. 379 The Art of Deal Making Deal Secret-21 Following the Logic Start With Logic No Matter Where You End Logic is a thought process in which each step dictates the next. Such thinking is built on facts, not opinion; truth, not belief. Well, that's the theory. But facts and truth in science are one thing; in deal making, they are something else again. Consider this very simple example of logic: 1. All people are honest, and 2. All dealmakers are people, then 3. All dealmakers are honest. Now let's get a bit more complicated: If some dealmakers are honest, and some honest people live in New York, it does not follow from logic that some dealmakers live in New York (though they do) or that the New York dealmakers in your deal are honest (though they probably are). How Logic Works The scientiﬁc method is the application of logic to analyzing data and drawing conclusions. It seeks to understand how the world works from what can be observed. Proof involves the repeated testing of hypotheses against evidence, and the rejecting of those explanations that do not ﬁt the facts. PERSON_NAME are modiﬁed to match the ﬁndings as the process is repeated. Such repetition is essential. Deal making follows a similar pattern: 1. In deal selection, you repeatedly test which of several possible deals looks better. 2. In deal negotiations, you repeatedly assess how well you can achieve your goals based on feedback from the other side. 3. As a result of such regular reassessments, you constantly modify your goals and strategies.

mergers_acquisitionsadvisorym&amergers and acquisitionsvaluation

Mergers & Acquisitions E-book, 462 Pages (Part 3 of 5)

sci_adam_ma

Considering a Strategic Buyer Strategic buyer is simply a fancy term for corporate buyer. Companies make acquisitions for a slew of reasons: growth, new markets, new products, buying out competitors, and more. Strategic buyers often focus their acquisition activity on companies that are a fit for their current (or future) strategic plans, often buying from PE firms. (See the earlier section "Looking at private equity (PE) firms.") A strategic buyer is often the final buyer after a PE firm has made an acquisition. PE firms may be willing to dirty their hands a little more than a strategic buyer is; that is, a PE firm may be willing to take on a deal with some moving parts, replace management, fix operations, add on other acquisitions, and so on. After the PE firm has spruced up the portfolio company, a strategic buyer may have great interest in making an acquisition. Much of the heavy lifting, such as turning an entrepreneurial company into a professionally managed company, has been done by the PE firm, and a strategic buyer recognizes and pays for that value. Aside from the added value of professional management, strategic buyers pay more for companies for a few reasons. A strategic buyer May need specific pieces for their puzzles: A strategic acquisition is exactly as its name implies: The acquirer is buying a company that has an important strategic fit, so the acquirer may be willing to pay a premium to keep a valuable company out of the hands of a competitor. Is often not bound by the same limitations as PE firms: The investors in PE firms agree to invest only if certain parameters are part of the deal; not paying too much for a portfolio company is often part of the PE mandate. Strategic buyers have more freedom to spend what's necessary to get what they need. May be looking for a long-term investment: Strategic buyers may be willing to pay a higher price because their strategy is to buy and hold long-term. They aren't seeking to earn a return on the investment; they're seeking to earn a return on the cash flow of the acquired company's operations. Going With a Fund less Sponsor A fund less sponsor is a person or a group of people seeking to make acquisitions without the use of PE funds. Though the lack of a dedicated fund can add a layer of complication and can delay closings, a fund less sponsor often has a coterie of well-heeled investors willing to back the sponsor 181 | Chapter 12: Financing the Transaction when the right situation arises. Some fund less sponsors have numerous investments and have set up a company to help manage said numerous investments – in a sense, they act like a PE fund without the actual fund. Keeping It on an Individual Basis Individuals who make acquisitions without the use of an outside fund or other investors are not unknown in the M&A world, but typically they transact smaller deals. They use their own money, and probably borrow some funds from a bank to help finance the deal. Striking the Right Type of Deal M&A transactions are basically variations on a theme: How much of the company is being sold, and what is the buyer acquiring – stock or assets? The following sections delve into these issues. Nothing the Difference between Majority and Majority Investments When buyers make acquisitions, those purchases can take the form of a complete, 100 percent buyout (mainly for PE firms), a majority investment, or even a minority investment. As its name suggests, a buyout occurs when 100 percent of a company is sold to another company. A buyout results in a change of control and, although 100 percent of the outstanding stock may be acquired to affect the transaction, it's possible for a buyer to acquire a seller's assets (instead of buying stock) and still have a buyout. In other words, buying 100 percent of the stock means you buy 100 percent of the assets, but buying 100 percent of the assets doesn't necessarily mean you buy any of the stock. (Head to the "Buying assets or stock" section, later in this chapter, for more on that topic.) The new owners may allow the management of the acquired company to acquire the new shares either for a discounted price or as a part of some sort of stock option plan. A majority investment is when a buyer acquires greater than 50 percent of the company. A minority investment is when a buyer acquires less than 50 percent of the company. Regardless of whether the transaction is a majority or minority investment, in most cases a buyer buys the stock of the seller. If the acquired stock is sold by an existing shareholder, that transaction is called a 182 | Chapter 12: Financing the Transaction recapitalization. In this case, no new shares are being created; existing ones are simply changing hands. Understanding Supermajority Rights Given the difficulty PE firms have had in deploying capital, take a look at "Entering the M&A zone" in Chapter 2 for a refresher) they often seem to be more willing to take minority positions. This gives sellers more options and more potential partners – all good things, of course, but selling a minority stake means giving up some level of control. The seller who retains a majority stake in the company will likely have to play by rules set by the minority investor. These are called supermajority rights. For the company to perform certain acts – issues more shares, take on more debt, sell equipment, sell stock, and so on – a certain percentage of shareholders need to agree. If a minority investor owns 40 percent of the company but the threshold for supermajority rights is 80 percent, the company can't complete those acts unless the minority and majority owners agree. Supermajority rights aren't intended to hamper the ability to run the company, instead, they're meant as reasonable protections of the minority owner. If the majority owner, who is the CEO, needs to hire a new marketing person or buy a new machine, the owner isn’t restricted. Those decisions remain with the management team. Buying Assets or Stock One often-overlooked area of M&A is the question of what exactly the buyer is buying. Companies themselves aren't really sold, per se; instead, the buyer is acquiring either certain assets of the company (in an asset deal) or the company's stock (in a stock deal). If the acquired stock is the result of a new issuing, however, the money raised from selling those shares goes to the company. This setup is often called growth capital because the company retains the money for the purposes of facilitating growth. Buyers prefer asset deals over stock deals because the former are much cleaner logistically. PERSON_NAME assets involved may or may not constitute the entire company and often include intangibles such as company name, domain names, customer lists, work in progress, sales pipelines, and so on. Asset deals are cleaner because a buyer is essentially picking and choosing what it wants to buy. The buyer picks the good assets and leaves behind the bad assets and some (or perhaps all) of the 183 | Chapter 12: Financing the Transaction liabilities. Most often, a buyer does assume certain liabilities relating to working capital. A smart buyer makes sure any assumed liability is current – meaning the liabilities are not overdue). The main perceived advantage for a buyer in an asset deal is successor liability: If the buyer acquires the stock, any past misdeeds of the company are a liability for the new owner. An asset deal, on the other hand, may in some cases help shield a buyer from the past misdeeds of the seller, but that's not always the case. Stringent representations and warranties (see "Representations and warranties" in Chapter 8 and "Review the representations and warranties" in Chapter 15 for more) and an escrow account help mitigate this concern, but the risk never completely goes away. Sellers usually don't like asset deals because those deals pose the risk of double taxation. Proceeds from the sale first go to the company, which may have to pay capital gains tax on those proceeds. The remainder of that money is then paid out to the seller, who in turn may have to pay tax on that after-tax amount. For that reason, sellers tend to prefer stock deals. In a stock deal, owners of the company's stock sell those shares to a buyer and in most cases face just one layer of tax (which is hopefully at the capital gains rate). Unless buyers want to increase the purchase price to offset the higher taxes of an asset deal (and some buyers will do that), they need to get themselves comfortable with the possibility of stock deals. Explaining How EBITDA Impacts Deals As I discuss in Chapter 1, EBITDA measures a company's profit if it did nothing except sell its products or services. The effects of interest, taxes, depreciation, and amortization are stripped away. Adjusted EBITDA, also explained in Chapter 1, is the same as EBITDA, but it also accounts for the elimination of one time only expenses or other expenses that go away after the closing. For brevity, I'll just use EBITDA (instead of writing EBITDA or adjusted EBITDA) for this section. Banks and other sources of capital tend to use EBITDA when determining how much money they can lend. These institutions measure that amount in turns: One turn is equal to the business's EBITDA. For example, if the business is generating $3 million in EBITDA, one turn of EBITDA is $3 million. If a company is being sold for $15 million, the buyer needs to come up with five turns of EBITDA. A buyer doesn't necessarily come up with all the necessary turns from one lender. A senior lender may be willing to extend, say, two turns of EBITDA to a buyer ($6 million, in this example). If a buyer gets a subordinate debt of one turn ($3 million) and chips in three turns itself, the acquisition financing is complete. (Flip to the "Understanding the Levels of Debt" section, later in this chapter, 184 | Chapter 12: Financing the Transaction for more on senior lenders and subordinate debt.) Most acquisitions follow a financing model along these lines. Comprehending the Cost of Capital Money isn't free. It has a cost, and because capital has a cost, owners and executives are wise to follow a simple plan when trying to decide how to finance their companies: Seek the lowest cost of capital. Rates are liable to change over time, so coming up with consistent numbers is, of course, folly. That said, let's look at the cost of capital from the cheapest to the most expensive. Senior Debt Debt can help a buyer make an acquisition by leveraging the buyer's existing capital. The following sections cover the different types of debt that are common in M&A, so dig in. The cost of senior debt (sometimes just called "senior") generally is less than 10 percent, but that interest rate depends on many factors – most notably, the current interest rate environment. If interest rates go up, the rate on senior debt increases. Commercial banks will likely be a little less expensive than finance companies. During the teens and early 20s of this century, the rates for commercial banks were usually at about 5 percent to 6 percent, and for a while dropped to 2 percent to 3 percent. Rates for finance companies are a bit more expensive, usually 7 percent to 8 percent, maybe more if interest rates increase. Often, senior debt is used as a working capital line, which a company taps whenever they need to cover payroll or other near-term expenses, and then repay as receivables are collected. Senior debt might also take the form of a term loan, which the company repays over time – usually, about five years. Sometimes the loan is interest-only with a "balloon" at the end of the term. When that point is reached, all the money is due. If the company doesn't have the cash, they usually find a new creditor or work out a new deal with the incumbent bank. A senior loan might also be used as a separate stage-funded facility dedicated for acquisitions. Rather than draw down the entire amount when the company and the bank come to terms, a stage- funded facility enables the company to uses only what it needs when it has an acquisition ready to close. In other words, the lender funds the acquisitions in stages, one after another, and not in advance of making the acquisitions. This saves money for the company because, rather than pay interest on the full facility, it pays only on what it uses. This sort of facility is beneficial because the 185 | Chapter 12: Financing the Transaction company leaders know they will have the funds whenever they're ready to do a deal. A stage-funded facility usually has a five-year term, with a balloon payment due at the end. The pluses of senior debt are pretty straightforward. First, it's the lowest cost of capital. Second, it doesn't dilute the owners' equity. Third, interest payments are expensed. This means they are an operating expense (similar to rent to utilities or payroll). In other words, pre-tax dollars (or euros or yen or pounds or whatever is your preferred currency) are used to make those interest payments. This lowers taxable income (but not EBITDA). Fourth, the fee structure is low. Nothing comes without a cost, and the ability to take advantage of senior debt is limited by the total amount of debt compared to EBITDA. Called the senior debt ratio, this typically is two to three times EBITDA. If the company suffers a drop in profitability, the bank may require the company to pay down the loan to bring the ratio into compliance. Senior debt also comes with the strictest covenants – stipulations about who can operate the company, for example, or demands that the books be kept according to GAAP protocols as well as limitations on selling assets or doing things that might negatively impact the company and thereby imperil the creditor's loan. Senior debt usually affords the business owner the best pricing and the best structure. Other than the covenants imposed, the corporate governance of the company remains unchanged. Looking At Lines Of Credit A line of credit (LOC) is simply a loan from a bank, often used to help finance acquisitions. Unlike a senior debt (explained earlier in this chapter), the borrower pays interest on the amount it has used. A company may have a $5 million LOC, but if it has tapped only $2 million to help pay for an acquisition, the company pays interest only on the $2 million, not on the full $5 million available. A revolver is a type of LOC designed to help with the short-term cash flow needs of a business. A revolver is helpful to a company whose cash reserves are low (perhaps because it just spent some money making an acquisition) and that needs to pay bills even though its clients are a wee bit slow in paying. Making payroll is usually the main reason for establishing a revolver. To help during a cash crunch, a company may establish a revolver with a bank. If the company needs cash, it utilizes the cash on its revolver and then repays the revolver as clients remit payment to the company. 186 | Chapter 12: Financing the Transaction Mezzanine Financing If you look up "mezzanine" in your old, worn-out college dictionary, you'll see one of the definitions refers to a story or floor of a building, between two other levels. Mezzanine derives from of the Latin word for median. Mezzanine, in the context of financing, simply means in the middle, between equity and debt. Because mezzanine financing isn't as high up on the food chain, it's more expensive than senior debt. It comes in numerous flavors, but the gist is it kind of acts like debt, and it kind of acts like equity. I'll explain. One type is preferred stock. This is an equity instrument, which means the holder owns a piece of the company instead of being a debt holder. Preferred stock receives a dividend, usually higher than any dividend common stock might pay. Common stock, if you don't know, is equity ownership at its most basic, and it is the most prevalent (or common) type of stock. Get it? Common stock carries the greatest risk because it is dead last in terms of liquidation preference (everyone gets their dough before common stock owners get a penny), but common stock also represents the greatest upside, because its share price is theoretically unlimited. That unlimited upside is why people like to own common stock. A company that issues preferred stock usual has a provision whereby the preferred stock can be called, which means the company can effectively force the preferred stock owners to sell their shares back to the company (the company "calls back" the shares, get it?). This can limit the upside, as the company can buy back the stock before the stock gets too expensive. While specifics can vary (largely due to changes in interest rates), preferred stock usually pays a dividend of about 8 percent, with a total return targeted to be 20 percent or better when factoring in gains from selling the stock. Private equity firms and family offices often use preferred stock. Even though some equity is given up, the dilution of equity is minimal. The portion of the deal tied to equity isn't included in the debt coverage ratio calculations, and covenants are unlikely. The minuses with preferred stock are that the payments are considered dividends, which means they aren't tax deductible. They must be paid with after-tax dollars. Also, the equity portion usually includes a put option, meaning the investor can put shares back to the company in exchange for cash. The time clock is usually five to six years. Preferred stockholders most likely will require a board seat. They'll also demand supermajority rights. Convertible subordinated debt is another type of mezzanine financing. Wow, what's a mouthful! Who comes up with these names? An abbreviation you might see is sub debt. The holders of this type of instrument are debt holders, which means they loan money to the company. They earn interest on the loaned amount, and then at some point in the future, they get back the loaned amount. Subordinated means the loan is secondary to the debt provided by a senior lender (banks are a 187 | Chapter 12: Financing the Transaction typical senior lender). Senior lenders get repaid before holders of convertible sub debt get their dough back. The convertible bit means the holder can convert the debt into equity. Sometimes a warrant is included. A warrant allows the holder to buy stock. The result is an instrument that provides the protection of debt, with the upside potential of equity. Specifics will vary and will be impacted by changes in interest rates, but the cost for this instrument is usually mid to upper teens (call it 14 percent to 18 percent). On top on interest payments, investors usually expect this instrument to have returns north of 20 percent (that's assuming the debt is converted to stock and the stock is sold). Senior subordinated debt is similar to its convertible cousin, as described above, but, as you may have deduced, it is not convertible into stock. The senior bit means it is the highest ranking of the sub debt products, and holders of senior subordinated debt get their money back before everyone except senior lenders. The cost will be higher than the interest rate changed by senior lenders, but lower than other mezzanine products. Figure something around 8 percent or 10 percent. This is the least equity-like debt product on the list. Oh shucks, let's call it what it is...debt that is slightly more expensive that senior debt. Current pay is an element of this sort of financing. As the name implies, these are payments made – yeah, you guessed it, – currently! Let's say you invest $1,000 in a bond that pays 8 percent, with a maturity date in five years. That means you would receive $80 per year in interest. Those 80 bucks is the bond's current pay. Maturity refers to the date when the loaned money needs to be repaid. Over five years, that bond would pay a total of $400 in interest (5 X $80), and at maturity, the investor would get back the initial $1,000. Here's where things get even trickier. Instead of current pay, sometimes something called payment in kind (PIK) is used. Instead of paying out cash as current pay, a PIK increases the principal amount of the loan. When the loan matures (comes due, in other words) the principal amount plus the cumulative amount of Interest is paid. Let's take a look at that $1,000, five-year bond from above, but instead of paying the interest, it will accumulate as an 8 percent PIK. The $80 in interest in year one gets added to the principal, which increases it to $1,080. In year 2, the interest would be $86.40 ($1,080 X 8 percent), which – you guessed it! – gets added to the principal. This continues until the bond matures. In five years, that bond would return about $1,469 to the investor ($1,000 principal plus $469 in interest). PIKs are used when the company wants to preserve cash and use it for operations instead of paying it to investors. This tends to make PIKs a little more expensive than current pay arrangements. On the plus side of subordinated debt and convertible subordinated debt, the dilution of equity is minimal and the interest payments are deductible for tax purposes. The fees are usually higher than what you find with senior debt, but not outrageously high. Negatives include a short time clock for repayment – usually, five to six years. A put option is often part of the deal, which means the mezzanine provider can sell the equity it gets from the company 188 | Chapter 12: Financing the Transaction back to the company at an agreed-on price. Also, mezzanine financing is included in debt leverage ratio calculations, which means an intercreditor agreement needs to be struck with the senior lender: This agreement basically says the senior lender allows the company to use the services of a mezzanine provider. Covenants similar to what you see with a senior lender will likely be a part of the deal. Financing a Problem Child Not all companies go up for sale in the rosiest of circumstances. Sometimes, sellers need to unload debt-laden or money-losing businesses. Working out financing for these so- called problem children is trickier than finding financing for healthy companies, but it's not impossible. The following sections present some problem situations and suggest ways you may be able to finance such deals. Debt Is Greater Than Purchase Price When the external debt of a business exceeds the purchase price a buyer is willing to pay (known as being underwater), the seller is in a sticky situation. To accept the price means the seller literally has to write a check for the honor of selling the business. Here are some options when trying to sell an underwater company: Ask a buyer to pay more. The seller should explain the situation to the buyer; if the buyer is hot enough for the deal, that buyer just may be willing to pay enough to cover all the outstanding costs and debts of the business. Negotiate with creditors. This situation is tricky because informing a creditor that a company is in financial trouble may cause that creditor to place a lien on the business or force a bankruptcy on the company. The key is to not say the creditor will receive nothing, but rather that the creditor will receive something. If a seller in financial straits can get major creditors to agree to accept less than the full amount owed, the owner may be able to extract the company from a precarious position without going through a bankruptcy. The Business has Operating Losses If a business has operating losses, a seller is wise to ask the buyer to pay for the assets of the business, which may have more value than the business itself. Sellers are strongly encouraged to speak with their accountants and lawyers before pursuing this course of action. 189 | Chapter 12: Financing the Transaction Another method of selling a business with losses is to determine the contribution –essentially, revenues minus direct costs associated with those revenues (typically, cost of goods sold, salespeople, marketing, and so on). Say a seller has $30 million in revenue and $32 million in costs, resulting in $2 million in losses. Assume the direct costs associated with those revenues is $22 million. Therefore, the total non-sales and marketing administrative costs are $10 million ($32 million $22 million). In this example, the seller would provide $8 million in contribution ($30 million – $22 million = $8 million) to the buyer, assuming the buyer has sufficient existing administrative overhead to absorb the seller without needing the seller's $10 million of non-sales and marketing administrative costs. In this example, the question a seller should ask the buyer is, "What value does my company's $30 million in revenue and $8 million in contribution have to your company?" For the right buyer, all or most of that seller's $8 million in contribution would go to the bottom line. Even if the buyer figures it would need $7 million in overhead to handle the seller's revenues, that still leaves $1 million that would fall to the bottom line. Any capable investment banker should be able to make that case! 190 | Chapter 12: Financing the Transaction Chapter 13 Learning How to Negotiate Successfully Negotiating is the name of the game. A seller constantly jockeys for a higher price, and a buyer constantly seeks ways to lower the price. Although these opposing points of view may seem to be at never-ending loggerheads, deals can come to fruition if both sides understand how to negotiate. In this chapter, I introduce you to some of the lessons and tricks I've observed from doing deals. This isn't your father's negotiating book! Knowing Your Position As I note throughout this book, M&A dealmaking is a lot like playing poker. For example, knowing whether you have a weak or strong hand is important because your hand's strength helps dictate how you negotiate the deal. Simply put, a weak hand means you have limited options. Time isn't your friend. Work as quickly as possible to wrap up a deal (but be wary to not appear too desperate, because that tips off the other side to your situation). A strong hand means that you have more options; time is on your side. However, hand must be played skillfully. Many novices overplay strong hands and end up chasing away from the deal dealmaker an otherwise willing dealmaker on the other side. Being Prepared Great chess players don't just look at the current position of the pieces; they think ahead as many steps as possible and try to position today's movements for tomorrow's developments. The same principle applies to negotiating. I try to think of every possible answer to every question I pose, and then I try to figure out my response to those answers. 191 | Chapter 13 - Learning How to Negotiate Successfully Have you ever had a discussion with someone who seems to have an immediate retort for everything you say? That person has probably worked out a decision tree of possible answers ahead of your conversation. Trial lawyers are taught to not ask a question unless they already know the answer. Granted, in an M&A negotiation, you're asking questions because you do not have the precise answer, so the take away is this: Don't ask a question unless you're prepared to respond to all possible replies. Reading the Other Party's Situation Whether you're a buyer or a seller, in any sale process you want to be able to read your opponent like you would read somebody sitting opposite you in a poker game. You also want to know whether your position is a strong or weak one. The stronger your position, the greater your negotiating leverage. Looking at the different positions that can result during negotiations, it's possible to divide them into four different categories: You have a strong position and your opponent knows it. This situation is where you may need the most skill. You have the upper hand, but if you push too hard, you lose the deal or get a less-than-ideal return. In poker, if the table knows a person has a great hand, all the other players will fold. Although the person with the strong hand wins that game, that strong hand, if played properly, should have been in a position to win a far bigger pot. Keeping the other players in the game for as long as possible should be the strategy. You have a strong position and your opponent doesn't know it. Being underestimated is a great thing! Hubris is the great enemy of getting deals done, so check your ego at the door, play the simpleton and let your opponent be the one who crows and brags. Remember what people think of you during the process isn't what's important –how the deal ends is. And if it ends in your favor, what do you care about what other people think of you? You have a weak position and your opponent knows it. This position is the danger zone. Your options are limited, and the other side is calling the shots. In this situation, your best bet is to move as quickly as you can and close the deal. Take your lumps, lick your wounds, and move on. The longer you linger, the worse your deal may become. You have a weak position and your opponent doesn't know it. It's time to test your poker-playing skills and bluff. I'm not saying you should lie, but you have no reason to say (or show) that you're in a precarious position simply because you are. Finding that out is the other party's job, and you don't need to make the other side's argument for them. So, short of having ESP, how can you ascertain the strength or weakness of the other party's position? Here are a few pointers: 192 | Chapter 13 - Learning How to Negotiate Successfully Ask questions and shut up. Let the other person talk. You may be amazed at how much someone divulges when given a chance to talk. Find out about the other party's personal interests and likes. What seems like an innocent discussion about hobbies may reveal that the person on the other side can't wait to sell the business and pursue a true passion (such as sailing, travel, golf, or volunteer work). Pay attention to details. For example, observe the faces of the employees when you visit the other party's office. Are they generally upbeat and happy, or do you see a lot of long faces? How clean and orderly is the business? Messes, clutter, water stains, burned-out bulbs, mold, and so on are often the signs of a business in decline. The employees (and ownership) no longer have the pride of a well-run business, and they may be ready to simply give up. Providing Information to the Other Side At some point or another in a deal, you may find that you need to give the other party a piece of information that gives that party more power over you. These suggestions can help you control all that you can (legally) control: Don't lie. It's an old adage, but it's true: Honesty is the best policy. Deliver the news in a matter-of-fact manner. Although being honest is vital, how you present your information is also key. If you have bad news to share, don't editorialize or tell a long, drawn-out story. Simply say what you have to say as neutrally as possible. You may be surprised by the other side's reaction. An Issue you think is problematic may turn out to be no big deal for the other party. However, if you phrase the news in the form of a negative editorial, you may transfer that negative vibe and thus turn a nonissue into a weapon your opponent may use against you. Never make your opponent's argument for them. Disclose everything early. If you have a disclosure to make, do it sooner rather than later. And if you think you can hide negative or bad news, remember that those kinds of skeletons usually come to light during due diligence. Remember The Goal: Closing A Deal The process of buying or selling a business can be a messy affair. M&A insiders call it "making sausage" because it's an ugly process with a tasty end result. (Well, assuming you're not a vegetarian, in that case, think of a messily prepared falafel.) 193 | Chapter 13 - Learning How to Negotiate Successfully As a result, those caught in the throes of a negotiation can lose sight of the end result: a closed deal. In fact, the experience of negotiating can be so frustrating that many people simply throw up their hands in frustration and scuttle the process. But whether you're a buyer or a seller going through the M&A process, set your sights on that final, satisfying goal of closing the deal. Avoid getting testy and try to tamp down the irritability that almost always comes as the result of a heated negotiation. If you're seemingly at an impasse, tell the folks on the other side that you're not trying to be punitive, capricious, or unreasonable. Tell them you understand that a deal will get done only when it's mutually beneficial to both sides. Ask them to sit down with you, face-to-face, to try again to hammer out a deal. Seemingly dead deals have been revived because of a willingness on both sides to continue talks toward a creative, mutually beneficial deal. If you need to, hire advisors who previously have structured similar deals. Using Successful Negotiating Tactics For some reason, people seem to get nervous when I talk about negotiating. I suspect they think of negotiation as a combination of yelling, bluﬃng, and demanding. When negotiating is done correctly, nothing could be further from the truth. Negotiating is not about forcing your will on the other side. That's called unconditional surrender. If the other side has other options, they won't agree to your stringent and unbending demands. And if they don't have other options and instead reluctantly accept your oﬀer, you're unlikely to ﬁnd you have a loyal business partner. Negotiating With the Decision-Maker The biggest, most important, and most basic negotiating rule is to make sure you negotiate with the actual decision-maker and not an inﬂuencer. Of course, speaking with an inﬂuencer isn't automatically bad. In many cases, negotiations that come on the wake of such a discussion can advance relatively smoothly. But in some cases, an inﬂuencer, who may or may not have the authority to negotiate the transaction, might try to become part of the proceedings. These kinds of inﬂuencers tend to impede deals; in the best cases, they're overzealous underlings trying to make a splash with their bosses. In the worst cases, they're manipulative head cases following a personal agenda with little or no regard for the company's goals. 194 | Chapter 13 - Learning How to Negotiate Successfully In other situations, the actual decision-maker may be hiding behind the inﬂuencer. In this example, the inﬂuencer is little more than the mouthpiece for the true decision-maker. Typical rants from this person include abrupt and curt pronouncements such as, "We don't think we will negotiate or ﬁnd middle ground" or "We're not going to contemplate your proposal." What's going on here is that the decision-maker is using the inﬂuencer as a buﬀer. The decision- maker can easily bark unﬁltered orders at the inﬂuencer order the decision- maker probably wouldn't make if speaking directly with you. In turn, the inﬂuencer simply parrots the decision- maker by delivering the same message without editing it or moderating its tone. This unﬁltered communication often the hallmark of passive-aggressive types or perhaps someone who simply can't be bothered to deal with the situation at hand, is highly frustrating. The best (and perhaps only) way to handle this situation is to try to set up a meeting or a conference call with the inﬂuencer and the decision-maker. You need to get the inﬂuencer out of the way and communicate directly with the decision-maker. Bending Where You Can Flexibility wins the day. Know what you want. Rank the most important issues as must-haves. All the rest of the details of a deal are bargaining chips. Bargain away the deal points you don't really need in order to obtain the concessions you need the most. Don't give away the house, but be willing to bend where you can bend in order to wrap up a deal. If a counteroﬀer cedes to your main wishes and asks for some concessions for the relatively minor issues, take the deal. For example, buyers and sellers invariably have valuation gaps (especially in today's market). If both sides are willing to be creative, structuring can provide a bridge to valuation gaps. Although cash at closing is great (and preferred!), the seller may be able to garner a higher price if earnouts and/or accepting a seller note is worth considering. Remaining On an Even Keel 1 often refer to the M&A process as a roller-coaster ride. One day everything goes perfectly and you leave the oﬃce on a high note after an exhilarating day of high- level accomplishment. You think you're a dealmaking genius! Nothing can go wrong. Then when you go to work the next day, everything that can go wrong does. 195 | Chapter 13 - Learning How to Negotiate Successfully When I have those inevitable bad days, I always remind myself that the bad day isn't as bad as it seems. I also refrain from being overly excited and optimistic on those days where everything perfectly. Remembering Your ABNs: Always Be Negotiating: Okay, so "Always be negotiating" doesn't roll oﬀ the tongue like Alec PERSON_NAME's immortal "Always be closing" line in Glengarry Glen PERSON_NAME, but you get the point. For sellers, negotiating starts with the teaser and the oﬀering document (see Chapters 5 and 7 for more on these elements, respectively), Buyers are negotiating from the moment they place a phone call or send an email to a business owner. A wise dealmaker is always looking for an angle. You're always under the microscope. Throughout management meetings, due diligence, contract drafting, and right up until the day the deal closes, both sides should consider themselves in full-on negotiation mode. Sterling Cooper Negotiation Master Class Honesty is an important part of any negotiation; however, being honest, along with open and forthright, doesn't mean you have to be a sucker. After you determine whether you have a weak or strong hand (as described earlier in this chapter), you need to proceed with nerve, knowledge, Intelligence, an understanding of the present situation, an appreciation of value, a plan for security, and smarts. All these points are interconnected, and budding dealmakers are wise to commit them to memory. Follow the guidelines in this list: Nerve - don't be afraid to ask. Yes, some people become nervous when the subject of negotiating rears its scary-sounding head. Nevertheless, if you want or need something to be part of the transaction, make sure the other side knows what it is. Ask for it! The worst the other side can say is no. The other side won't make your case for you. Knowledge – everything is capital. Every aspect of a transaction can be bartered, traded, or exchanged. I am not referring only to the ﬁnancial considerations. I mean everything: riding out the transition period, being willing to take stock instead of cash, or oﬀering to make (or eliminate) certain representations are just a few examples. Speciﬁcs will depend on each deal. That small, seemingly inconsequential detail? It might be worth something in trade. If the other side oﬀers something and asks for nothing in exchange, take it! 196 | Chapter 13 - Learning How to Negotiate Successfully Intelligence-don't make the other side's case. Just as the other side won't make your case for you, don't foolishly make their case for them. Let them make the argument for their needs. Understanding – explain, don't demand. If the other side comprehends your point of view, you have a better chance of successfully negotiating something that might seem diﬃcult to obtain. Appreciating value – give nothing away. The urge to oﬀer without recompense is likely due to an innate sense of fair play and the desire to be helpful. These are not bad traits, and of course dealmakers are wise to be cooperative with the other side. This isn't meant to suggest that you should withhold important details or devolve the negotiation into an inch- by-inch battle royale for everything. Be fair in your dealings, but don't give anything away. Security – keep something in your back pocket. As indicated in the ﬁrst entry in this list, everything is capital, and when I learn of something a client might otherwise be willing to give away, I advise that we put it in our back pocket – ﬁguratively, not literally – In case we need it later. This is for our security. When I ﬁnish a deal, I want to have something remaining in my back pocket that I can use in trade. This means I didn't haven't to fully exhaust my reserves. Smarts – do not bluﬀ...unless you are prepared to have the other side leave. To the uninitiated, or those who suﬀer from nerves, the specter of negotiating seems to introduce the scary and, frankly, deceitful practice of bluﬃng. People unfamiliar with poker seem to think the same thing, that bluﬃng is the skill above all others needed to excel at the table. Though bluﬃng is a part of poker, bluﬃng in and of itself isn't the skill that's needed. That skill is the ability to read your opponent. Determine whether you have a weak or strong hand.... but only in context of your opponent. If you're negotiating against an experienced dealmaker and you attempt to bluﬀ, be prepared to have your bluﬀ called. Instead of bluﬃng, a better tactic is to get the other side to believe that you're bluﬃng. When they call your "bluﬀ," you'll be prepared. Digging Into Nitty-Gritty of Negotiating While you're spending so much time dealing with the other side, get to know those folks. Draw them close. If you know the other party, their habits, and their methods of doing business, you have a far better chance of successfully negotiating a mutually beneﬁcial deal. 197 | Chapter 13 - Learning How to Negotiate Successfully Fessing Up When You Don’t Know If you don't know something, remember the sage words of Jeﬀ Spicoli in Fast Times at Ridgemont High: "I don't know." Or, if you prefer a musical reference, you can recall the DIGITS song from The Replacements that has the same title. "I don't know" is far preferable to guessing. An incorrect guess is tantamount to lying. If you don't know, simply admit it and state that you'll ﬁnd the answer. If you guess and you guess wrong, you have essentially passed along a falsehood. Don't let someone else turn you into a liar. Saying “Here’s The Deal That Gets It Done” This line is one of my favorites because it puts a closed deal on the other side's plate; all the others have to do is agree. It's usually best served toward the end of a negotiation, after some back-and- forth. Let a few issues get settled. Let both sides compromise. Then deliver the deal that gets it done. Picking up The Phone Pick up the phone and have a conversation, especially if the subject is delicate. The ﬂip side to picking up the phone is avoiding email. Email is a wonderful tool, but it's a passive form of communication. A single ﬁve-minute phone call often resolves issues that otherwise would play out in ﬁve or ten (or more) email exchanges. I'm not opposed to using email in M&A negotiations. In fact, email can be an imperative tool because it allows you to memorialize a conversation. Hammer out the details on the phone and then follow up with an email that describes your understanding of the discussion. Ask the other side to respond, and if they do so, you've given yourself some backup to what was just negotiated. 198 | Chapter 13 - Learning How to Negotiate Successfully Oﬀering a Conditional If-Then Agreement I always refrain from oﬀering up a concession without getting something else in return. As you try to work out a deal with the other side, don't simply oﬀer a concession (or ask for one without expecting to give something back). Instead, say this: "If you can agree to A, B, C, and D, then we can agree to X, Y, and Z." If the other side balks at your idea, you haven't conceded a point; you've simply oﬀered an idea. Because the idea was rejected, any conceded therefore removed from the discussion. This bundle approach often works well when coupled with saying, "Here's the deal that gets it done." Understanding That the First Who Speaks Loses Here's another insight I learned years ago at a long-forgotten job: The ﬁrst person who speaks loses. Say your peace, make your point, and then shut up. We humans tend to have an innate need to ﬁll the void of silence because it makes us uncomfortable. If you can ﬁght against the need to ﬁll that silent void, you may be surprised at what your negotiating opponent is willing to concede. Being Unafraid To Haggle Haggling, or the incessant back-and-forth volleying of oﬀer and counteroﬀer, is a typical negotiating tactic. You say 50, I say 30; let's agree to meet at 40. Is haggling permissible? Of course! It's a natural part of any negotiation. Although you should pad oﬀers to allow for some wiggle room, haggling can grow tiring. In my opinion, it quickly becomes a waste of time. Padding an oﬀer or a counteroﬀer can help, but structuring a deal you can support is the most important aspect of getting a deal done. Although I don't recommend going overboard when structuring a deal or a counteroﬀer, don't be afraid to push the envelope. You never know whether the other side will accept your proposal unless you ask. 199 | Chapter 13 - Learning How to Negotiate Successfully Being Wary Of a Bad Bluﬀ Bluﬃng may be a bit Machiavellian, and as cited earlier in this chapter, I don't recommend it, but on occasion, particularly if you don't care if the other side walks away, it can be utilized. Bluﬃng most often happens when one side wants to do a deal but feigns indiﬀerence in the hope that the other side will come to the table with a better oﬀer. I don't recommend this strategy. If you need to do a deal, you're better served if you're open and honest with the other side. If you're going to cross Bill's Maginot Line and oﬀer up a bluﬀ, keep the following points in mind: Sell it! Speak conﬁdently, get to the point, resist overselling, and avoid appearing rushed or in need. The idea is to come across as nonchalant. Be prepared for someone to call your bluﬀ. If the other side picks up a tell and determines you are bluﬃng, you may be out of luck. Crawling back to the other side after a failed bluﬀ may simply reduce your negotiating leverage. If you suspect that the other side is bluﬃng you on a subject, assess the strength of your position relative to the other side's position before you decide whether to call the bluﬀ. If you're in a strong position – if you can ultimately walk away from the deal and you know that the other side needs to do a deal – you're in the driver's seat. Call the bluﬀ. But if you're the one who needs to do a deal and the other side has a strong position, the bluﬀ may not actually be a bluﬀ. It may be the other side's actual position. Settling Common Transaction Issues The issues that can arise while making a deal are limitless, so trying to think of everything you might experience when trying to cut a deal is impossible. Frankly, almost every deal I've worked on has introduced a new ﬂavor to the types of issues that can become diﬀerences. This list describes some of the most common: The seller can't do an asset sale. Certain types of corporations may be burdened with higher levels of taxation than others. (See Chapter 9 for more on taxation.) In situations where a seller absolutely does not want to do an asset deal, the buyer has two options. First, the buyer can agree to pay more to cover the taxes, called a gross up. If that strategy isn't of interest, the seller can ask for extra stringent representations and warranties, and perhaps a higher escrow amount, to help cover the added risk of buying stock. Speak with an experienced M&A attorney to determine which path might be best to follow. Key managers might leave. Try a stay bonus. If a buyer wants a seller or some key personnel to stay on board for a period after the deal closes, oﬀering that seller or the key people a bonus for not leaving can be another way to settle the issue. The buyer gains the 200 | Chapter 13 - Learning How to Negotiate Successfully security of knowing they won't have to pay the bonus if the key people leave early, and those key people know they'll receive added money by simply staying put. Buying a company with losses. In certain industries, the underlying method to value a business is to pay a multiple of gross proﬁt. This technique might work for companies with losses, especially if the buyer plans to move the company to a new facility and/or simply buy inventory, receivables, the customer list, and the intangible assets. Bridging a Valuation Gap Disagreements about the price of the company are sure to pop up in any sale process. In fact, I can't think of a single deal I've worked on where valuation wasn't the central issue of disagreement. But you have a few options for PERSON_NAME a valuation agreement, including structuring an earnout, using a note, accepting stock, and selling only part of the company. The following sections explore these alternatives in more detail. Using an Earnout to Prove Valuation The earnout allows the seller to prove the company is worth a higher valuation by agreeing to get paid a higher price only if the company achieves certain agreed-on goals. A buyer pays that higher price only if the company achieves ﬁnancial results that warrant a higher price, thus providing the buyer some protection. Essentially, the buyer tells the seller, "Okay, if you really think the future prospects of the business are as rosy as you say, put your money where your mouth is." The earnout is especially useful for sellers who want to be paid for the future performance of the company. You can structure earnouts in an almost unlimited manner. Settling a Valuation Disagreement with a Seller Note If a seller wants a certain price for the company, the buyer may be willing to pay that price over time. The buyer has the beneﬁt of the time value of money (today's dollars are worth more than tomorrow's dollars, so paying today's debts with tomorrow's dollars is a beneﬁt to the buyer), and the seller gets to tell everyone that the desired valuation was obtained. As I discuss elsewhere in this book, sellers can help buyers with the ﬁnancing by agreeing to take part or all of the proceeds in the form of a note that the buyer pays oﬀ at some future date. In addition to helping the buyer acquire the company with less money down, the note provides the 201 | Chapter 13 - Learning How to Negotiate Successfully buyer with the beneﬁt of the time value of money. In other words, $5 million in three years is worth less than $5 million today. A seller willing to wait for payment is providing a beneﬁt to the buyer. Paying For a Company with Stock Stock can be a great way for a buyer to help ﬁnance an acquisition. If a buyer and seller disagree over valuation, the seller may be receptive to taking stock in the parent company. The situation is often win-win: The buyer lays out less cash at closing, and the seller has the upside potential of stock appreciating in value. When considering the pluses and minuses of accepting stock, the chief consideration should be liquidity: How easily can a seller sell that stock? If you are considering accepting a buyer's stock, here is a list of questions that should be answered before you proceed: Is the stock traded on a public exchange, and if so, which exchange? If stock isn't publicly traded, the owners of that stock may be severely limited in their ability to convert that stock into cash. If a seller doesn't anticipate needing that cash anytime in the foreseeable future, perhaps that seller can risk owning illiquid stock. But accepting illiquid stock doesn't make sense if the seller needs the cash soon. If a buyer's stock is publicly traded, the next thing to remember is that not all stock is equal. Accepting stock traded on a major exchange (NYSE or NASDAQ) is far more desirable than accepting stock traded over-the-counter (OTC) or other exchanges that specialize in what are commonly called "penny stocks," because the major exchanges have far stricter listing requirements. What is the average daily volume? Average daily volume (the average number of shares traded per day over time) is an important consideration, too. If a stock is thinly traded (has a low average daily volume), the seller who accepted it may be limited in their ability to sell that stock. Say a seller receives 10 million shares of stock as part of the consideration for selling the business. If the stock trades at $1 per share, the seller has $10 million worth of stock. However, if the average daily trading volume is, say, 10,000 shares, the seller essentially has an illiquid stock. Putting in a trade for all 10 million shares results in crashing the share price. If only 10,000 shares (on average) trade hands per day, the odds that the seller can sell 10 million shares in a short period are virtually nil. On the other hand, a stock with a higher trading volume is usually easier to sell. 202 | Chapter 13 - Learning How to Negotiate Successfully Selling Less Than 100 Percent of the Company If a buyer and seller can't agree on a valuation for a full buyout, a partial buyout is often the solution. Selling a piece of the company allows a seller to take some chips oﬀ the table and create some liquidity right away while allowing for further participation in the future of the company. Ideally, those remaining shares will be sold at some point at a higher valuation. In M&A lingo, this later sale is called a second bite of the apple. Most buyers want a control stake in the business, meaning they acquire more than 50 percent of the company's equity. Depending on the situation, some buyers may be amenable to buying a minority position, but most will likely insist on supermajority rights. (See Chapter 12 for more on supermajority issues.) Including a Consulting Contract Another way buyers can provide sellers with added dollars is by including a consulting contract in the purchase agreement. Buyers have the beneﬁt of the seller's advice and counsel, and sellers get the beneﬁt of increased deal value. Avoiding Common M&A Negotiating Mistakes The number-one negotiating tactic to steer clear of is bullying. For some crazy reason, negotiating novices tend to believe that negotiating is about imposing their will on the other side with a take- no-prisoners approach. But M&A insiders simply laugh at negotiators whose main goals are to act belligerently and talk tougher than the other side. Bullying and cajoling don't work. A tyrannical or dictatorial style may suit you well if you're one of the bad Roman emperors, but for mere mortals, bullying simply gets in the way of getting a deal done. Someone experienced at negotiating M&A transaction either sidesteps the bullying, ignores it, or calls the bully out and ﬂatly says, "I'm here to negotiate in good faith; I was hoping you'd do so as well." An inexperienced dealmaker who lacks conﬁdence, might simply leave the arena and refuse to reengage in discussions. Or a seller, who might otherwise be able to stand up to the bully, might decide against further discussions out of concern for the employees who would have to work for the bully after the deal closes. All that bluster from bullying and cajoling will go for naught, and the chance for a deal will dwindle and perhaps disappear. The only time you may be able to get away with a bullying approach is if the other side is completely desperate to do a deal. But even then, the belligerent approach may well backﬁre on you someday 203 | Chapter 13 - Learning How to Negotiate Successfully when you need a favor from the other side or if you need the other side to stay involved in the business. But bullying is only the tip of the iceberg in terms of potential negotiating pitfalls. Here are some other tactics to avoid while negotiating: Drawing a line in the sand: This approach is a favorite of the belligerent bullying novices. Drawing a line in the sand merely places the line-drawer in a corner. If, and invariably when, the line-drawer needs to close a deal, that line can become a moot point. At that point, the line-in-the-sand approach actually backﬁres; If the line-drawer is willing to cede a point formerly ensconced behind the line, what else will that person give up? It's a fatal ﬂaw because it invites the other side to step over that line. And it's a classic mistake, equivalent to a poker player with a strong hand making overly aggressive bets, because it's prone to push away the other side. Resorting to take-it-or-leave-it: This tactic is the bratty cousin of the line-in-the-sand approach. Anyone who utters this line had better be willing to have the other side leave it. If the other side simply walks away and the person who gave the ultimatum actually wants to do a deal, that ultimatum-giver now has a weaker negotiating position. Engaging in logical fallacies: The two most common logical fallacies in the M&A world, from my experience, are appeals to authority and ad hominem arguments. Appeals to authority will inadvertently reduce the strength of the argument since the arguer is trying to prove a point by citing someone else's purported authority instead of, to paraphrase Judge PERSON_NAME from My Cousin Vinny, making a lucid, intelligent, well thought argument. Instead of explaining say, an accounting issue, the arguer simply holds up a report prepared by an accountant and claims the issue settled, "because of this report in my hand!" if the other side can ﬁnd fault with any aspect of that report or can counter or explain any contention made in the report, the entire argument falls apart. Ad hominem arguments, which rely on personal attacks directed at one's opponent rather than logic, will fail because insults and Invective are little more than name calling. Personal attacks expose the arguer as childish and incapable of winning an argument based on the merits of the underlying issue. Yelling: Yelling is the path of choice for the impatient and creatively bankrupt. Keep your temper under control. I know that can be diﬃcult, especially when you ﬁnd yourself in the midst of an inane argument with a silly, immature person, but blowing your top doesn't help advance the discussion. If calm, dispassionate logic and reason fail to win the day, histrionics do no better. And, what's worse, yelling may simply poison the well and prevent future discussions. Bogging down in minutiae: Getting sidetracked by insigniﬁcant points and worthless detail at the expense of hammering out the main issues needlessly slows a negotiation and may kill your deal. Prioritize the issues and remember this phrase: "Let's table that for later." 204 | Chapter 13 - Learning How to Negotiate Successfully Overselling: In my ﬁrst job out of college, a co-worker gave me a bit of advice that I've repeated ever since: When the other person says yes, stop talking and take the oﬀer. After you and the other side ﬁnd agreement, stop selling your point. Say thanks and move on to the next order of business. Taking the bait: If the other side is ranting about an issue, you don't need to respond in kind. They might be irrational; perhaps they're trying to pick a ﬁght, or as Mel PERSON_NAME's PERSON_NAME said in Braveheart, "I'm going to pick a ﬁght." If anything, if the other side has become overly emotional, simply say "Noted" and move the conversation to the next point. As much as possible, keep your tone friendly and upbeat. Do not become confrontational. Revealing too much too soon: Though honesty and disclosure are imperative, releasing information at the right time is also the key to getting a deal done. Pick a cliché – "Keep your cards close to your vest" or "Loose lips sink ships" – but the truth remains. Don't tip your hand. And remember the words of Vito Corleone from The Godfather, when he admonished his son for speaking out of turn at an important meeting: "Never tell anyone outside of the family what you're thinking again." Attempting a Jedi Mind Trick: Going for the classic movie hat trick, I’II remind you of what all fans of Star Wars already know: The Jedi Knights have incredible powers of persuasion. They simply say something and the target of their commands repeat the words and obey those commands. It's a neat device in the movies, but no one has that ability in real life. Trying to get a buyer to pay more by saying "You will pay more" is unlikely to work, and this strategy will backﬁre if you're negotiating against an experienced dealmaker. Droning on and on: Give direct answers to direct questions. Limit your reply to the topic at hand and avoid the temptation to jump ahead and provide an answer to what you think will be the next question. Surviving Unforeseen Twists and Turns Here's a key point for anyone who wants to get into M&A dealmaking: The process isn't linear. Expect the unexpected. Dealmakers need to have a plan, but they also must be able to adjust and adapt to the curveballs the changing environment throws at you. Putting A Deal Gone Sideways Back On Track A negotiation has a rhythm, a regular ﬂow of information, and phone calls and emails where messages are returned in a timely fashion. If this rhythm is broken (for example, an extended period elapses with no communication from the other side or else communication is stilted, clipped, and 205 | Chapter 13 - Learning How to Negotiate Successfully forced), you may have a negotiating partner who is getting cold feet and a deal that's going sideways (oﬀ the rails). If you ﬁnd yourself in a situation where your negotiating partner has gone silent (or radio silent, as some jokingly refer to the phenomenon), you have a couple of options to try to get the discussions back on track: Do something diﬀerent from the usual deal-centric message. Constant professional communication can be stupefying. You need to do something to snap the other person out of the haze of kindly professional correspondence, which is so easy to ignore. Send an email with a link to a relevant article or an op-ed column. Oﬀer to play golf or tennis or meet for a drink or invite the other person to a professional event. Ask them to do anything other than the usual "Please call me; we need to discuss something." Keep your message succinct. Avoid leaving long voice mails. If someone isn't responding to your correspondence, that person probably won't listen to a two- minute message. If all else fails, oﬀer a mea culpa: Simply ask whether you've done anything wrong. Ask the person to contact you, even if they have bad news to share. Bad news is better than no news. At least with bad news, you have a chance at crafting a solution or, if that fails, of moving on to the next prospect. Negotiating In Good Faith Negotiating in good faith is a term you may hear bandied about during the M&A process. In my view, negotiating in good faith follows a code of honor. It means you follow through on what you say you'll do, and that after you agree on an issue, you won't go back and try to renegotiate that point again. When someone fails to negotiate in good faith, that person is poisoning the well. Backtracking on a settled issue only serves to throw all other settled issues into question. That's akin to trying to reason with a child who agrees to one thing, only to capriciously renege on that agreement when something else pops up. (The term often used to describe such backsliding is re-trade, and it's covered in the later section "Dealing with Renegotiation.") Of course, sometimes events occur during a negotiation that require one side or the other to go back on part of the deal. For a seller, these events are typically called material changes. Material changes include losing a major client, being sued, coming under a federal investigation, and enduring other changes that materially aﬀect the business. If the seller's business takes a tum for the worse, especially if change renders the buyer unable to close a deal, the buyer should let the seller know. Both sides should immediately disclose any major bad news that may aﬀect the closing of the deal. 206 | Chapter 13 - Learning How to Negotiate Successfully Letting the Other Side Win the Last Skirmish A tactic I have used many times, especially if the negotiation was tense and emotional, is to let the other side gain a modicum of success by claiming a small victory. This can be helpful, especially if you get the sense that the other side feels like they got the worst of the battle. This way, they don't go back empty- handed - they have a small win. Perhaps this is a bit of a psychological ploy, but I always ﬁgure that if the other side can go back to their partners and say, "Look what we got!" the better they will feel about the ﬁnal deal. Dealing with Renegotiation Yes, valuation can change during the sale process. In fact, that occurrence even has a name: the re- trade. Re-trade is industry lingo for a renegotiation, and it occurs whenever one side tries to change the terms of an agreed-on deal. Basically, one side is saying, "Yeah, I know we agreed to trade on a certain basis, but now I want to trade on a diﬀerent basis." This often happens during due diligence, after an LOI has been signed but before the purchase agreement has been ﬁnalized. Usually, the guilty party is the buyer, but at times the seller might be the one trying to foist a meaningful change of the deal at the last minute. More often than not, that change involves price. The buyer wants to pay less or the seller wants more. Theoretically, when a buyer and seller negotiate a valuation, both sides want to see the deal close with that valuation. In practice, however, one side or the other may try to change the sale price before the closing. Sometimes, the change is warranted, but at other times, the re-trade is merely an attempt to score a lower price or diﬀerent terms, just because. You'll run into people who try to play games with your head in any walk of life. One typical reason a buyer might seek to change the terms of a deal is a material change to the company. In M&A lingo, this is called an adverse material change clause, and you often seen that term in the sundry documents used to govern the sale of a company. Adverse means “negative,” material means “enormous” and change means, well, change. Therefore, another way of saying it is, "enormous negative change." What are some of these enormous negative – er, sorry, I mean adverse – material changes? A decline in proﬁts, a loss of major customers, a loss of key executives, lawsuits, change in regulations, or a change (downturn) in the economy are some examples of adverse material changes. Now, if the business substantially improves (especially proﬁt-wise), we have a diﬀerent situation. In this case, the seller may feel that renegotiating for a higher valuation is warranted. In most cases, I'd argue against pursuing this course of action. I don't recommend it. Focus on getting the deal 207 | Chapter 13 - Learning How to Negotiate Successfully done. During the time the seller spends convincing the buyer to pay more, the business may take a step backward, reducing proﬁts and thus causing the buyer to ask for a lower valuation. In this situation, the only winners are the lawyers and anyone else billing for time as the process drags on. Comprehending Why Transactions Fail I have said many times, both in the course of my work and in this book, that a decent company with an owner who has reasonable expectations has close to a 100 percent, probability of getting a good deal. So, what are some reasons that deals don't close? Though an advisor dropping the ball can be the culprit in a failed process, more often than not, a deal doesn't close for one (or more) of the following reasons: Adverse material change: See the "Dealing with Renegotiation" section, earlier in this chapter, for an explanation. Shifting sands: This is the term I use to describe the phenomenon when a seller has unreasonable or changing expectations for a transaction. Falling knife: "Don't grab a falling knife," is an adage of cooks. Wait until it lands before you reach for it. The same advice often applies to companies in decline – buyers will likely want to wait until the company hits the ground and stabilizes before they bid. Why buy a company today if you think its value will be even lower tomorrow? Failure to plan for taxes: See Chapter 9 for more on this topic. Fatigue/not serious: At times, a buyer or seller may pull up stakes and quit a process if they are tired of never-ending discussions and negotiations. Perhaps they were only modestly interested in pursuing a deal. Poor communication: Lack of follow-up can kill a deal's momentum, and if that happens, one or both of the parties may halt their work and walk away. Unintentionally communicating incorrect information: If you don't know the answer, saying, "I don't know" is preferable to taking a guess – and guessing wrong. Intentionally communicating incorrect facts: This is also known as lying, and it isn't a recommended course of action in an M&A process – or anywhere. Withholding information: This is the kissing cousin to the preceding bullet. Remember to tell the truth – the whole truth. Omitting important facts is the same as lying. 208 | Chapter 13 - Learning How to Negotiate Successfully Chapter 14 Conﬁrming Due Diligence Abuyer conducts due diligence (a thorough review of the seller's books, records, inventory, contracts, and more) concurrent with the drafting of the purchase agreement. (See Chapter 15.) Due diligence is the "pull back the curtain time" when the seller reveals intimate details of the business, including (but not limited to) ﬁnancials, customer information, pricing detail, sales pipeline, contracts, and employee compensation. In this chapter, I introduce you to the ins and outs of due diligence – what to expect, what needs to be done, and (perhaps just as importantly) what doesn't need to be done. Digging Into the Due Diligence Process The purpose of due diligence is for the buyer to conﬁrm the many representations – promises, in other words – made by the seller. This typically includes examining the seller's ﬁnancials, contracts, customers, and all other pertinent information. In other words, the goal is to make buyers comfortable enough that they go through with the transaction and close the deal. The key word that both buyer and seller should bear in mind is conﬁrmatory. (That's why I added the verb conﬁrming to the name of this chapter.) This chapter provides an in-depth listing of the items that are typically sought during due diligence. If you have trouble falling asleep some night, you can read that section. It's better than chamomile tea! Recognizing the Key Focal Points Of Due Diligence Before we get to that exacting list of due diligence items, let's explore the main thrusts for most buyers. I always tell sellers that the buyer will examine many aspects, but the focus will drill down on two subjects: the quality of earnings and inventory: 209 | Chapter 14 - Conﬁrming Due Diligence Quality of earnings: Buyers will focus a lot of their energies to ensure that the earnings as represented by the seller are accurate. This is especially the case now that adjusted EBITDA is often the driving force behind valuations (see Chapter 1 for more on adjusted EBITDA) and it's why sellers should strongly consider undertaking a quality of earnings (QoE) report. (See Chapter 7 for more on QoE reports.) Inventory: Buyers will also focus on inventory to make sure the company has what it says it has. Not only does obsolete, damaged, unsellable, or missing inventory lower the value of the company's assets, but inventory adjustments can also have a compounding eﬀect on valuation. If earnings are reduced because of an inventory issue, the value of the company is reduced by the inventory reduction times the multiple used to calculate the valuation. (See "Dealing with inventory" in Chapter 7 for more on inventory concerns.) Working capital: This aspect often gets glanced over and sadly forgotten... until it rears its head late in the game. If the working capital target is set too high, sellers will see their sale proceeds reduced; if the target is set too low, buyers will end up paying more for the company. (See Chapter 1 for more on working capital adjustments.) Accounts receivable and accounts payable: These balance sheet items make up a large part of working capital; buyers are certain to examine them to ensure that both are current or within terms. This means the buyer might not pay for old receivables that are deemed uncollectable, and probably won't assume payables that could be considered past-due bills. Reconciling Bank Statements One of the main points of a buyer's due diligence is to conﬁrm that the money that has been deposited and withdrawn from the seller's bank accounts matches the numbers represented on the ﬁnancial statements. Comparing the bank accounts to the ﬁnancial statements helps root out any fraud and gives buyers a sense of security that the books are accurate. Getting the Process Underway Due diligence commences the moment the letter of intent (LOI – see Chapter 8) is signed, or at least theoretically it should. But frankly, many sellers are wholly unprepared at this moment; they often don't realize the vast amount of data they have to provide during due diligence. (To get an idea of just how much data due diligence requires, check out the "Looking More Closely at the Details of Due Diligence" section, later in this chapter.) 210 | Chapter 14 - Conﬁrming Due Diligence All due diligence information should be ready and available for the buyer the moment both parties have signed the LOI. Because compiling due diligence information takes time, I recommend that the seller begin to gather this information as the business is being marketed to the buyers. Allowing Enough Time for Due Diligence In theory, due diligence should take no longer than 60 days. When buying or selling a business, I never submit or agree to an LOI of more than 60 days. In both cases, I want to close a deal as soon as possible. In reality, the due diligence phase can take longer than 60 days. In many cases, the delay is the fault of the seller, who's often slow in getting information out. As noted in the preceding section, a seller needs to have all the due diligence materials prepared and ready to provide to the buyer as soon as both sides sign the LOI. The length of time for due diligence should coincide with the length of exclusivity laid out in the LOI because the buyer wants to avoid the seller's being able to negotiate with other buyers while due diligence is still underway. See Chapter 8 for more on PERSON_NAME and exclusivity. Covering the Expense Each side pays its own expenses. The buyer hires their own lawyers, accountants, investment bankers, and other sundry consultants, and the seller retains their own similar set of advisors. Each side is responsible for paying only its own set of advisors. However, buyers may be able to negotiate with their advisors to accept payment after the deal closes, meaning a buyer can pay the bills by either using the seller's dash ﬂow or perhaps adding the cost of the advisors to the amount of money the buyer borrows from other sources. Conveying the Due Diligence Info to the Buyer In days of yore, back when the slide rule and rotary-dial phone ruled, M&A dealmakers conducting due diligence would sit in a room, informally called a data room, with a stack of ﬁnancial statements, contracts, and all manner of information and slowly but surely conﬁrm what they needed to conﬁrm. 211 | Chapter 14 - Conﬁrming Due Diligence This task wasn't fun, so Al Gore took it upon himself to invent the Internet. Okay, I'm joking, but thanks to that non-Gore invention, the insanity of the physical data room ended. The M&A dealmakers of today use an online data room (sometimes called a virtual data room). An online data room has many advantages over the old-fashioned approach involving "a bunch of documents dumped in a cold, impersonal room," including these: The seller can control who sees what information and when. The buyer can conduct due diligence from wherever they choose. They can choose the comfort of their cold and Impersonal oﬃce instead of traveling to the seller's facility and sitting in their cold and impersonal oﬃce. Multiple people from the buyer's side can access the data room. The seller only needs to grant them access (username and password). The online data room acts as a central depository. This function cuts down on multiple people from the buyer's team repeatedly making the same request. The seller can monitor who from the buyer's team has accessed the online data room and which documents those people have reviewed. This helps the seller gauge the buyer's seriousness. Is all the information being accessed or just certain bits – say, the customer list? The seller gains a level of security. Documents uploaded to most online data rooms have a watermark displaying the name of the user, the date of access, and the IP address. If the buyer breaches conﬁdentiality and gives the due diligence materials to someone not approved by the seller, the documents clearly point out the person responsible for the breach. Running the Company During Due Diligence The seller should continue to run the business as if an M&A process were not ongoing. The company should buy supplies, pay bills, and make sales calls as before. This is called normal course. If a seller is thinking about making major business decisions, such as substantially increasing overhead or hiring new salespeople or executives, the seller should confer with the buyer before engaging in any substantial changes to the business. Keeping the cards close to one's vest is important for a couple of reasons. If a seller informs the employees of a potential sale that ends up falling through, that seller loses face. Worse, employees may start to wonder why the deal didn't close. They may assume that the company is facing some sort of problem and start a mass exodus. Additionally, employees who hear about the pending deal may assume they'll get ﬁred after the deal closes and begin to jump ship as they look for new jobs. 212 | Chapter 14 - Conﬁrming Due Diligence Sellers should immediately contact the buyer if someone from the buyer's side attempts unapproved contact with an employee. Pick up the phone and call! Don't rely on email. You need to have a conversation. Buyers need to adhere to protocol and the terms of the conﬁdentiality agreement (see Chapter 5) and should not make contact without the seller's approval. Most buyers immediately understand the gravity of the situation and take steps to ﬁx the problem. In other words, someone on that team is about to get an earful! ONGOING DISCUSSIONS WITH MANAGEMENT Part of the due diligence process occurs when the buyer interacts with the seller. Both sides gauge whether they can work together, whether their interests and goals are aligned, and whether the other side has the right level of professionalism, knowledge, and gumption. Oh, and a personal connection helps, too. If the two sides have that unquantiﬁable essence called chemistry, the odds of closing a deal and successfully working together after the close go up drastically. Looking More Closely at the Details of Due Diligence Earlier in this chapter, in "Getting the process underway," I warned you about the amount of due diligence data, and now, we'll take a closer look. If you have trouble falling asleep, just start reading here, word for word. You'll nod oﬀ quickly. PERSON_NAME, if you're a glutton for punishment, you'll probably like it! The expanse of due diligence information is far deeper and wider than the information the oﬀering document provides. The oﬀering document (see Chapter 7) provides enough information for a buyer to make an oﬀer. Due diligence provides enough information for that buyer to be able to close the deal. Another diﬀerence is that the oﬀering document is intended for laypeople. It's relatively easy to read and comprehend, and its focus is high level – that is, it contains fewer nitty-gritty details. The due diligence material is for experts and can be mind-numbingly boring. Corporate Info Buyers want to pay close attention to a bevy of legal paperwork to make sure the seller has the legal right to sell the business to the buyer. Not having the legal right to sell something poses a wee bit of a problem in selling a business. To that end, some of the corporate info items that are reviewed during due diligence will include the company's articles of incorporation, bylaws, minutes from board meetings, and annual reports. The names and contact information of shareholders and the 213 | Chapter 14 - Conﬁrming Due Diligence number of shares held by each is usually part of due diligence, as are the names and contact information of directors and oﬃcers. Other information in this section includes a listing of the jurisdictions where the company is incorporated or qualiﬁed to do business, a listing of any assumed names or DBAs (doing business as) of the company, and governmental permits, licenses, and approvals. Any service providers (law ﬁrms, accounting ﬁrms, consulting ﬁrms, and so on) are usually listed. Operations In a typical due diligence process, most buyers seek a listing of products or services as well as a listing of any customer complaints and warranty claims. Details on any rebate programs or discounts or special deals with customers are provided. Customer contracts are provided, as are any awards for quality. Boring items, like a listing of all software programs, are included. In addition to reviewing a slew of operations-oriented documents, buyers often want to see the seller's facility, especially if the seller is a manufacturing or distribution company – in other words, a business that has inventory and/or is involved with fabrication. Flip to Chapter 11 for more of my thoughts on meetings between the buyer and seller. Financials I hope you aren't surprised to hear that ﬁnancial information is the cornerstone of M&A deals. As you can probably guess, the buyer conducts a thorough review of the seller's ﬁnancial information. In most situations, the ﬁnancial review is the most intensive and important analysis during the whole due diligence process. The usual trio of ﬁnancial statements (income statement, balance sheet, and cash ﬂow statement), preferably prepared by an outside accountant, are examined. Buyers usually drill into minutiae and look at accounts receivable and accounts payable information, including aging schedules and details on bad accounts. They even ask for the general ledger! Projections, capital budgets, and business/strategic plans are often requested. Buyers want a listing of all bank accounts, including authorized signatories. Schedules for prepaid expenses, deferred income, security deposits, and a listing of all indebtedness and contingent liabilities should be prepared. Detail for all accruals is provided, as is detail about customer advances and deposits. 214 | Chapter 14 - Conﬁrming Due Diligence Accrued vacation time is often the one lurking problem sellers don't think about. If employees are due vacation time but haven't yet taken that time before the closing, a buyer will demand a reduction in the purchase price equal to the value of that vacation time. Sales and Marketing Info Who are the customers and how does the company market to them? Who are the competitors? These are important bits of information, so guess what? The buyer will want to know all about these things – and more. Other sales and marketing due diligence can include customer lists, open orders, supply or service agreements, surveys and market research reports, copies of the company's current advertising programs, marketing plans, budgets, and physical marketing materials. A listing of the company's major competitors is also fair game. One of the most sensitive bits of information for any company is its customer list. Most companies would give their corporate eyeteeth to learn their competitors' intimate customer details. If you're a business owner, I'm sure I don't have to do much to convince you that your customer list is highly conﬁdential. Due to the sensitivity surrounding the customer list, I recommend sellers release customer information on a staggered basis, especially if a buyer is a direct competitor at the beginning of due diligence. Other sensitive information, trade secrets, formulas, customer data, software code, and related info should also be staggered in its release and, depending on the sensitivity of the data, maybe not revealed until after the deal closes. Initially, a seller should provide the buyer with an anonymous list (using a code such as customer 1, Customer 2, and so on). Only if the seller believes that the buyer will close the deal should the seller release speciﬁc customer names. For the sake of convenience, that list should match the anonymous list (that is, Customer 1 should be the ﬁrst customer on the list, and so on). Release of the speciﬁc names of customers should occur as late as possible in the due diligence session – ideally, as close to closing as possible, to minimize any potential problems. If the buyer is asking to speak with some customers before the closing, the seller should grant that request only as a last and ﬁnal step before closing. Real Estate and Facilities Info A business isn't a business unless it has a place to operate from. Providing the buyer with details about locations and the nature of those locations is another key responsibility of the seller during 215 | Chapter 14 - Conﬁrming Due Diligence due diligence. To that end, copies of all real estate appraisals, leases, deeds, mortgages, title policies, surveys, zoning approvals, variances, or use permits likely will be required to close the deal. The key aspect of real estate often is who owns the facility and is it part of the deal? Is the buyer also buying the facility, or will it be leased from the seller? In most cases, the parties need to conduct any real estate transaction outside the business sale. Fixed Assets Fixed assets can play an enormous role in ﬁnancing an acquisition and in helping an owner obtain a loan. For this reason, sellers need to spell out all of the company's ﬁxed assets to the buyer during due diligence. This information includes a basic description of the asset, date acquired, original purchase price, and depreciation years. If any Uniform Commercial Code (UCC) ﬁlings have been made, that needs to be disclosed as well. (UCC ﬁlings occur anytime a lender makes a loan secured by the assets of a business; the lender uses the ﬁPERSON_NAME to document the fact that they have a claim against the business's assets.) A listing of ﬁxed assets should also include any major capital equipment purchases and sales, along with a listing of unpaid balances and open purchase commitments for any capital equipment. Any vehicles owned by the company should also be listed. Inventory Inventory is another key component of a company's assets and therefore impacts the ability of an owner to obtain ﬁnancing for the company. All items in inventory should be listed (by location, if applicable), including item description, item number, acquisition date, number of units, and acquisition cost. A description of practices regarding inventory aging, valuation, and obsolescence and any methodology changes should be included. Details of inventory reserves and/or write-oﬀs should be provided. Inventory likely will be inspected by the buyer; the buyer may also require the seller to conduct a physical count of the inventory before the closing of the deal. 216 | Chapter 14 - Conﬁrming Due Diligence Supplier Info If a company has inventory (see the preceding section), that inventory must come from somewhere. Therefore, the buyer needs to know all about a company's suppliers and how that company makes purchases. Required information here includes a listing of major suppliers and the volume (in dollars or euros or whatever is the local currency) of purchases from each supplier, a listing of open purchase orders, contracts with suppliers, and a summary of the company's purchasing policies. Intellectual Property Intellectual property is an area that many skip over when thinking about due diligence. But make no mistake: A company's intangible assets may be among its most valuable. Therefore, a listing of all patents, patent applications, patent applications in process, trademarks, trade names, and copyrights should be included. Internet domain name registrations are also considered intellectual property. Human Resources A company's most valuable assets, especially for consulting and service ﬁrms, are the assets that enter and leave the building each day: the employees. A buyer is wise to understand during due diligence how the company hires, compensates, and accounts for employees. This information can include an organizational chart for entire company as well as a listing of employees with details of hire date, position, job description, and current pay rate. Any employment or consulting agreements as well as nondisclosure, no solicitation and noncompete agreements should be included. Resumes for key employees, the employee handbook, and documentation for retirement plans should also be provided. Any worker's compensation claims and unemployment insurance claims should be included as well Debt and Financial Dealings A wise buyer needs to fully understand the seller's ﬁnancial dealings, for two basic reasons. Are there any hidden or unforeseen problems with a creditor on the horizon? The buyer will also want 217 | Chapter 14 - Conﬁrming Due Diligence to understand the company's ability to garner ﬁnancing. Required information may include a listing of loan or credit agreements, letters of credit, or any agreements where another company has a claim to the seller's assets. Environmental Concerns Environmental concerns are an increasingly important part of due diligence. A consulting ﬁrm or another business service company probably doesn't have an environmental issue. Phase I and II reports are typical, and any notices, complaints, suits, or similar documents sent to, received by, or served on the company by the US Environmental Protection Agency or another local or state regulatory body are usually provided. See the "environmental" section in Chapter 9 for a refresher on Phase I and II reports. Taxes Not surprisingly, taxes are a major concern for any buyer. Taxes run the gamut from income taxes to payroll taxes to sales taxes. Paying taxes drives everyone mad; not paying taxes may send you to jail! Federal, state, local, and foreign tax returns are usually required, as are any sales tax ﬁles, employment tax ﬁlings, and any real estate and property tax ﬁlings. Contract Information Contracts – the written and oral obligations of the company, in other words – are hugely important for any buyer, and therefore any contract should be included in the due diligence information. Insurance Insurance – that is to say, risk management – is another important factor for any buyer. Understanding the costs of ensuring the seller's business is important, of course, but so is understanding the underlying risks associated with the business. Insurance info for due diligence may include policies for general liability, personal and real property, product liability, errors and omissions, directors and oﬃcers, and worker's compensation. 218 | Chapter 14 - Conﬁrming Due Diligence Litigation History Understanding a seller's history with lawsuits, as both a defendant and plaintiﬀ, is another must- know due diligence area for any buyer; therefore, any litigation, arbitration, and other proceedings to which the company is a party are included. Governmental Filings Depending on the industry and the nature of the seller's business, a slew of government ﬁlings and paperwork are a part of due diligence. These documents include any governmental licenses, permits, and authorizations and ﬁlings for any national, state, or local governmental agency or authority, including the SEC, the IRS, the FDA, and the INS, to name just a few. Requesting Additional Information I recommend sellers get ahead of the due diligence process by proactively preparing a data room. This way, the moment an LOI is signed, the seller can tell the buyer, "Everything you need to close the deal is here." Often, a buyer will have additional requests, and sellers should give each request due consideration. The key consideration is this: What does the buyer need in order to conﬁrm the representations made by the seller? Due diligence should focus on conﬁrming material facts: the numbers, the ownership, the customers, the contracts, and so on. But what falls outside those material facts can be a complicated matter. Each deal is diﬀerent. To help gauge whether a request is appropriate and covers material facts, sellers should ask a simple question: "How does this information help close the deal?" If the answer is unclear, then the request is busywork. Well-meaning busywork, perhaps, but busywork nonetheless. In this case, a seller shouldn't be afraid to challenge a buyer's request. 219 | Chapter 14 - Conﬁrming Due Diligence Chapter 15 Documenting the Transaction Concurrent with conducting due diligence (see Chapter 14), the buyer and seller draft a purchase agreement to memorialize the deal. Although most documents produced during the M&A process are nonbinding (that is, generally unenforceable in a court of law), the purchase agreement is a ﬁnal, binding document. In this chapter, I introduce you to the purchase agreement and tell you what to watch for while writing and reviewing it and what you should leave to your lawyer. Drafting the Deal The purchase agreement is the ﬁnal, binding contract between the buyer and seller, memorializing everything the two parties have negotiated. Excitingly, it comes in two ﬂavors: asset purchase agreement (APA) and stock purchase agreement (SPA). The major diﬀerence between an APA and SPA lies, as their names imply, in what the owner is actually selling: assets (APA) or stock (SPA). Whatever ﬂavor you're dealing with, the purchase agreement can seem like a large, cumbersome document, The salient fact is, however, that most of the document is boilerplate legalese – stuﬀ you'd see in almost any agreement. The following sections give you an overview of the writing-and- reﬁning process. Writing the First Draft In most cases, the buyer writes the ﬁrst draft, but either side can do so. Sometimes, a seller includes a draft of a purchase agreement in the LOI stage and then asks buyers to not only submit their oﬀers but also include a markup of the purchase agreement. 220 | Chapter 15 - Documenting the Transaction As with most legal documents, the side that writes the agreement usually has a leg up on the other side. That said, I strongly advise the author of that ﬁrst draft to do so fairly. Submitting an overly biased draft to the other side can be construed as a negative move – something that creates resentment and, in a worst-case scenario, might poison the well and scuttle the deal. Redlining the Initial Draft No matter who provides the initial draft, the next step in the writing process is something I call redline ping-pong, where both sides send marked-up (or redlined) versions of the purchase agreement back and forth as the lawyers work through as many issues as possible. Amazingly enough, redline ping-pong often allows the lawyers to settle many of the legal issues in a purchase agreement. However, the lawyers invariably end up at loggerheads on certain issues, usually of the business variety; at this point, the dealmakers (investment bankers) need to reconnect to settle those remaining issues. Navigating the Final Purchase Agreement Purchase agreements are lengthy, detailed documents that can make your eyes bleed if you don't know how to read one properly. PERSON_NAME. They're dreadful. Joking aside, knowing how to read a purchase agreement is as important as knowing what is in the purchase agreement. That review is a two-step process: 1. Review the document to make sure it accurately represents the main (and major) facets of the deal. 2. Take a deeper dive into the minutiae of the document. For that in-depth review, you may want to rely on your attorney. Purchase price: This point includes any conditions attached to the seller receiving the full purchase price by the time the transaction is complete. Does the seller have to jump through any hoops to get the dough – in other words, does the deal include contingent payments such as a note, earnout, and so on? (Check out Chapter 8 for more on these structuring options.) What's being sold: Conﬁrm that the purchase agreement adheres to the deal type (stock or asset) that you've negotiated. I explain these deal types more in the later section "Determining what's being sold, for how much, and when." Escrow: The agreement lays out the amount of escrow, how long that money stays in escrow, and what the seller needs to do (or not have happen) to obtain that money. 221 | Chapter 15 - Documenting the Transaction Cash at closing: This ﬁgure is the actual amount the seller receives in cash after escrow, debt, advisor fees, and taxes are subtracted from the purchase price. Post-closing adjustments: Post-closing adjustments (see Chapter 16) are usually relatively straightforward. However, the mechanisms for delivering a post-closing balance sheet (in order to calculate those adjustments), the ability to dispute, and what happens if the buyer fails to deliver necessary information to the seller after closing can occupy multiple paragraphs or even pages, so be sure to review them carefully. PERSON_NAME, consult with your attorney! That's it! Those are the main issues you should be initially concerned with as you make your ﬁrst review of the purchase agreement. Though these are the big issues, they aren't the only issues. Conﬁrming the Name, Rank, And Serial Number Of the Deal 1 call this part, which is usually toward the beginning of the document, the Whereas section because most paragraphs start with the word whereas. This preamble sets the tone for the rest of the document. Here are a few items to verify: The legal names and addresses of the entities (the buyer and seller) are correct. The deal is clearly deﬁned as either an asset sale or a stock sale. The deﬁnition of the business is accurate. The Intentions of the buyer and seller are clearly stated – the buyer desires to buy, and the seller desires to sell. Determining What's Being Sold, For How Much, and When The purchase agreement also clearly deﬁnes what is being sold: the company's stock or the company's assets. Sellers usually prefer stock deals because of tax reasons. Buyers typically prefer to buy assets because assets can help reduce the worries of successor liabilities – problems caused by the seller (such as wrongful termination lawsuits) that may pop up after the deal closes, in other words. The agreement should also specify the purchase price, the structure of that price (cash, notes, stock, earnout, and so on), and the amount that goes into escrow. This section also details the anticipated closing date and location. Usually, the closing occurs in the lawyers' oﬃces. In the old days, the closing took place in a speciﬁc oﬃce, but because of today's technology, most closings are virtual closings conducted via email, video calls, and traditional phone calls. See Chapter 16 for more on closing. 222 | Chapter 15 - Documenting the Transaction Knowing What to Bring To the Closing The purchase agreement deﬁnes certain items the buyer and seller may need to physically bring to the closing (or deliver ahead of time, if the closing is virtual, as I describe in the preceding section). The seller's deliveries may include stock certiﬁcates, ledgers, minute books, other corporate records, corporate seals, the company's articles of incorporation and bylaws, legal opinions that all the necessary legal documents are in order, signatures for the escrow agreement, conﬁdentiality agreements, noncompetition and no solicitation agreements, employment agreements, documentation that all outstanding options, warrants, or other instruments that can claim ownership in the seller have been extinguished or exercised before closing, and a closing ﬁnancial statement (generally, as of the close of business from the previous day). The most important of the buyer's deliveries is the money! That money is usually in the form of a wire transfer, not a check. Beyond that, the buyer brings some sort of documentation that they have performed all necessary due diligence, that they have the approval of the board of directors, and that they have obtained a legal opinion. Also provided are signed counterparts to the various agreements, which can include the escrow agreement, noncompetition and no solicitation agreements, employment agreements, conﬁdentiality agreements, leases, and any other agreement between the buyer and seller. Reviewing the Representations and Warranties The purchase agreement spends a disproportionate amount of space dealing with the issue of representations and warranties – or reps and warranties, for short. Reps and warranties are basically promises and fall into three camps: promises the seller makes, promises the buyer makes, and promises both sides make. These guarantees tend to be pretty similarly worded from deal to deal; in fact, many lawyers simply use the language from an earlier agreement they worked on. Representations and warranties can be provided on the past events (in other words, on known events), but they should not be provided for future events (unknown events). For example, a seller can provide a representation that the books are accurate, but that seller should not make a representation that the company's largest customer will still be the largest customer in one year. 223 | Chapter 15 - Documenting the Transaction Handling Seller's Reps and Warranties The seller typically provides the buyer with a bevy of representations and warranties to proclaim that everything the seller says (or represents) about the company in the purchase agreement is true to the best of the seller's knowledge. The gist of all these promises is that the seller is being completely truthful, has run the company in the normal course of business (nothing unusual, in other words), and has the right to sell the business and that the company has experienced no adverse material changes since the LOI was signed. In an actual purchase agreement, each bullet consists of a lengthy paragraph chock-full of legalese. In brief, these promises can involve ownership of the company, authority to enter into agreements to sell the company, the indebtedness of the company, any outstanding options or warrants to purchase the company's stock, tax matters, property and real estate, the accuracy of the ﬁnancial statements, contracts, litigation, labor issues, compliance with all laws, compliance with environmental matters, customers, vendors, and much, much more. Speak with your attorney about the speciﬁc representations and warranties that might be involved in your transaction. Dealing With Buyer's Reps and Warranties Although the buyer provides far fewer reps and warranties than the seller, buyers will make some promises. Usually, those involve reassurances that the buyer is legally organized and has the authority to close the transaction. Including Mutual Promises between the Buyer and Seller Most purchase agreements have at least a couple of mutual representations and warranties that both sides agree to. These may involve both parties refraining from making any public announcement of the deal until after the deal closes. 224 | Chapter 15 - Documenting the Transaction Securing Against Loss with Indemniﬁcations All the representations and warranties are meaningless unless one side has some sort of recourse against the other. Indemniﬁcation means one side is providing security against a loss for the other side. Another term you might see in these legal documents is hold harmless. One side agrees to hold the other side harmless in the event something happens (or doesn't happen). As with the representations and warranties, the seller generally provides the buyer with many more indemniﬁcations than the buyer provides to the seller. The purchase agreement deﬁnes how long the representations and warranties are in eﬀect. Generally, this period ranges from one to two years. In addition to time limits, the purchase agreement also explains the limits on damages from indemnity. This ﬁgure depends on the speciﬁcs of your deal. A good rule of thumb is to limit the damages to the amount of money in escrow, but as with all legal issues, speak to your attorney to determine these details. Rather than nickel-and-dime each other with relatively small damage claims, M&A parties often agree not to seek money from each other until the net damages reach a certain amount, called a basket. In other words, if the basket is $100,000, the buyer doesn't ask for reimbursement if it suﬀers $500 in damages from some sort of breach of representation. However, if the net damages reach that $100,000 threshold, the buyer can seek reimbursement from the seller (usually, from the escrow money). The Rise of Reps & Warranties (R&W) Insurance Representations and warranties insurance (often called reps & warranties insurance or R&W insurance) is another new development since the publication of the ﬁrst edition of this book. In the olden days you know, a few years ago – the typical benchmark for the money held back in escrow was 10 percent of the proceeds. Depending on the deal, that amount may have been a bit higher or a bit lower, but 10 percent was the number. Rather than place money in escrow, buyers and sellers increasingly use insurance to provide that indemniﬁcation. If the buyer has a claim against the seller, the insurance pays the claim. The beneﬁt for the seller is clear: They receive more money at close because less is held back in escrow. The beneﬁt for the buyer is fewer headaches and ﬁghting and bickering in case a claim needs to be ﬁled. Initially, R&W insurance was limited to larger deals. Because of the premium cost – specially the minimum premiums demanded by insurers – the deals that could PERSON_NAME expect to aﬀord insurance were north of $100 million. As of this writing, deals with $30 million or higher can likely aﬀord insurance. 225 | Chapter 15 - Documenting the Transaction Like all insurance products, the cost is called a premium, and though the cost can vary depending on the size of the transaction and market factors, as of this writing, premiums are often 3.5 percent to 4.5 percent of coverage. That means a $50 million transaction that in the past would have put $5 million in escrow, would instead use insurance. The cost, assuming a 4 percent premium, would be $200,000. Determining Who Pays As with everything else, who pays the cost of insurance is something to be negotiated, but often the buyer pays the premium costs. Sellers increasingly ask buyers to include a R&W product as part of their oﬀer, but when they do, the buyer usually prices that cost into the valuation. Looking At the Exhibits and Schedules As 1 note earlier in this chapter, purchase agreements are long, and that doesn't even address the exhibits and schedules. For any given agreement, you may see 50 to 100 exhibits and schedules that run the gamut from the escrow agreement to legal and accounting opinions to employment contacts and a lot more. The following list gives you only a partial view. Depending on the speciﬁcs of a deal, a purchase agreement may have more or diﬀerent schedules than those I list here. Check with your lawyer to see which documents your deal requires; I can't provide a one-size-ﬁts-all approach. Instead, here are some of the items that might comprise the schedules: Escrow agreement Flow of funds at closing Adjusted EBITDA calculation table Real estate leases and deeds Conﬁdentiality agreements Noncompetition agreements Nonsolicitation agreements Employment agreements Calculation of net working capital Products in development Shareholder list Liens Owned properties 226 | Chapter 15 - Documenting the Transaction Real estate options/rights of ﬁrst refusal Leased properties Annual ﬁnancial statements Closing date balance sheet Material contracts Bank accounts Litigation Employee beneﬁt plans Intellectual property lists Computer software and proprietary databases Environmental reports Storage of hazardous materials Material changes Insurance policies Inventory lists Open purchase orders Product design Open sales orders Customers and vendors Buyer consents and approvals Much more. 227 | Chapter 15 - Documenting the Transaction Chapter 16 Closing and Integrating the Acquisition After due diligence is completed and the purchase agreement ﬁnalized, closing time is nigh. Closing the deal occurs on a day called, ingeniously enough, closing day, where both parties sign the agreements and the money changes hands. Although this setup seems simple and straightforward, failure to be prepared can cause unexpected problems. When you've gotten this far, the last thing you want is to have the deal fall apart at the last minute because of a lack of planning. In this chapter, I introduce you to a day in the life of a closing: what happens, what to expect, and how to successfully close a deal. Gathering the Necessary Parties In the olden days (you know, before the advent of the Internet), closing day meant lots of people gathering in an oﬃce, signing a boatload of documents, perhaps haggling over last-minute details, and exchanging the money. Today, most if not all closings are virtual, meaning they occur by email and take advantage of new- fangled software applications such as DocuSign. (I bet some old time Luddites out there might even use a fax machine to send signature pages to their lawyers.) Each party gathers in its respective lawyer's oﬃces, signs what it needs to sign, and faxes or emails the signature pages (not the full documents) to the other side. The lawyers assemble the documents, conﬁrm that everything is in order, and make the instructions to wire the money. Then it's done. The deal is closed. Representatives from the buyer and seller (that is, the owners and executives of both companies) are present at closing, along with lawyers for both sides. Accountants, investment bankers, and ﬁnancing sources may also be present – they should at least be available by phone in case anything goes wrong. 228 | Chapter 16 - Closing and Integrating the Acquisition Believe it or not, closing an M&A transaction is highly anticlimactic. No bells and whistles, no soaring music, no quick cut to a celebration in a PERSON_NAME watering hole. When the deal is done and the money has exchanged hands electronically, you simply go back to work or head home. It's just another day. Walking Through the Closing Process A closing should occur like a well-oiled machine, with steps that are well laid out and planned in advance. It should be perfunctory, a mere formality. All the hard work – the negotiating, the arguing, the gnashing of teeth – should be in the past. As a general rule, a closing should take less than two hours. Essentially, a closing should involve the considerations in the following sections, although variations on the following may exist. Reviewing the Flow of Funds Statement The ﬂow of funds is a detailed list of the sources and uses of money – where the money comes from and where it goes. It's typically created in the days right before the closing and is among the last steps of the process. Usually, it's the buyer who's responsible for compiling this document (usually a spreadsheet). The statement lists everyone and every entity that is either providing money for the acquisition (or receiving money as a result of the impending deal), the amount of money being contributed or collected, all necessary contact information (company name, contact name, maybe a phone number), and wire instructions (bank, account number, and routing number). Typical entities that show up in the ﬂow of funds include the buyer's and seller's advisors (investment bankers, accountants, lawyers, and any other consultants), any bank or entity holding a debt that's being paid oﬀ at closing, and any vendors the seller has been slow to pay. After all entities have received their cut, whatever is left over ﬂows to the seller. The buyer compiles the ﬂow of funds and circulates it to the seller and any other advisors who may need to review the document for accuracy. The seller (and advisors) should carefully check and double-check the document for accuracy and immediately contact the buyer with any corrections. Look at the ﬂow of funds statement in Figure 16-1. The buyer is contributing $13.3 million and obtaining $4 million from a bank, plus another $2.5 million from a mezzanine fund. In addition, some executives from the buyer are contributing an aggregate amount of $700,000. The purchase price of the business is $20 million. However, based on the purchase agreement, a working capital adjustment of $200,000 in the seller's favor needs to be added to the price. (See the section "Closing the loop on post-closing adjustments," later in this chapter, for more on this topic.) 229 | Chapter 16 - Closing and Integrating the Acquisition The buyer owes their advisors a total of $300,000, to be paid at closing. In this example, the buyer needs to bring $20.5 million to the closing in order to make a $20 million acquisition. Sources Buyer 13,300,000 ABC Bank 4,000,000 Mezzanine fund 2,500,000 Executives 700,000 Total sources 20,500,000 Uses Purchase price 20,000,000 Working capital adjustment 200,000 Buyer fees and expenses 300,000 Total uses 20,500,000 Funded to Seller Purchase price 20,000,000 Plus: Working capital adjustment 200,000 Less: Seller expenses (660,000) Less: Bank loan (3,250,000) Less: Note payable (2,500,000) Less: Funding of escrow account (2,000,000) Net Amount Funded to Seller 11,790,000 Buyer Expenses Lawyers 200,000 Accountants 50,000 Marketing consultant 25,000 Environmental consultant 25,000 Total Buyer Expenses 300,000 Seller Expenses Lawyers 125,000 Accountants 35,000 Investment banker 500,000 Total Seller Expenses 660,000 Figure 16-1: A sample ﬂow of funds statement. 230 | Chapter 16 - Closing and Integrating the Acquisition Buying or selling a business doesn't simply involve transferring money from the buyer to the seller. In other words, the seller doesn't walk away from the closing with a pile of money while leaving behind a pile of bills. Instead, the seller pays oﬀ the company's debts, including debts to lending sources, vendors, taxing authorities, consultants, and any other creditor at closing. In addition to debts, money for the escrow account is deducted from the sale price. Take another look at Figure 16-1, which shows the buyer bringing $20.5 million to closing. The seller doesn't actually get near that amount, because money is owed to the bank and advisors need to be paid oﬀ from the sale proceeds while some money is held in escrow as well. The actual ﬁgure the seller receives is $11.79 million. The buyer wires that amount to the seller and will wire the rest of the money to every other party in accordance with what is owed them at closing. Also, sellers may want to make estimated payments to taxing authorities (for income taxes or capital gains taxes as result of the transaction) at the time of the closing. These authorities may or may not be represented in the ﬂow of funds, but paying them oﬀ along with the other debts may be beneﬁcial simply because, if the seller takes care of those payments at closing, the odds of forgetting to make those payments is reduced, if not eliminated. Sellers should speak to their tax advisors to learn the best way to handle their speciﬁc tax situations. Signing the Final Purchase Agreement and Other Documents After both sides have approved the ﬂow of funds statement (see the preceding section), the closing proper begins. This is when both sides sign the ﬁnal purchase agreement and sometimes other agreements, such as employment contracts, noncompete agreements, nonsolicitation agreements, and leases. The documents pass back and forth as I describe in the earlier section "Gathering the Necessary Parties," and then all that's left is paying out the money. Distributing The Funds: Show Me The Money! After all the necessary agreements have been signed, the buyer funds the deal by obtaining money from other sources and distributing that money to the seller and any other party that appears on the ﬂow of funds statement. A typical funding occurs in this order: 1. Money from the buyer and any other funding source (such as a bank) comes into a buyer- controlled account. 2. The seller's debt – including bank loans, notes payable, promissory notes, and loans by shareholders – is paid oﬀ with the seller's money. 231 | Chapter 16 - Closing and Integrating the Acquisition 3. The seller's advisor fees – including legal, accounting, and investment banking – are paid oﬀ. These expenses come out of the seller's money. 4. Money is wired to the escrow account. 5. Money is wired to the seller's account. 6. The buyer's advisor fees are paid oﬀ. The buyer usually pays these expenses. Popping the Champagne After the wires are sent, both sides should contact any advisors or team members not present at the closing and inform them of the happy news. Your advisors can then constantly check their bank accounts, waiting for news of their wire transfer. And you're done with the deal. Pop some champagne, celebrate a bit, and start spreading the news, cause the deal is closed. Tying Up Loose Ends Shortly after Closing Closing a deal really doesn't mean the deal is completely closed on closing day. (That's not a version of "How much wood would a woodchuck chuck" – it's a reality of M&A.) In most deals, the buyer and seller have little bit of work to conduct after the deal closes. Allowing Time to Fully Close the Books Although the deal is closed as of the closing date, a company can't produce an accurate balance sheet on that very day. Depending on the business, 30 to 90 days are necessary to fully close the books. For that reason, the closing uses an estimated balance sheet. At some agreed-on post-closing date, the parties make adjustments to that closing-day balance sheet based on the fully closed books. In some cases, the buyer pays more, and in other cases the seller receives less. Often, this adjustment is made to the money in escrow. Making a Working Capital Adjustment Most purchase agreements include an adjustment for working capital. Before closing the deal, the buyer and seller agree to the amount of working capital that the buyer is purchasing. 232 | Chapter 16 - Closing and Integrating the Acquisition Working capital is the diﬀerence between assets that can quickly be converted into cash (accounts receivable, inventory, and prepaid expenses) and the bills that are due immediately (accounts payable, wages payable, interest accrued, and unpaid liabilities). Think of working capital as being the same thing as cash. At closing day, the parties adjust the purchase price based on the amount of the company's working capital. Working capital adjustments help prevent a seller from simply not paying bills before closing; cash belongs to the seller, so the seller may be inclined to sell oﬀ inventory and accounts receivable and stop paying bills in order to generate cash. In that scenario, the buyer assumes a business with huge debts at closing. For example, if both sides agree working capital should be $1 million at the closing date but the closing day balance sheet shows $1.2 million in working capital, the buyer pays the seller an extra $200,000 at closing. Shifting from Entrepreneurial to Professional Just because the deal is closed doesn't mean all the work is done. You need to announce the deal to employees and to the rest of the world. And, in most cases, both buyer and seller have to continue to interact with each other on some level for some period of time after the close. In this section, I introduce you to the wonderful world of post-closing issues, including informing employees about the deal, making media announcements, taking care of the post-closing adjustments, addressing any contingent payments, working through breaches, and handling escrow. Spreading the News Following the close of the deal, the ﬁrst order of business for many dealmakers is to announce the deal. Make the announcement to employees and the media as soon as possible after conﬁdentiality no longer prevents you from talking about the deal. Telling the Seller's Employees about the Deal Employees are important stakeholders in any business. They deserve to learn about the sale as soon as possible. They probably want to know the identity of the new boss! The buyer and seller both need to address the employees. Those disclosures often occur at separate times, but depending on the speciﬁcs of the deal, both parties may want to coordinate eﬀorts and make the announcement at the same time. 233 | Chapter 16 - Closing and Integrating the Acquisition Now, when I say employees should learn about the sale as soon as possible, I mean the same day the deal closes – stat! After the papers are signed and the wire transfers clear, you should assemble the employees (if in one location) and make the announcement. If the closing is ﬁnalized after hours, tell the employees ﬁrst thing the following morning. The key is to control the message and make sure you're the one delivering it. If employees are going to hear the news, better they hear oﬃcial and accurate news from their leader than hear unoﬃcial and potentially inaccurate secondhand innuendo (masquerading as news) from fellow employees. If the company has multiple locations, do your best to assemble as many people as possible and have other locations join by conference call. If a conference call isn't feasible, make sure the managers in all other locations deliver the news as soon as possible. Be sure to keep the proceedings positive. Selling a business can be a highly emotional time; after all, owners often view their employees with a parental eye. Expressing and displaying emotions is wholly appropriate, but don't let the meeting become downcast. The announcement should focus on what the employees and new owner will be able to do in the future. The announcement should not be a pity party for the seller as they move on to their next phase of life. A positive and uplifting message helps eliminate ambiguity and, hopefully, creates excitement and amity between the employees and the new owner. Making a Good First Impression If buyers have not coordinated with the seller to make the announcement together, I highly recommend they get in front of their new employees as soon as possible; no more than a few days should elapse between the deal closing and such a meeting. When speaking with the employees, act like a leader at all times because you'll be under a microscope. Although talking about your plans for the company is permissible and encouraged (even if those plans diﬀer from the previous owner's plans), refrain from bad-mouthing the former owner. However, don't go overboard and become cloying in your comments, either. Don't dwell on the past too much. Move forward and focus on the future. Check out Chapter 17 for more on combining the companies post-sale. 234 | Chapter 16 - Closing and Integrating the Acquisition Making a Media Announcement After the deal closes, news of the sale can become public information. Usually, the buyer controls news releases; in fact, the purchase agreement may deﬁne how to disseminate the information to the media. Typically, the buyer decides how much information to release to the media. Private companies making acquisitions of other private companies usually don't furnish the media with speciﬁcs such as revenues, proﬁts, and prices paid. Executives with public companies should consult with their advisors before making any written or oral public statements about the deal. Following Through: The Deal after the Deal Rarely do a buyer and seller conclude a deal, walk away, and never interact again. Even though the seller has their money and the buyer has the company, the two sides usually have some post-closing issues to conclude. The following sections walk you through some of those matters. Closing the Loop on Post-Closing Adjustments One of the ﬁrst items that needs wrapping up after the deal closes centers around the post-closing adjustments. The closing day balance sheet often involves some guesswork, and the actual balances may not be available until a few weeks go by. Usually, 30 to 90 days after closing, the buyer presents an actual balance sheet as of the closing date to the seller. The parties compare this balance sheet to the estimated balance sheet presented at closing and true up (adjust) any diﬀerences in working capital. In most cases, the adjustments are relatively small in relation to the purchase price, and most adjustments can be made by adding or subtracting money from the escrow amount. However, depending on how the purchase agreement is worded, one side may have to write a check to the other side. The buyer is usually the one writing the check; sellers usually insist on having any downward adjustments made to the money in escrow rather than pay them out of pocket. 235 | Chapter 16 - Closing and Integrating the Acquisition Wrapping Up the Contingent Payments Depending on the deal, contingent payments such as earnouts, seller notes, and stock may be part of the seller's proceeds. In the following sections, I provide information on following up on these payments. Chapter 8 discusses the various contingent payments in more detail. Maximizing the Earnout Earnouts can be the trickiest of all contingent payments. The seller is trusting the buyer to provide necessary and accurate documentation regarding the speciﬁcs of the earnout. The key to the earnout is how it's crafted and deﬁned in the purchase agreement. (See Chapter 8 for more detail on earn-outs.) Simplicity is the best course of action; avoid using a complex formula for calculating the earnout. The more complex the earnout, the more calculations involved and the greater the chance the buyer and seller will disagree. For sellers, the best chance at inﬂuencing the earnout occurs if they remain with the company as an employee and have a direct impact on the earnout metrics. For example, a seller can impact an earnout that's based on top-line revenue by staying employed in a sales position. But if the seller is leaving the company after the closing, that seller will have little or no control over the earnout. Collecting the Note If the seller agrees to accept a note, it becomes a creditor of the company and the buyer is therefore legally obligated to pay that note (as opposed to an earnout, which may not have to pay if the company doesn't meet the metrics). Sellers should make sure the buyer's books oﬃcially record any note. Dealing with the Stock The ability to sell stock received in an M&A transaction depends on where it trades, any restrictions on selling it, and its liquidity or trading volume. If the stock a seller receives is with a publicly traded company, that stock can be sold after any restrictions are removed from the stock. 236 | Chapter 16 - Closing and Integrating the Acquisition If the seller accepted stock in a private company, the ability to sell that stock may be limited. Not only may a market not exist for the stock, but the seller may also be expressly prohibited from selling the stock even if another buyer is found. Dealing with Disputes If the post-closing matters in the earlier section "Following Through: The Deal After the Deal" proceed without incident (no breaches of representations or warranties, no claims to escrow), the escrow agent releases the escrow money to the seller at the appointed time. However, some deals don't proceed in an orderly and uneventful post-closing fashion; the buyer and seller may have disputes. In the following sections, I give you some guidance on taking care of breaches and disputes that may arise after the deal closes. Handling Breaches Breaches (in other words, post-closing disputes between the buyer and seller) come in three basic ﬂavors: violation of noncompete and nonsolicitation agreements, discrepancies with working capital, and breaches of reps and warranties (R&W), The following sections delve into these issues. Violations of the Noncompete And Nonsolicitation Agreements One of the biggest concerns a buyer has is that the seller will take the money from the sale and open a competing business across the street, perhaps even hiring (or attempting to hire) employees now working for the buyer. Because of these concerns, most purchase agreements contain noncompete agreements preventing the seller from opening a competing business in a certain deﬁned geographic area for a certain deﬁned length of time, as well as nonsolicitation agreements barring the seller from hiring or trying to hire the buyer's employees. Buyers who suspect a breach of these agreements should speak with their attorney. The typical course of action in these cases may include going to court and obtaining a temporary restraining order. 237 | Chapter 16 - Closing and Integrating the Acquisition Discrepancies with Working Capital Won M&A parties make adjustments to the purchase price a few weeks after closing, after the buyer has an updated balance sheet for closing day. Sometimes, this balance sheet can be a source of disagreement between the buyer and seller because the buyer's calculations don't match what the seller promised. In particular, working capital calculations (the diﬀerence between quickly convertible assets, such as accounts receivable and inventory, and the bills that are due within 30 days, such as accounts payable) commonly create disputes. These are some typical areas of dispute between a buyer and seller: Bad debts reserve: The buyer may claim that the seller didn't set aside a suﬃcient reserve against bad debts. In other words, the value of the accounts receivable wasn't as high as the seller claimed at closing. Inventory valuation: The buyer may claim that the seller overvalued inventory and/or kept unsalable inventory on the books. Writing oﬀ inventory reduces a company's earnings, and if the valuation was based on some measure of earnings, the buyer could claim it overpaid for the business. Failure to record liabilities correctly: The buyer may claim that the seller didn't properly record employees accrued (that is, unused) vacation. If the buyer disputes the value of working capital and asks for a substantial post-closing adjustment, the seller may have to live by the terms of the purchase agreement. This situation can be costly for the seller. A seller in this predicament should consult with their attorney. Breaches of Representations or Warranties (R&W) In a typical purchase agreement, the seller provides the buyer with a slew of promises known as representations (reps) and warranties, or R&W. (See Chapter 15 for more on these topics.) A breach occurs when the buyer disputes one of those reps or warranties. Essentially, the buyer is claiming, "The business wasn't as I thought it was." Common disputes can include undisclosed pending litigation, ﬁnancial statements with mistakes or omissions, an undisclosed material liability (such as a large unpaid bill of the company), and illegal immigrant employees. 238 | Chapter 16 - Closing and Integrating the Acquisition A buyer claiming a breach of a representation or a warranty usually makes a claim to money held in escrow. (See the following section.) But escrow is only the buyer's ﬁrst recourse. If the breach is egregious enough, the buyer may end up suing the seller. Making Claims against Escrow The surfeit of representations and warranties a seller provides the buyer in the purchase agreement forms the basis of what, if anything, the buyer can claim against escrow. In other words, if something the seller says is inaccurate or false and causes harm to the buyer, the buyer can make a claim and recoup money from the escrow account. If the buyer discovers a problem or suspects a breach by the seller, the buyer usually informs the seller, and the seller has a length of time to either reimburse the buyer for the damage or contest the damage. If the buyer and seller are unable to settle the issue, the issue may go to court. 239 | Chapter 16 - Closing and Integrating the Acquisition Sterling Cooper, Inc. www.sterlingcooper.info Mergers And Acquisitions for Private Companies The merger or sale of a private company diﬀers in style and substance from the merger or sale of a public company. Such a transaction is usually a unique event in the life of the owners of that private company, who are often the entrepreneurial founders or their families. Most likely, the entrepreneur will never have sold his or her business before and the prospects are both bitter and sweet. On the one hand, it is time enjoy the ﬁnancial rewards after years of hard work. On the other hand, selling your company feels like selling your baby. Our orientation in this chapter is that of investment bankers representing sellers or buyers of privately held companies. With the increase activity in entrepreneurial ventures, there is a growing market for mergers and acquisitions (M&A) among private companies. Investment bankers should be sensitive to the special issues involved and not assume that “M&A is M&A.” In most respects, private company M&A is not much diﬀerent from traditional M&A. Virtually all of the issues involved in ﬁnding, facilitating, valuing, pricing, strategizing, and structuring M&A transactions apply equally well to private companies as to public companies. What we stress in this article are the exceptions (i.e., those areas where private company M&A diﬀers from traditional 240 | Mergers and Acquisitions for Private Companies M&A: personal motivations for selling, personal motivations when selling, business analysis, ﬁnancial analysis, and structuring the deal). These diﬀerences may seem subtle, but whether or not the deal gets done often depends on whether or not such subtleties get sensed. We conclude with some thoughts about the role of investment bankers in private company transactions. PERSONAL MOTIVATIONS FOR SELLING From the viewpoint of a private business owner, there are four primary driving motivations for merging or selling his or her business: personal liquidity, expansion capital, personal liability, and generation transition. Personal liquidity First, clearly, is the desire to liquify one’s personal holdings. In many cases, the seller is the founder of the company and his or her personal wealth is virtually 100 percent tied up in the business. Here is the ﬁrst opportunity to reap the ﬁnancial fruit of one’s labor, to diversify one’s portfolio (“taking some chips oﬀ the table”), to enjoy the material beneﬁts of building a successful business. In many cases, achieving security and conﬁdence rather than making maximum monies is most important. Many entrepreneurs have been living on the edge for years – their risk/reward proﬁle has skewed far toward high risk – and they look forward to reducing the incessant pressure. Expansion capital The second reason for sale is the recurring need for expansion capital. The only thing more ﬁnancially taxing than a stagnant business is a growing business. Growth demands capital – for research and development, plant and equipment, inventory and receivable, distribution and service, and a host of administrative necessities. Oftentimes, good growth companies outrun their internal ﬁnancial capabilities (even supported by commercial banks), and the public markets are either not available or not desirable. Suddenly, these small and medium-sized companies ﬁnd themselves competing against larger players in larger markets. Success has catapulted them into a diﬀerent league, and competing in the new league requires new strengths. Many companies have discovered, to their chagrin, that success at one size does not guarantee success at another size. Personal Liability The desire for ﬁnancial reward and the need for expansion capital are not the only motivations for private company merger or sale. The elimination of personal liabilities can be powerful stimulant. The most common kind of personal liabilities are personal guarantees of company debt. Many owners of private businesses are required to support their company’s credit with commercial banks by giving their own commitments; this pledge means that they are legally obligated to use their own 241 | Mergers and Acquisitions for Private Companies private assets to pay back any bank debt that the company is unable to pay for any reason whatsoever. (The owners’ signatures may even be required for real estate mortgages.) In many cases, such personal guarantees originated years before in the early, risky days of the business and just were never removed. (There are few things harder to do in business than to take away security from a bank once they have it.) Successful entrepreneurs are self-conﬁdent to a fault and may not give those guarantees a thought or a worry. That is a serious mistake: Such guarantees may put at risk a family’s entire net worth. In business, there is no certainty. You can never control the future. Eliminating personal guarantees and liabilities is an entirely appropriate motive for selling a business. Generational Transition Generational transition is another reason that owners of privately held businesses seek to sell. Private businesses are often sold as part of the estate planning or settlement process. They are also sold to resolve family disputes, generally occurring when the founders’ progeny encounter fundamental disagreements (Both personal and professional). Motivation of Acquirors From the viewpoint of potential acquirors of privately held companies, motivations are more traditional. Good private companies may have proprietary products or technology. They may have a solid position in a small market niche and enjoy strong customer loyalty. Often such companies have product lines that can be expanded dramatically when supported by adequate resources, organizational and ﬁnancial. There can be high market leverage in privately held companies. Personal Motivations When Selling In most cases involving the sale of private companies, emotions run high. When it comes to their businesses, owners of closely held businesses usually think beyond dollar signs. Their motivations encompass more than the simple maximization of purchase price. Broad Concerns Consideration to founder/owners takes on broader meaning, expressing itself in nonﬁnancial terms as well as ﬁnancial numbers. For example, a continuing involvement in the business is desired by many selling entrepreneurs. In these situations, remuneration may play a more minor part. Participating in the business and assuring its continuing success are the things that count. The nonﬁnancial concerns of selling shareholder/managers frequently reach beyond themselves and involve their employees and even their customers and vendors. The company founder feels a sense of family for those with whom he or she has long worked. Loyalty is typical trait that 242 | Mergers and Acquisitions for Private Companies entrepreneurs value in employees and associates, and at the time of the sale many come to realize that loyalty should be a two-way street. Comfort with new owners It is important for founder/owners to feel comfortable with the new management and owners. Will they do right by the company and its people? Will they preserve what the founder built? Private company transactions often fall apart when the founders or their families “just didn’t feel right” about the prospective buyers. (For example, this hesitation might develop if part of the new owner’s plant would involve plant relocations and employee layoﬀs or a cheapening of the quality image of the company’s products.) Conversely, more than a few private company transactions were made in which the new buyers were not the highest bidder but were the “best people.” Business Analysis Due diligence is critical to all mergers and acquisitions, and there are standard systems of “business reviews” that are an essential part of the process. We assume that such detailed analysis has been done successfully. The key criterion to assess when doing due diligence of privately held companies is the personal importance of the owner or owners (i.e. the selling shareholders). How important are the current owners to the continuing operations of the business? Are they involved actively in management, and if so, in which aspects? (Sales is generally the most sensitive area.) There are some serious traps here. Assume that retaining the previous management/owner is critical for business success, at least for the short term. A long-term consulting contract with the former owner is no guarantee of his or her continued participation. Nor is a contingent payout based on performance for part of the purchase price. (The diﬀerence between no million dollars and one million dollars in purchase price is far greater than between one million and ten million.) There are psychological factors at work here, some outside of the owner’s control, intent, or even awareness. When Owner/Managers Are No Longer Owners What happens when the entrepreneur puts real money into his or her pocked for the ﬁrst time, the fact is that no one can predict what will happen. Work habits may not change an iota, or on the other hand a penchant for exotic travel and strange companions may suddenly emerge. Another factor is the diminished sense of personal ownership. The realization of loss has a slow but insidious impact on the performance of many former owners. Identity is blurred and estrangement breeds, and the work product becomes severely depresses. Said one entrepreneur so aﬄicted, “What seemed to be my normal job on the outside was bothering me PERSON_NAME on the inside. It was something like being asked to continue living with my wife after she has just married another man.” Entrepreneurial founders of companies are a feisty lot, and are not accustomed to working for anyone. Organizational structure and bureaucratic procedures are not things with which they can 243 | Mergers and Acquisitions for Private Companies identify. Taking direction is not something they can do well. There are too many things to rub them the wrong way. It is a simple historical fact that most arrangements for entrepreneurial founders to work with their companies after its sale will terminate, for one reason or another, short of the original contract date. Business importance of owner/managers Consequently, it is vital for investment bankers representing buyers or sellers of privately held companies to appreciate the business importance of the selling shareholders. The more important they are for the continuing prosperity of the company, the less that company should be worth. This means that the business signiﬁcance of the owner/managers is a vital modulating force on the normal quantitative techniques and qualitative factors in valuating and pricing mergers and acquisitions. When considering the importance of the selling shareholders to the business, the following areas of potential concern should be considered: relationship with customers; relationship with suppliers; technology and product development; management and labor relations. For example, how much of the company’s revenues do the shareholders/managers generate or inﬂuence strongly? Are there particular customers with whom they have a special relationship? Are they vital force behind new product development? Might there be labor problems without their paternal or maternal guidance? On the other hand, some companies may be more valuable without the former owners involved. (Witness the stock jump of some public corporations when the founder/chief executive retire or dies.) Sometimes founders cannot see beyond their own prejudices and once-wonderful ways of thinking. For example, when the old guard I no longer holding the reins, younger executives may be inspired to do better work (“to bring the company into the modern world,” as one liberated manager put it); freedom from the shackles of fear can stimulate creative and innovative thinking. For another example, unproﬁtable lines of business may be closed since new owners will have no emotional attachment to them. Noncompete Clauses Noncompete clauses are an essential part of virtually all purchase of privately held companies. It would be height of folly to buy a company only to have its key people go out and start a competitive company. Noncompete clauses normally run from three to seven years and are usually related to a contemporaneous consulting contract. One problem with noncompete clause is that they are diﬃcult to enforce. Courts are reluctant to deprive an individual of his or her only means for making a living. So although noncompete clauses are critical and essential, be aware that they may be unenforceable. 244 | Mergers and Acquisitions for Private Companies Financial Analysis There are three general ways in which the particular ﬁnancial analysis of privately held companies may diﬀer from the general ﬁnancial analysis of all M&A companies: (1) diﬀerences in ﬁnancial reporting motivations (e.g., tax minimization procedures); (2) personal compensation and beneﬁts for the owners and their families; and (3) business changes that should or might be made. Investment bankers must be attuned to these issues and, whether representing buyers or sellers, use them to best service their clients in the requisite ﬁnancial analysis. Reconstructed Income Statements The normal procedure for conducting a ﬁnancial analysis of privately held companies is to prepare a reconstructed income statement, giving eﬀect to all changes that would be immediately instituted (or could be easily implemented) once new buyers take over. It is commonly acknowledged that privately held companies have diﬀerent ﬁnancial reporting objective than public companies. Nonpublic ﬁrms have no incentive to maximize reported earnings – there are no stock prices to worry about and no ﬁnancial analysts with which to bother. In fact, there is a major disincentive for showing high earnings – taxes. The higher the earnings a company shows, the higher the taxes a company pays. The more money that appears as income, the more money that is paid out to the government – with the paradoxical results that the more a company shows in earnings the less it is actually worth! Consequently, private companies do everything legally appropriate to diminish proﬁts for tax purposes (and sometimes that fuzzy line between legal and illegal is shaved rather closely). There are two primary methods that private companies use to reduce earnings: compensation to owners and their families, and evaluations of inventories. Compensation to owner/managers High compensation of owner/managers is virtually universal in all proﬁtable private companies. For owners to draw low PERSON_NAME and take out their proﬁts as dividends, they must pay a double taxation – ﬁrst at the corporate level and second at the personal level. That hardly makes sense, especially to aggressive entrepreneurs. What to do? Owners of mature proﬁtable business seek to take money out of the business in tax deductible form – salary and expenses. PERSON_NAME are often higher than comparable PERSON_NAME in public companies. (Note: The Internal Revenue Service [IRS] will challenge “excess compensation”). There may be numerous ways in which general expenses are charged to the business (e.g., travel and entertainment, automobiles and the like) with questionable beneﬁts for operating the business. (Note: The IRS has become much stricter in disallowing personal expenses as business deductions). 245 | Mergers and Acquisitions for Private Companies Nepotism Nepotism, the employment of family members, is a common custom in private companies. And although the word connotes an activity somewhat shady, there is nothing intrinsically wrong with families working together to build a business and make it prosper. We do not suggest that nepotism is merely a circuitous route for reducing taxes. Family members are often very hard workers, feeling a great sense of commitment to the business. Indeed, the business becomes in many cases an extended family, with the positive results beneﬁcial for all. Nonetheless, a new owner may not feel the need to employ so many members of the family and perhaps those jobs could be replaced at lower pay scales. Pitfalls of Income Reconstruction In reconstructing an income statement for a privately held company, be aware of the pitfalls. It is clear that the PERSON_NAME of owners and their families can often be added back to income. What is easily forgotten is that most of those jobs must be done by someone. Other people-new people – must be hired to do jobs. The reconstruction needs to make provisions for the new compensation packages required for the replacements. See Adj EBITDA. Inventory evaluations Regarding the evaluation of inventories, private companies can be tempted to understate their values – for example, taking aggressive write-oﬀs to reduce proﬁts and hence taxes. (Such write- oﬀs might be praised in a public company as conservative management.) Although inventory should be valued at market, market is often diﬃcult to estimate, and value judgments are almost always required. There is an interesting trap in inventory evaluations for unwary buyers. Private companies may choose to “let out” the build-up “cushion” in their inventories in preparation for a merger or sale (or going public). In these cases, proﬁts in the last year or so might appear greater than they would normally be. How to assess the numbers and get at the truth? The key is to compare the gross margin percentages. If this margin has jumped up in the last year, though there may be other explanations, suspicion should be aroused. (Making comparisons with industry averages is one method of corroboration.) New operating strategies Potential buyers should evaluate M&A candidates in the light of how new owners might run the business. This analysis takes on added weight when appraising privately held companies since there are often rather obvious business decisions that the original owners were just unprepared to make. 246 | Mergers and Acquisitions for Private Companies (Often the old owners tell the new owners exactly what they should do.) these decisions are usually unpleasant ones disappointing employees, customers, and/or vendors – dropping unproﬁtable product lines long associated with the company, closing ineﬃcient plants, getting competitive bids for supplies, transferring lackluster executive, ﬁring unproductive staﬀ, and the like. There is also the stagnancy factor. Many founders like to keep doing business the way they have always been doing business. The power structure considers change uncomfortable, if not downright dangerous. It is hard to be creative and innovative in such an environment. Founders of companies can exhibit high inertia to fresh ideas. The challenge of the new appears to be an attack on the old – and the old is what made the business successful in the ﬁrst place. Some founder/managers act as if all new ideas are a personal aﬀront. In such stiﬂing situations, new owners can come in, do what has to be done, and improve the business substantially. Yet it is diﬃcult to project up front, before the deal is made, the impact of such beneﬁts. Consequently, buyers should not count on making signiﬁcant improvements in the company – but should rather consider the potential opportunities as incremental proﬁles. Structuring the Deal Making deals with privately held companies is often more complex than making similar deals with publicly held companies. The number of elements and options of consideration, ﬁnancial and nonﬁnancial, can be greater. When acquiring public companies, cash must be, by far, the primary consideration. It is possible to use stock in mergers with large companies, and sometimes debentures can play a part, but cash is almost surely king. When acquiring private companies, investment bankers on both buy and sell sides have more with which to work. Cash, of course, is still king. Indeed, many entrepreneurs will have an inherent distrust of anything else. Nonetheless, there is more ﬂexibility here. In fact, there has to be room for structural elasticity, since it is often more diﬃcult to harmonize price. To ﬁnd any overlap between the lowest price the founder is willing to accept and the highest price the buyer is willing to pay is a formidable task. After all, the founder is giving up his or her life’s work, and the buyer is incurring severe risk when purchasing a relatively unknown business. Often, there is no chance whatsoever of overlap if the purchase price must be paid all in cash. How to bridge the gap between sellers and buyers? Frequently it is the noncash portions of the consideration that work the harmonizing magic. In a typical case, perhaps 50 to 75 percent of the purchase price may be paid in cash or highly liquid securities. The remainder may be composed of the following elements. 247 | Mergers and Acquisitions for Private Companies Seller paper Seller paper is where the former owner takes back debt as part of the purchase price (much as in real estate transactions). This debt can be structured with great variety and creativity. It usually pays a market rate of interest (or slightly less) and has an acceptable amortization schedule, say, ﬁve to seven years. Seller debt is often subordinated to any senior ﬁnancing that is part of the buyout. Though owners and their bankers may squawk, subordination is usually the rule in leveraged buyouts (but not in sales to corporate acquirers). Occasionally, there may be a “grace period,” in which the amortization of the seller principal is postponed for several years and/or the seller’s interest is accrued but not paid, thus giving the new owners some cash ﬂow breathing room. If the sellers agree to take back paper in order to assist to buyers ﬁnancing the transaction, the sellers always seek to maximize the likelihood of getting their money. Sellers desire guarantees for their debt. Ideal third-party guarantees, such as irrevocable bank letters of credit or insurance company guarantees – but such security is rarely achieved. More customary that the sellers take a second position on the assets and stock of the company behind the senior debt. This would mean that, in the worst case, the seller would have a chance of getting their company back if the buyers would default on the debt. Earn-out Contingent Compensation Earn-out contingent compensation is the trick that gets impossible deal done; it is the vehicle that spans the unbridgeable gaps in private company transactions. In earn-outs, the additional compensation is related directly to some future performance or events, thereby harmonizing the disparate interests of sellers and buyers. The contingent formula for the additional purchase price is often based on ﬁnancial performance, which is preset by formula and payout schedule. An earn- out can take many forms, though it is most often ﬁgured as a percentage of earnings. Experienced M&A specialists representing a private company seller are usually uncomfortable with proﬁt-based contingency formulas since the new owners have full control of the company (and the books and can alter the proﬁt picture signiﬁcantly. Even if a major accounting ﬁrm is doing the audit, there are too many ways in which proﬁts in any given year can be severely depressed – such as increasing managerial bonuses, R&D, advertising, and capital expenditures and consequent depreciation. To make matters more complicated, many of these decisions may be in the best long- term interests of the ﬁrm. Furthermore, sellers do not want to be forced to delve into the books of the buyer. Better for many sellers is to devise a formula based on operational information, such as gross revenues or numbers of items sold. 248 | Mergers and Acquisitions for Private Companies Stock of the Acquiring Company There are two general conditions when shareholders of privately held companies will take the stock (preferred or common) in the acquiring company as consideration in the transaction. First, stock can be used as additional compensation–as a mechanism of PERSON_NAME a mutually acceptable price. (Stock is often used as the medium for paying the earn-out contingency compensation.) Second, there are occasional tax considerations that make it desirable for founder/owners to take all stock (less likely) when there is no distinction between capital gains and ordinary income). But whenever a seller agrees to take all the consideration in stock, it is essential that the stock must be in a well-capitalized public company whose shares are highly liquid and traded daily on a major exchange. (In all cases, the ﬂoat should be very large relative to the seller’s total position.) Note that when some companies give their stock as consideration in the acquisitions of other companies, they may require certain restrictions to be placed on that stock. Such restrictions would decrease its value, perhaps substantially. Private companies are ill-advised to take restricted stock as a major part of their consideration when selling. If the transaction is a merger in which they have or share control, it may be a diﬀerent story. Assumption of Liabilities When a buyer accepts a selling company’s liabilities, this kind of consideration can be just as important as if that buyer were paying cash or assets (all the more so if some of those debts are personally guaranteed by the owners). Though it is often hard for founder/owners to accept, the fact is that sometimes the assumption of liabilities is even more important than being paid cash (e.g.,) when all seller responsibilities for ongoing lawsuits are eliminated). A private company’s bankers will strive to eliminate all possible legal and ﬁnancial responsibilities of the previous owners in any M&A transaction. Related-Party Transactions Owners of private companies often have various relationships with their business. For example, they or their family members may own the land on which the factories are built or the buildings in which the retail stores are leased. These relationships give opportunity for more creative structuring, taking advantage of win-win tradeoﬀs such as tax beneﬁts. The entrepreneur can be allowed to keep ownership of these properties, and long-term contracts can be signed, assuring the former owner and family of long-term income and relieving the new owner of having to ﬁnance a larger purchase price. Employment Agreements Employment agreements are common when founder/owners sell the business. After all, the buyer wants to assure continuity, and the seller looking for additional consideration (and probably 249 | Mergers and Acquisitions for Private Companies meaningful work). Pending the precise situation, it may be mutually beneﬁcial to put more dollars into employment agreement and less into the purchase price. The term of employment contracts are often tied to the payment of ﬁnal obligations; for example, the contract can be structured to last until the later of either ﬁve years or ﬁnal payout of the seller’s debt. Consulting Contracts Multiyear consulting contracts are common in the sale of privately held companies. Such contracts normally last as long as the necessary non-compete clause and may involve other members of the family as well as the founder/owners themselves. The amount of actual work done under the consulting contracts is usually minimal. Fringe Beneﬁts Oﬀering fringe beneﬁts, though the amount is minimal compared to other elements in the merger consideration, can be an important psychological assist in doing a deal with a founder/owner. Continuing to maintain an oﬃce or provide health insurance can be a powerful incentive to someone who has never had another corporate home other than this company. Employee Beneﬁts Finally, founder/owners will likely bring their employees into the deal. They might have given some stock to personnel at very low values they might require pledges of employment. They might insist on contracts for key people. They might even opt to go for an Employee Stock Ownership Plan (ESOP) when selling their business, even if it doesn’t generate the most money with the best security. Role of Investment Bankers Most entrepreneur/founders of small and medium-sized companies never have worked with an investment banker in their lives and the prospect probably does not thrill them. All they know about these Wall Street Wolves they have learned from the mass media. Talk about starting out with two strikes against you! What beneﬁts can investment bankers bring to private companies seeking merger or sale, how can these be communicated? First of all, the inexperience of entrepreneurs should be stressed – especially in relationship to potential acquirors who are almost always highly experienced in negotiating acquisitions (whether large industrial corporations or ﬁnancial investment groups) Entrepreneurs understand expertise: They are experts in their business and should appreciate that investment bankers are experts in mergers and acquisitions. Next is the matter of secrecy and discretion. It is vital to respect the conﬁdentiality of clients. This is a central ethic of investment banking but it takes on special signiﬁcance in private company M&A. 250 | Mergers and Acquisitions for Private Companies There is often some reticence, if not ambivalence, on the part of the seller. Any premature disclosures may disrupt the entire process. Unauthorized exposure may cause personal and professional embarrassment and could damage the client company’s business relationship with customers and vendors. Frankly, investment bankers provide a buﬀer between the company’s manager/owners and the public. If there is an accidental leak (often from the manager/owners themselves), the “blame” can be placed on the ﬁrm’s “overly aggressive investment bankers.” (It is easy to blame investment bankers for their over-anxious rapacity; everyone will believe the excuse and belt the scapegoat.) Selling a business is a sophisticated process, demanding the highest professional standards. Investment bankers should be able to fulﬁll the following services for private companies. Understand the Business First of all, the investment banker should really get to know the company–its products and people and the reasons that make it all work. Examine all facets of the business–market, products, product development, manufacturing, distribution, service, reputation with customers, image, advertising management, organization, ﬁnances, and the like. Go for jugular issues, the critical success strategies–what makes this company special, what are its distinctive competencies, what are its comparative advantages and competitive strengths? Since the company is private, getting inside (ﬁguratively speaking) will be more diﬃcult than with public companies. Manager/owners will be reluctant to talk openly–even though they have invited the investment bankers to come in. After all, a private company is not used to conﬁding in outsiders (a public company, remember, deals continuously with the insistent and incessant questions of shareholders and analysts). Patience is tops as are interpersonal skills such as sincere human interest and warm compassion. Conducting due diligence on a privately held company is like running a group therapy session for ﬁrst-time patients. But don’t go milquetoast and forget about the weaknesses – then discuss market soft spots, company defects, and organizational problems. You don’t want to appear negative (or a boor), but ﬁnding the truth is your responsibility. Explain that, as their representative, you are professionally bound by conﬁdentiality and to presenting them in the best possible manner. In the M & A process, it is best to assume that investment bankers who represent potential buyers will uncover all skeletons, so investment bankers who represent seller must be ready with all answers and explanations. Understand Owner Priorities As M&A representatives, the investment bankers must know what their client/owners want to achieve. Not everyone’s objective is similar. In fact, not everyone’s objective is logical. 251 | Mergers and Acquisitions for Private Companies Some owners want to get their money and get out totally. Others desperately want to stay in the company and remain a part of their life’s work. Still others want to enable their family members to continue in the business in some way. It is even possible to develop a transaction in which owners can cash out most of their value in their company and still maintain control (whether themselves or through their families). Deals can be structured to accomplish virtually all interests. Business Presentation Investment bankers are known for the professionalism of their presentations. They generally prepare a “book” portraying the company in the best possible light, which would include a description of the business and industry, products and market, competitive positioning and market share, management and organization, operating history, ﬁnancial history and current condition, future opportunities, and the like. The book is presented quite elegantly, with thick dividers, embossed lettering, and perhaps a hard cover. Special attention should be focused on recasting the ﬁnancial statements to reﬂect properly how a traditional business would appear without the special owner beneﬁts. Such a recasting should not include the hypothetical results of assumed business decisions–such as curtailing unproﬁtable product lines or closing ineﬃcient plants–no matter how obvious or easy. The eﬀect of implementing such cost eﬃciencies as well as developing growth opportunities should be described in a diﬀerent section and can include appropriate ﬁnancial estimate of what the company would like if the stated changes were made. Buyer List Development First-rate investment bankers can interact with a large universe of potential buyers, calling on the experience of its internal team and the information of its external network. In addition, investment banks have access to sophisticated public and private databases with enormous amounts of data on industries and companies. From these vast resources, investment bankers should be able to bring dozens of potential candidates to the table, international as well as domestic. In addition, they should be able to develop lists of comparative transactions that give ballpark estimates of values and general categories of structures. Such unbiased data helps bring both buyers and sellers closer to the real world. There are various factors to consider in evaluating a long list of potential buyers. Degree of interest in the client’s business is obviously ﬁrst, and the ﬁnancial capacity to complete the deal is a close second. But other factors should also be involved. For example, suppose that the founder/owner insists on retaining a minority share (say 20 percent) of the company for his son; such a demand would eliminate many potential buyers, but not all. The corporate culture of potential purchases could be another important factor in that most owners want their employees to be happy in their future home. 252 | Mergers and Acquisitions for Private Companies Buyer Contact and Evaluation Minimum interference with business operations is vital in the early stages of all M&A situations, and this is especially true for smaller, privately held companies. It is highly disruptive to have waves of potential buyers stomping through the oﬃcers and arousing uncertainty and worry. (After many years of working for the founder or his family, most employees would needless fear for their jobs.) Why allow the merely curious to agitate your people. Investment bankers have a responsibility to minimize such disruptions. Negotiating the Deal How a deal is negotiated depends on company conditions. Sometimes it is best to evaluate buyer interest and then work with the two or three most serious candidates. At other times, a controlled auction makes the most sense. This is where potential buyers submit one round of bids based only on the “book prepared by the investment bankers–and then only the few leading bidders are interviews. The negotiating stage is where many founder/owners begin to get nervous. They imagine they are losing control of their businesses (and their lives). They seem surrounded by swirling, simultaneous meetings of multiple buyers on a feeding frenzy. It may appear that all decision making has passed to these fast-talking, fancy-dressed, hot-shot investment bankers whom they barely know. Investment bankers working with private companies must be sensitive to the special concerns of manager/owners. Care must be taken never to slight their clients, no matter how irrelevant their questions or how pressing the situation. Investment bankers must always be cognizant of the fact that they are agents, not principals. Owners should never lose control of the process and it is the responsibility of their bankers to give such assurances. Legal, Accounting, and Tax Here is where the professionalism of investment bankers should shine. The places of possible pitfalls in structuring a deal are innumerable. For example, the simple decision whether to sell stock or assets is fraught with complex ramiﬁcations involving tax, continuing liabilities, and future plans of both buyers and sellers. Since this sale is probably the most important transaction that the owner will ever make, and since most of his or her net worth is probably tied up here, nothing less than the best professional advice must be used. This is another example of investment bankers being far better equipped to handle mergers and acquisitions than “business brokers,” who are often just gloriﬁed matchmakers. Investment bankers being an integrated, professional approach to the most important decision of a company’s life. 253 | Mergers and Acquisitions for Private Companies Investment Banking Fees You get what you pay for. Investment banking fees are calculated as a percentage of the transaction size. They are normally set as a sliding scale downwards as the transaction increases in size. The traditional “PERSON_NAME Formula” is the standard on which most fees are based: ﬁve percent on the ﬁrst million, four percent on the second million, three percent on the third million, two percent on the fourth million, and one percent on the ﬁfth million and thereafter. However, as with everything else in M&A, many modiﬁcations are made. In small, hard-to-do deals, the ﬁve percent may extend for several millions or for the entire deal. In very large deals, the total fees will amount to less than one percent. Innovative, incentive-based fee structures may oﬀer investment bankers a lower amount, say one percent below a certain trigger and a high amount, say two percent, above that trigger. Such an incentive fee structure really encourages the bankers to “top out” the price. Since investment banking fees are a percentage of the entire deal, they can become quite large. Such numbers can only be justiﬁed if they are a very small percentage of the incremental value that the investment bankers add in a transaction. (Value added is most often reﬂected in a high purchase price – derived through attracting better buyers and negotiating better deals. It is also reﬂected by a smarter structure for both sides, a greater likelihood of closing a transaction, and a lesser likelihood of legal and tax foul-ups.) Many investment bankers currently seek an up-front retainer before they begin M&A work with a company, especially a privately held company where owners have been known to change their minds halfway through the process (or just before the end). Should such retainers be charged, or should the only fees be contingent on the successful conclusion of a transaction? (Out of pocket expenses, from travel to computer time, are always billed to the client company, irrespective of transaction outcome.) There are two sides to the issue: On the one hand, a retainer seems coercive and not in keeping with industry tradition where only success is rewarded and failure means failure for the banker as well as the client. On the other hand, a retainer separates the serious from the curious. An enormous amount of work is involved, and opportunity costs are high; consequently, an investment bank must be assured that, should a reasonable deal materialize, its client is committed to close the transaction. Investment Banking Attitudes It is important that investment bankers treat their private company clients properly. The fact that the deal may be small should not aﬀect the work product at all. Even the appearance of a condescending or patronizing attitude must be avoided. Granted, the entrepreneur/founder is not ﬁnancially sophisticated. But he or she is a signiﬁcant success (and is probably more than the banker!) Unless investment bankers are going to do their possible job, they should not take the assignment. 254 | Mergers and Acquisitions for Private Companies Each transaction should be given the attention of a senior banker, one with signiﬁcant experience handling either private companies or ﬁrms in the speciﬁc industry (or both). Although the proverbial young MB will be doing much of the work, they must be continuously guided by experienced dealmaker. Indeed, the fundamental diﬀerence between investment bankers and business brokers is that the bankers must be able to provide signiﬁcantly more services and expertise. Private company M&A is generally not the grist for page one news or even the inside pages of The Wall Street Journal. Some investment bankers, accustomed to the megamerger spotlight, cannot get themselves up for smaller deals. However, these are the exceptions. To true investment bankers the deal itself is the thing, its size being little matter. Most M&A specialists just love doing deals and doing them well. Indeed, some bankers enjoy doing smaller, private company deals more than larger, public company ones. It is in the private company deals that investment bankers can take more personal responsibility and thus gain greater satisfaction from a job well done. 255 | Mergers and Acquisitions for Private Companies The Art of Deal Making THE ART OF DEALMAKING HOW TO DO DEALS STEP BY STEP 256 The Art of Deal Making Part I Deal Skills How to Organize Your Deal Making 257 The Art of Deal Making Deal Skill-1 What’s a Deal? Doing Deals in Real Life When, in DIGITS, General Motors bought back PERSON_NAME Perot's stock for $700 million, and, just for good measure, added a little proviso that squelched the pesky fellow's irritating critique, that was a deal. When the Securities and Exchange Commission agreed to a reduced penalty for Ivan Boesky in exchange for his cooperation, including the secret recording of friends and associates that was a deal. When companies buy and sell goods and services, when bonuses are given for exceeding quotas, when careers are advanced by undermining rivals, these are deals of the commercial kind. When spies are traded across Berlin bridges, when weapons are shipped and hostages released, when missiles are limited and countries divided, these are deals of the political kind. When you buy a car, sell a house, set your salary, or trade your stocks, you are also making deals. Whether the exchanges are explicitly stated or implicitly assumed, such deals make the world go round. Making deals makes human life, and life success requires deal success. You can't get around it. There's no other game in town. Want to achieve business goals? Build personal stature? Improve your standard of living? There's only one route straight and true. Virtually all achievement demands the successful selection and execution of transactions among individuals, groups, organizations, and institutions. Transactions take place in every corner of commerce and career. They occur all day every day. Like it or not, we are all deal-makers. And the best love it. Deal Fallacies Let's start in reverse. What common assumptions about deal making are just plain wrong? What is real deal making not? 258 The Art of Deal Making Not Just Edge Getting The popular press harangues us with getting-the-edge indoctrination. Predatory propaganda is the way of our world. If you don't know the craft of negotiation, you're a dolt and a doormat. If you don't conquer through intimidation, you're a pushover and a place mat. If you don't watch out for Number One, you're a ﬂake and a dishrag. No one wants to be a blockhead, a pansy, or a nerd with a wet noodle for a backbone, so we are all compelled, actually bullied, to play the one-upmanship game. But it's all so fugitive, so shortsighted. Today's quick buck chokes oﬀ tomorrow's thousand. Streams of dollars that could ﬂow in the future are never seen. The irony is that what is not seen is not known; no negative reinforcement ever occurs, no long-term consequences of short-term actions are ever appreciated. Self-impressed edge-getters go blithely on their devious ways, smug that they have mastered the craft of negotiation, conquered through intimidation, and watched out for Number One-whereas, in reality, they have ﬂubbed the deal, blown the negotiations, and ﬂattened Number One. Not Just Negotiations What constitutes a deal? Clever negotiations, if you believe popular wisdom. True-but not truth. Deal making requires greater talent and demands broader technique. Deal making means more than negotiating. Learning how to do deals means more than learning how to negotiate them. How to get what you want in trading and haggling is only part of our story. Deal making describes the whole process whereas negotiations deﬁne speciﬁc skills. Deal making involves far more than is usually assumed, and if you begin with techniques of negotiations, you've already conceded half the battle. Negotiations, if you think about them, start in the middle-taking for granted that a certain deal should or must be made. But which deal should or must be made? How do you know? It makes no sense to negotiate in a make-believe world, however nice the feathery fairyland. It is better, I tell you, to negotiate the right deal badly than the wrong deal well. Think about that. Many experts teach negotiations in seminars or write about the subject in books. I admire those who teach and write. But I trust those who do. ("Those who can, do; those who can't, teach.") This study guide is about doing. Not Just Tactics Deal making is strategy as well as tactics, how to plan ahead as well as how to carry out. It is creative choice as well as shrewd manipulation. Choosing the right deal-knowing in advance which deals 259 The Art of Deal Making are doable and which are not-is more important than negotiating that deal. You need to be much more than a good negotiator to be a good dealmaker. Not a clever negotiator? Not to worry. You don't need to be one to be a good dealmaker. Surprised? Read on. Certainly, the skills of adroit bargaining are valuable. We will discuss them in detail-adding a few twists and turns sure to delight even the most jaded negotiator. But the facts are that one can be a good dealmaker without being especially wily in negotiations and that a smart negotiator may be winning minor victories on the wrong battleﬁeld. Not Just Finance Another common fallacy is to assume that deal making is limited to ﬁnancial buying and selling, to the movement of money, and that the only people who do deals work in corporate ﬁnance or patrol the Street called Wall. The fact is that everyone interested in bettering themselves should learn better techniques for making deals. The principles apply in every facet of every life. Deal Making in History Human history is driven by ﬁghting wars and making deals. (The start of the former is often triggered by the failure of the latter.) Deals highlight all chronicles and records. Wherever we look we see deals. Many of the earliest annals from the ancient Near East are descriptions of trading transactions, mundane accounts of agricultural exchanges inscribed on cuneiform tablets. Modern politics is nothing if not doing deals, a dense web of making and breaking promises, tough trading and constant trickery. Some deals literally changed epochs of history, such as the infamous nonaggression pact between Hitler and Stalin that ripped apart PERSON_NAME and brought about World War II. Some deals are trying to stop an inexorable slide into oblivion, such as the strategic arms limitation talks and nuclear weapons reduction proposals. Some deals are bold and triumphant, such as the Camp PERSON_NAME accord between PERSON_NAME and Egypt. Some deals are foolhardy and naive, such as the attempt to buy hostage freedom with weapons for Iran. Finally, some deals are just good old pork- barrel politics, backslapping wheeling and arm-twisting dealing, with special favors being bartered and swapped in smoke-ﬁlled rooms. Deﬁning a Deal What, actually, is a deal? Let's frame some basic deﬁnitions. A little precision can't hurt. A deal is an exchange of value and consideration among two or more parties. Value means anything whatsoever that at least one side thinks has some kind of worth. 260 The Art of Deal Making Consideration means whatever things are used to purchase that value. A tangible or intangible "something" must change hands. The value and consideration of the exchange may include goods, services, assets, liabilities, cash, cash equivalents, promissory notes, stock ownership of all kinds, patents, rights, royalties, responsibilities, or commitments. Each side seeks to achieve speciﬁc objectives, and may include any combination of tangible and intangible value and consideration in the deal. In a traditional corporate deal, one party exchanges cash to purchase the stock or assets of a company. In a less traditional corporate deal, a weak business might be exchanged solely for the assumptions of its liabilities. Deal Complexity Complexity is a killer in deal making. It sucks time and saps strength. Dealmakers should fear its ominous advance. There is an inverse relationship between complexity of deals and probability of closure. This means that the more complicated the deal structure the less likely it is to work. The KISS principle-Keep It Simple, Stupid-is as valid with giant corporate transactions as it is with small personal arrangements. In fact, small deals are no easier to make than big deals. Sometimes they are even harder, since personality and ego can more easily foul up the air and choke oﬀ progress because the parties may be “small thinkers” with big egos. Transactions may be disarmingly simple or tortuously complex. A purchasing agent and a vendor can agree on price without need for written conﬁrmation. Some corporate mergers cannot close without consuming hundreds of turgid legal documents. But a deal is a deal is a deal, and every point in every transaction must be sifted and selected, dissected and analyzed, considered and decided, no matter how large or small the numbers. Our CEO closed one of the largest deals our ﬁrm ever handled, with revenues of $900 million, 12,500 employees and 300 locations, in the week between PERSON_NAME and New Year, with only a one-page agreement, without any lawyers! When all the parties like something, they can make it happen! Deal Components Stripped to basics, all deals are similar. Simple or complex, all deals look the same inside and underneath. 261 The Art of Deal Making All deals have common components: distinct parties with diﬀering interests, value and consideration to be exchanged, terms and conditions to be discussed, a process of negotiation, a closure or consummation event, and an execution or implementation of the agreed-upon terms and conditions. Mutual agreement is the key idea. Easy to say. Hard to do. Determining terms and conditions is the crux of most deals. It is the area of greatest conﬂict, yet it oﬀers the most opportunity for dynamic creativity-for bridging unbridgeable gaps and climbing unclimbable cliﬀs. A ﬁrst step in devising good terms and conditions is to understand their composition. The following seven questions should be answered before the deal terms and conditions can be established. 1. What Kind of Stuﬀ ? What is the nature and character of the value and consideration being exchanged? 2. How Much of the Stuﬀ ? What are the amounts of the value and consideration being exchanged? 3. What's the Stuﬀ Really Worth? What is the relative beneﬁt of the value and consideration being exchanged? 4. What's the Stuﬀ Really Like? What promises and assurances (representations and warranties) are given to the value and consideration? 5. What's for Sure and What's Not? Which terms and conditions cannot change (non-contingent) and which can change (contingent)? 6. How to Assure Compliance? How to provide for each side living up to its side of the bargain? 7. What's the Timing? What is the schedule for completing the transaction? Deal Domains Diﬀerent deals have diﬀerent traits, and diﬀerent traits require diﬀerent strategies. When a factory manager negotiates with Ford, it's not the same as when Toyota does the talking. Deals can be viewed from various perspectives, or "cut" from various angles. Three diﬀerent ways to size up deals-deal participants, deal locus, deal sector. Mood and feeling, the fuzzies and tinglies, are at issue. Make no mistake: How your stomach is churning inﬂuences how your head is working. 262 The Art of Deal Making Deal Skill-2 What's A Good Deal? Good Deals Are Good For All Parties Good deal making is when both parties are satisﬁed, each party enjoys it more-and wants to do it again! Being satisﬁed, however, does not require being satisﬁed at the same time, to the same degree, or in the same manner-on either side of the analogy. Deal making, involves a complex PERSON_NAME of personality and passion, a mysterious mixture of ego and desire. A good deal means diﬀerent things to diﬀerent parties: To a company enjoying high growth, a good deal might mean a 25 percent annual return on investment. To a company threatened with bankruptcy, a good deal might mean selling oﬀ inventory at a loss to generate survival cash. To an independent consultant, a good deal might mean selling services at low fees to establish a reputation. That's the nature of deal making: lower risk for lower reward and higher risk for higher reward. In the short run, a good deal is whatever makes you happy. In the long run, a good deal is whatever makes everyone happy. Short run boosts egos; long run promotes careers. In making deals, one often chooses between ego and career. It's a tough call: Conceit never likes second place. When Bad Means Good In the language of the street, bad (pronounced something like "Bhhaaaaayyd", means good, something tough and strong; and good means mediocre, something soft and weak. The same reverse sense applies in evaluating deal making. A good dealmaker is often glamorized as a ruthless manipulator, a cold-blooded predator of the concrete jungle who devours all without mercy. HELLO, STERLING COOPER? By some quirk of character, evolutionary or social, we admire the tough guy. Macho is cool. The masculine image is steel and ice, not satin and silk. The feminine image is warm and sensitive, and few dealmakers have the ego strength to survive such compliments. 263 The Art of Deal Making How to win accolades and respect in this media-blasted world of saber-toothed virility? Pressure and squeeze the other side. Better yet, pummel and pulverize them. To trick your opponents and seize more for yourself is the touchstone of success, the proverbial pot of deal-making gold at the end of the shrewd tactician's rainbow. Building the business takes a backseat when personal ego does the driving. Too many businesspeople pride themselves on besting their buddies. They must twist an advantage to feel productive; they must feel the turn of the screw to sleep satisﬁed. You know the type. A fair price is never fair. Grinding never stops. Agreements are changed constantly. Power plays never end. An agreed-upon deal is altered on signing. Payment is delayed deliberately. Simple meaning is confounded by calculated obfuscation and legal pyrotechnics. The pounding is relentless. Some of these characters browbeat and coerce. Others prefer to dupe and deceive-the former like to see you squirm; the latter enjoy the painless slice. Priorities are always inverted, objectives pulled inside out, goals ﬂipped upside down. Getting the edge is the goal and shaving points is the game. Edge-getters are often haughty and swell-headed ("legends in their own minds") with more vanity and arrogance than acumen and smarts. When these types fancy themselves dealmakers, they are often more addicted to the clever kill than to the extra meat. What counts is not the spending power of the bigger payoﬀ but the puﬃng power of the smoother stroke. It's the edge itself that's sought, not necessarily the amount-the intoxicating elixir of Darwinian dominance brewed with sublimated sexuality. Cutting a deal with a 1 percent nick is almost as gratifying as one with a 10 percent gouge. But whatever the hit, the entire deal becomes more tenuous and closure less sure. Commitment is weakened, conﬁdence is shaken, and time is lost. Problems can erupt, days are wasted, deals delayed, relationships ruptured, and reputations ruined-all silly sacriﬁces on the high altar of ego worship and gamesmanship. Morality is not the issue here. Straight pragmatics is what we promote. We count numbers and keep score, with no special points given for being fair or nice. Know, however, that the race we run is a marathon-our time frame extends well beyond the close of the current deal-and what will be remembered as a good deal tomorrow deﬁnes what must be considered as a good deal today. Describing a Good Deal A deal is good when it optimizes objectives. This general deﬁnition means that solutions must be found for most problems under consideration. But optimal is diﬀerent for each party and for the deal as a whole. From each side's separate viewpoint, a good deal fulﬁlls most of that side's wants and needs- irrespective of the impact on the other side. In other words, as long as your side is content, it matters not a whit how the other side comes out. 264 The Art of Deal Making A "best" deal, then, is the maximum you can PERSON_NAME expect to get combined with the minimum you can PERSON_NAME expect to give. This is what you give in deals: The value and consideration, the cash and stuﬀ you paid or received. The risks assumed, such as the potential default by the other side. The opportunity costs incurred, such as the lost chances to do other deals. When both sides of the deal are assessed at the same time, a deal is good when it optimizes objectives of both parties. A deal is "best" when it achieves the maximum total goals of every side while sustaining minimum risks all around. Using this collective deﬁnition, a good deal is not all that common and a best deal is indeed a rare ﬁnd. Most deals have uneven value to the opposing parties. A best deal for one side is likely to be only a good deal for the other. Good deal making is a means to an end, not an end in itself. Though it is satisfying to do good deals, the source of that satisfaction should be the higher goals being attained-not a showcase for advancing ego. All parties to a deal should be satisﬁed on signing, enthusiastic during execution, delighted on completion, and pleased on reﬂection. Sets of solutions that achieve non-conﬂicting objectives are always present in deals and should be sought aggressively. A deal can be considered good when it fulﬁlls at least minimum goals of all participants. A good deal is as good 10 months after closing as it is after 10 minutes. Good deals should stand the test of time and be remembered fondly 10 years hence. Unequal Roles in Good Deals Don't misunderstand. We build no safety nets under weaker parties. Social support has no place in this deﬁnition. Bleeding hearts are barred. The toughness of the marketplace must dominate. Deal- makers must consider the other side simply because in the long run it makes smart business sense- not because it is a nice thing to do. This point is vital. Unequal outcomes result from unequal positions. Each side is seeking good, better, and best for itself. The contest is adversarial and win-lose (i.e., if one side gets $1 more, the other side has $1 less). The rules of the game, even when known, are not always fair. You play dealmaker, therefore, very much at your own risk. Final decisions are yours alone. A good deal does not require each party to play an equal role, to achieve the same success, or even to make money. Natural power is distributed according to preexisting patterns. For example, if a liquidator buys end-of-season merchandise below cost the manufacturer seems to lose money. But if the manufacturer's overall costs are covered, the conversion of the unsalable inventory into ready cash produces a beneﬁt. 265 The Art of Deal Making In another example, when a company with a tax-loss carryforward and low proﬁts pays a whopping price to purchase a company with substantial proﬁts, the deal can be good for both sides. The buyer thinks in terms of the acquired company's pretax income (which it shelters from tax) and the seller thinks in terms of receiving top dollar. How about a more extreme example? Assume you are able to purchase a company in serious financial trouble by assuming only part of its outstanding liabilities. The previous owners wind up with residual debt and a negative worth. Is this a good deal by our definition? The answer is yes, if it is the best arrangement the sellers can construct under the circumstances. In these dire situations, good dealmakers like to give something positive to the other side. Here a multiyear, personal consulting contract is one possibility. Relativity Makes Deals Good Variety in deals is endless. No two are exactly alike. Good deals, however, have one facet in common: Comparisons are always made and assessments are always relative. Satisfaction is achieved to the extent that each party feels relatively positive about the outcome. The key word is relatively. To ﬁnd out what it means, we explore a peculiar aspect of human nature. Human beings are creatures of comparison. We react emotionally to recent events, even when it makes no sense to do so. Consider the following situation. You own DIGITS shares of a stock selling for months at $20 per share. On PERSON_NAME you hope but don't expect the price to rise. Suddenly, on Tuesday, there is a rumor of an unfriendly takeover and the stock shoots up to $30. You are elated. You are also $10,000 richer, at least on paper. You tell your spouse, kids, relatives, friends, perhaps plan some long-wanted pleasure purchase-you're a hero. Then, on Thursday, the target company sues and the raider backs oﬀ. While there may be other suitors, no one surfaces and the stock drops to $24 where it closes on PERSON_NAME. You are depressed. Even though you are $DIGITS richer on PERSON_NAME than you were on PERSON_NAME, you feel terrible-after all, you just "losť" $DIGITS. This emotional relativity is what we mean by saying that humans are creatures of comparison. Your mental attitude with the stock at $24 is controlled by your mental attitude when the stock was $30 (however momentary the event) and not when it was languishing at $20. Now, for the sake of argument, we make the middle of the week disappear. There is no dramatic announcement of an unfriendly raid. Rumors of merger build slowly. The company states it might begin negotiations. The stock moves smoothly from $20 to $24 over the course of the week. And on PERSON_NAME, you are feeling ﬁne-after all, you just "made" $DIGITS. 266 The Art of Deal Making The same relative emotions dominate in deal making. Absolute assessment of transactions carries less weight than logic would suggest. "Good" is appraised, consciously or unconsciously, in relation to other real or imagined alternatives. The closer you think your deal is to the best deal, the better you feel. The better you feel, the likelier you are to make that deal. There is another, invidious kind of comparison skulking around deal making. This is the comparison between or among parties. All too often, one side blows a superb deal simply because it feels that the opposing side is getting a "better" deal. The truth or falsity of the attitude is irrelevant. Judging motivations of the other side is impossible. Furthermore, it doesn't matter how successful the other side is if your objectives are achieved. Nixing a deal because of ego imbalance is akin to cutting oﬀ your nose to spite your face. Good deal-makers evaluate what they get, not what others get. They like their noses uncut. Why Deals Get Done At ﬁrst blush, doing any deal would seem unlikely. How can human nature allow it? Agreement on terms and conditions appears impossible. Yet dozens of healthy-sized deals, hundreds of mid-sized deals, and thousands of smaller ones are consummated every day. Deals get done because, ultimately, each side comes to believe that it is getting more than it is giving. Making each side emerge a winner is the critical essence of doing good deals. Why Work Good Deals Good deal making is the way of dynamic action, potent growth, and competitive edge. This is the frontier, the comparative advantage for contemporary businesspeople. Good deal making is intense, gutsy, spirited, and aggressive. Good deal making, in short, propels companies and catapults careers. Edge-getters, however, often wind up with few deals and fewer friends. They can be found spinning endless hero stories of long-forgotten transactions. In deal making, if you will pardon one more love-making analogy, you can play by yourself, but it just isn't as much fun. 267 The Art of Deal Making Deal Skill-3 What's a Good Dealmaker? Good Dealmakers Have Long Legs You, a good dealmaker? No fooling, read and believe-it's what you can become. Inherited talent is not a necessity. Nor is Wall Street work in any way required. Desire is important, no, very important. So is drive. And never forget dedication and persistence. (Don't worry, I won't let you.) Attitude. Substance. Skill. These are the three pillars that support good dealmakers. Attitude is personality of the dealmaker. Substance is content of the deal. Skill is deal-making technique. Image versus Reality What's the classic picture of a superb dealmaker? What image pops into your mind? Probably a sophisticated banker type, a denizen of New York's ﬁnancial district, bedecked with three-piece suit, expensive jewelry, styled haircut, and big cigar, LOL. Despite the visual stereotype, many of these folks are truly outstanding dealmakers. They have to be. Whatever their external appearance, they know how to cut a deal-exacting maximum value and consideration while risking minimum fracture and rupture. They are intense, smart, single-minded, committed. Investment banking is a deal-making profession, with the largest ﬁnancial stakes on earth, and those who rise to the top are the cream of the crop. How these deal makers conduct their craft, how they work their wonders, forms the foundation for this book. The principles of Wall Street can apply for you. A sharp businessperson is a sharp dealmaker-someone who formulates, evaluates, and implements various transactions; someone who works with sensitivity and ﬁnesse. Such a person plans, organizes, strategizes, and structures the interchange of products, services, and ﬁnancial considerations between companies and people. Such an animal, common wisdom assumes, survives in the market-place jungle by wit and scheme-these being claw and fang-with only raw 268 The Art of Deal Making cunning providing protective cover. Yet the best business-people live by reputation, the evidence of past deals done well, the image of personal integrity long lasting. Sterling Cooper, Inc., and aﬃliates, have the reputation of making great deals, quietly. Good dealmakers defy stereotype. They cannot be easily classiﬁed. They can be female, minority, young, or old. They can be doctoral graduates or high school dropouts. They can work in large companies or oﬀ by themselves. The sole distinguishing characteristic is their capability and compulsion to do good deals. To fulﬁll this one passion, they are united by drive and determination. Involving the Other Side Good dealmakers want the other side to know what they're doing. If your opponents aren't knowledgeable, it is more likely they may back out later-after you've expended money and eﬀort and, most costly of all, forfeited other opportunities. This rule, as you might expect, has exceptions. The idea of intimately involving the chief decision maker of the other side only applies when your property is ﬁrst-rate. Your stuﬀ is hot and you won't waste time with lookers and tire kickers. However, when you are trying to unload, shall we say, inferior merchandise, you play a diﬀerent game. If the top guy gets involved too soon, the deal could be history. The "sunk cost" principle applies here. You want the other side to invest their time, money, eﬀort, and ego in examining the deal. Nothing dishonest, mind you. Just let them sell themselves. Let them take their time. Then, with higher costs already sunk, they may not scuttle the junk. They're less likely to fold the hand and more likely to see the next card. After all, they have to justify their already-gone investment. Action Principles for Good Dealmakers I like four action principles that mark good dealmakers: choosing deals wisely, developing common interests, achieving personal objectives, and building personal careers. I use these principles myself and recommend them to others. They are eﬀective guides for making deals happen. Choose Your Deals Wisely Don't squander your eﬀorts. The most critical moment in making good deals is often overlooked. The decisive point comes up front, right at the beginning, before you start negotiating. I've said it once and I'll say it again: It is better to do a good deal poorly than a poor deal well. Your chances of success are aﬀected dramatically by the type and nature of the deal you've chosen to do. Sensing "doability" of a deal is an art developed through insight and experience. This is where the 269 The Art of Deal Making experience of Sterling Cooper comes to play. WE GET DEALS DONE WHEN THEY NEED TO BE DONE! Time, too, is a valuable resource and it cannot be squandered on unlikely prospects. The tick of the clock is a dealmaker's primary asset. Time allocated is the highest cost of doing business. Develop Common Interests Don't ignore the needs and wants of the other side. The best deal makers have a keenly developed sense of "people assessment." They just seem to know where that elusive bottom-line falls-the absolute minimum that various parties must have for the deal to happen. They can separate necessity from desire. They can decide when to give something to their opponents and when not to. Power relationships shift as deals develop, and you must be able to make similar judgments-necessity versus desire-for your own side as well. Achieve Your Objectives Don't polish your ego at the expense of doing your deal. The best dealmakers keep their goals clearly in mind and never allow personality conﬂict or narcissistic intrusion to deﬂect a straight run for the gold. Don't worry what others get. Don't worry what others think. Just know what you want to accomplish. Keep your eye on that ball and don't allow extraneous pressures to distract you. A good deal-maker is constantly enhancing his or her perceived power. The trick is track-record. Everyone wants to associate with a winner. Build a Career, Not a Caper Don't misjudge the point of good deal making. It's not about personal puﬀ before peers or press. It's not about gambits and games, strokes and schemes, sophistry and duplicity. It is about accomplishment and triumph, winning big and winning long. Constructing a career is a long-term program; copping a caper is a short-term heist. If you plan only one deal, go read the one-upmanship books and play the intimidation game. A fast- talking huckster, said to be "veneer all the way through," was fabulous at one deal, and maybe a second, but inevitably the bubble would burst and his deals would self-destruct. Personality Characteristics of Good Dealmakers Personality is vital: Good people make good deals. The reverse is also true: Good deals are made by good people. Demeanor, disposition, and manner are critical success factors for deal makers. A would-be dealmaker who stubbornly maintains poor character traits starts every inning with two outs, two strikes, and a knuckle ball zigzagging toward his leaden bat. 270 The Art of Deal Making Why start a tough game at such a disadvantage? The following seven categories of personality characteristics are important for being, or becoming, a good deal maker. They are exempliﬁed in the best dealmakers. Achievement and Accomplishment Good dealmakers are like successful entrepreneurs. They are motivated more by inner needs than outer show. They have a never-ending sense of urgency and are attracted to challenges, not risks. Power is important, but it is the power to make things happen, not the power to boss subordinates. They would rather consummate a deal from their makeshift garage oﬃce than command a huge corporate division from an elegant executive suite. Commitment and Dedication Good dealmakers invest themselves in all their deals. Psyche and soul are always on the line. They consider their current deal, what-ever the size or substance, to be the most important thing in the world, and on it alone does the sun rise and set. The day begins early and ends late. Fervent conversations with other deal participants proceed virtually nonstop. There is tension, insistence, and compulsion. The commitment must be wholehearted and the dedication monastic. These traits won't assure deal success; but omitting them can guarantee failure. Focus and Intensity Good dealmakers shoot riﬂes, not shotguns. They deﬁne tight targets and never allow their eyes to waver from the bull's-eyes. To change the metaphor from shooting to ﬁshing, hook good dealmakers on good deals and they'll swallow the line and sinker as well as the hook. They may PERSON_NAME other deadlines or appointments, but they blaze a one-track path for doing their deal. Patience and Perseverance Good dealmakers never give up. They are bulldogs; they do not rest until every avenue and alternative is explored to exhaustion. A lost deal must be lost long before it is lost forever. They know how to wait, but they don't know how to quit. They have an exquisite sense of timing and have learned through experience that acting too quickly is as dangerous as reacting too late. They can read the verbal and nonverbal signs of deal participants on both sides of the table. They can discern the right moment for movement. Professionals know that sometimes no action is the most aggressive and powerful action that can be taken. The hardest thing for novice dealmakers to do, is nothing. 271 The Art of Deal Making Sensitivity and Perceptiveness Good dealmakers read people well. They translate emotions and feelings into plans and programs. They appreciate the negative impact of seemingly innocent suggestions and oﬀ-handed remarks. They rarely have personality clashes and never turn opponents oﬀ. They ﬁnd and push the "hot buttons" of allies and adversaries. They genuinely like people and thereby achieve competitive advantage. Integrity and Consistency Good dealmakers can be trusted. They say what they mean and perform what they promise. They are not volatile. They know from experience that truth is easier to remember than ﬁction, and that a reputation for honesty is the best advertisement for future business. Creativity and Innovation Good dealmakers try new tacks if old-ones stall. They are never at a loss for fresh suggestions to circle obstacles, bridge gaps, scale walls, and a bunch of other tiring clichés (pardon the pun). They use diverse techniques to devise unexpected responses to troublesome situations. Originality in deal making becomes both process facilitator and content contributor, stimulating helpful interaction among people as well as suggesting speciﬁc ideas to resolve deal points. Worried about Competition? Am I concerned that the cluttered marketplace will make my own deal-making life more competitive? No. The more really good dealmakers are working, the more really good deals are made. Good dealmakers do not require bad dealmakers as their natural prey. Rather, good dealmakers on both sides of transactions increase the overall quantity, and improve the overall quality, of deals being done. Good deals enhance the reputation of all dealmakers. 272 The Art of Deal Making Deal Skill-4 How To Learn “The Skills” Skills Give Broad Structure What made Sandy Sigoloﬀ, chairman and president of Wickes Companies, such a good dealmaker? How did Sandy negotiate his company out of ﬂat-on-the-back bankruptcy and into high-ﬂPERSON_NAME acquisitions? First, we will learn the skills; then we will learn about Sandy. Learning deal-making skills is easy-if you know what you're doing. Reading Dealmaker should help- if you know what to look for. What to do? What to look for? That's the purpose of this chapter. To become an eﬀective maker of deals, you must appreciate, remember, and apply these frame- works and elements. Hit it hard. Such proﬁciency requires the knowledge of essential attitude- building concepts called "idea-skills." How to Learn Skills and Secrets Consider three steps in learning to use deal-making skills and secrets 1. Understand. Understanding the deal-making skills and secrets means more than reading the words. It means knowing the essence Picture how each would be worked by professional dealmakers. Play with the skill or secret. Examine how it behaves under diﬀerent deal conditions (e.g., when the stakes are large or small) and explore how it aﬀects diverse deal situations (e.g., when negotiating with good guys or bad guys). 2. Image. Imaging the deal-making skills and secrets means pic turning how you would put each one into productive use in your own deal-making life. Project yourself into potential negotiations and watch yourself employing each speciﬁc skill or secret smoothly and suavely. Feel comfortable and free, wholly at ease. See the actual image in your mind's eye and hear the actual PERSON_NAME in your mind's ear. Construct give-and-take exchanges; gauge your responses and monitor your emotions. (This process of pretending is called simulation-doing something, as it were, without actually doing it.) 273 The Art of Deal Making 3. Utilize. Utilizing the deal-making skills and secrets literally means putting each one into practice. Don't fear failure-learn from it. Fear is the only thing to fear. Sure, you'll feel awkward at ﬁrst, but just as with learning a foreign language, you must use it to know it. Concentrate on two or three skills or secrets at a time, no more. If any don't work, ﬁgure out why-and then try it again. Remember, the more you use them, the better they work. Five Idea-Skills for Deal Making These following ﬁve deal-making idea-skills set apart leading negotiators from haggling hacks. They should live inside you and form the core of your natural deal-making instincts. These idea-skills should become second nature, loading automatically into your subconscious whenever you commence deal-making behavior. Know the Attitudes and Elements of Deal Making Knowledge builds conﬁdence and competitive edge. Your eﬀective-ness in using each deal skill and secret will increase as you appreciate the structure of the deal-making process. Picture this image: Each deal skill and secret is a tree and the deal-making process is a forest. Your task is to see how each tree builds and blends with the entire forest and how the forest gives context to each tree. Seat-of-the-pants deal making is ﬁne for some sharpies, but most mortals need some assistance in grasping the subjective aspects of each deal skill and secret. Know What You Want to Achieve It's self-defeating to judge by comparison. Jealousy and envy are diversions for dealmakers. They erect obstacles for making good business. Worry about yourself, and let the other side worry about itself. Don't get hot over what your opponents get and don't be bugged by their apparent satisfaction. Be pleased with what your side gets and be content with your own satisfaction. Good dealmakers can segregate their own needs and wants from those of others. However, to do so, you need preparation and self-conﬁdence. For instance, if you sell your business at the price you want, you should have no gripe when the buyer makes even more money over time. Discern What the Other Side Wants to Achieve Project yourself to the other side of the table. Float down into the seats of those with whom you are dickering. What are their real requirements? What's on their wish list? What are they looking for in the deal-bottom line-and how important is it? Most critically what are their priorities? 274 The Art of Deal Making Often, giving others what they want will not take away from what you can get for yourself. But gaining such insight does not come quickly or easily: You must develop sensitivity to people and awareness of situations. For example, if the owner of a closely held company wants to sell out in order to retire, there can be meaning beyond money. Maximum price can become secondary to special terms and conditions. Such an owner might well sell the business-a beloved "baby"-to a buyer oﬀering a lower price if the owner believed that these new managers would take better care of the family legacy (including employees, products, customers, community, and reputation) than those oﬀering a higher price. The best dealmakers always go for the emotional heart of the other side's interests-especially when it's not price. Seek "Win-Win" Solutions Search for areas where each side can achieve certain of its goals without adversely aﬀecting the other side. In the language of game theory, such sectors are called win-win, since one side is not compelled to lose (i.e., gives up something it likes) whenever the other side wins (i.e., gets something it likes). How to ﬁnd win-win? Establishing common ground is key. Examine each aspect, element, and component of the deal. Go through the pieces and particulars of the transaction several times-you never know where these optimal regions will turn up. Win-win intersections can be surprisingly broad if one has the foresight to search for them, the insight to develop them, the perception to recognize them, and the resolution to employ them. When one structures deals with innovation and intelligence, win-win solutions emerge constantly. For example, a company acquiring a family business might replace some of the cash purchase price with its own equity stock ( an equity interest in the business). Such a modiﬁcation may win for the selling parties by giving them a sense of participation and continuance, and win for the buying parties by diminishing the amount of cash they must dish up and fork over. What happens here can happen often: In a very real sense, the buyer pays less and the seller receives more. Think Alternatives and Solution Sets The best dealmakers multiply their options. They think on several levels at the same time; they plan for contingencies. The unexpected they expect; the unimagined they imagine. They are constantly watching over their shoulder with one eye and over the horizon with the other. Experienced negotiators keep diverse alternatives always in readiness, like having several relief pitchers always warming up in the bullpen. They play what-if scenario games, devising creative 275 The Art of Deal Making responses to dummied-up problems. Expecting surprise at all times, good deal makers are never surprised. They know how to hit curve balls even while waiting for sliders. Solution sets suggest a family of related ideas available for bridging gaps and resolving conﬂicts. No professional ever relies solely on one perfect solution to negotiating disputes. Perfection is impossible in the crazy-quilt world of human bargaining. Total control can never be exercised in deal making. There are too many issues, too many people, too many agendas-many of which can be hidden and all of which can be contentious. Dealmakers who think in terms of solution sets are better able to ﬁne tune their deal structures. Optimizing the interests of both buyer and seller is the objective. That's the meaning of win-win. Sandy at the Bat When PERSON_NAME C. Sigoloﬀ took the chief executive post at Wickes it was the second largest Chapter 11 bankruptcy in U.S. history with almost $2 billion in debt. Wickes emergence after two and one- half years, followed by its aggressive acquisition moves (not all friendly), has been hailed as a triumph of turnaround. Sigoloﬀ's deal-making skills played no small part in the transformation. In a Chapter 11 proceeding (called a debtor-in-possession), creditors and company are often adversarial. Both want the highest payback, making the best of a bad situation. Creditors, already burned, want quick cash. The company, seeking survival, wants to rebuild. Though creditors would get more of their money back if they waited (assuming that the company was successful in its rebuilding), they are usually scared of tomorrow and anxious to get what they can today. STERLING COOPER PROVIDES EXPERT ADVICE TO REORGANIZING BUSINESSES IN CHAPTER 11 PROCEEDINGS. Early on as the new CEO, Sigoloﬀ determined that he would not allow Wickes to be sucked dry of funds and mangled into an economic cripple. The creditors, for their own good, would have to be patient. "I never allowed uncertainty on this issue," said Sandy. "There was no debate in anyone's mind: I was not going to decimate the company. Feeble companies help no one." Sigoloﬀ combined toughness and fairness, keeping creditors intimately informed but resisting their natural bent for curtailment and liquidation. He stopped the current hemorrhaging by closing divisions that had no future (laying oﬀ, with personal trauma, hundreds of loyal, long-time workers). He built for the future by expanding divisions that had signiﬁcant potential (using capital the creditors sought for themselves). He came close to confronting creditors in court. But, in the end, with debt repayment and stock ownership, Wickes' creditors came out better. 276 The Art of Deal Making Deal Skill-5 How To Keep “The Secrets” Secrets Give Speciﬁc Strategy What are "secrets" in deal making and why should you keep them? Deal Secrets is my way of directing attention to real deal making in real situations. I like the concept. It stresses knowing and doing, remembering and applying. More particularly, it underscores the active accumulation of deal- making knowledge and the internal storing of fresh ideas. Practice, not theory, cuts ice. You must feel it inside. Often there's just no time for studied response. If you stop to think, you've stopped forever. If you hesitate, you could be lost. Dealmakers must be driven by instinct to react properly under all circumstances. How to train those instincts? You need right reﬂexes. That's the message here. In this guide, the word secret has two meanings. First, since the ideas presented here are often ignored by our deal-making populace, they are, in a sense, secret. Second, you can gain relative advantage over other dealmakers, especially in the long run, by keeping these ideas secret. Seven Instinct-Secrets for Deal Making The following seven deal-making secrets train your instincts for rapid response. Be Fair But Be Frank Some of the toughest businesspeople are also some of the fairest. Getting the upper hand should be gotten out of your head. But conceding the upper hand should be stricken from your mind. Don't seek personal domination. But don't appear frail, fragile, feeble, or ﬂimsy either. Remember, doormats get stepped on. Place mats, eaten on. Dishrags, wiped with. None of these textile-types do good deals (the soles of shoes, bottoms of plates, and dirt from dinner don't build negotiating strength). 277 The Art of Deal Making Being fair does not mean being weak. Weakness, in fact, disrupts deals by tempting the other side to expand expectations and swell demands. Creating false hopes-building appetite without satisfaction-is not conducive to good deal making. Let the other side realize that you know the nature of their game, the way they change the rules, and what their players have in mind. For example, if you decide to do business with a certain company regardless of price, be sure that they know that you know the score. If that supplier thinks they've pulled a fast one this time, they will try to pull a faster one next time. The price, already high, will go even higher. (As in the jungle, weakness is attacked mercilessly, and the nick will swell to a gouge.) However, if the supplier realizes that you know what's going on-that you've decided to do business in spite of the high price (for whatever reason, say quick delivery)-they will respect your strength. You may get a more reasonable price the next go-round. Respect encourages fairness. Heave Hype Hype helps? Well, that depends. Hype can sometimes sell a ﬁrst deal, but never a second. (Fool me once, shame on you; fool me twice, shame on me!) Exaggeration is a short-term, rapidly depleting asset-and a long-term, quickly accruing liability. Hype is usually either a bad habit or a desperate act. Be advised, neither is good for deal making. Just try negotiating again with someone you've jiggled. The French Resistance was no tougher than what you'll face. If all you have is one deal to make, be my guest, make my day-have at it. Though I admit I've done it myself, I don't recommend hyping it; nor have I ever met a person who has only one deal to do. So give hype the old heave ho. Be Conservative Always be moderate in projecting your most likely results. Make reasonable and restrained public pronouncements. Aim forecasts below center. Strive to exceed a pessimistic projection rather than fall behind an optimistic one. Develop Alternative Scenarios Allow the other side choices in assessing your analysis. (This transfers some of the burden.) Give them room and keep your option open. What impact would various internal surprises or external shocks have on your company? For example, what might happen to cash ﬂow if sales rose or fell 10 percent, 20 percent, or 30 percent? 278 The Art of Deal Making What if competition pressured prices? What if interest rates escalated? What if two surprises or shocks hit simultaneously? Such sensitivity analysis is particularly apt for buyers and sellers of businesses and for lenders and borrowers of debt. Sensitivity analysis should also be used to examine the position on the other side of the table. Such appraisal will probably be more descriptive than numerical, providing more insight than facts. What are best guesses of your opponent's current position and possible options? Are they really at the wall or can they be coaxed just a bit further back? Admit Uncertainty Don't be afraid to profess doubt about parts of your package. Point out, for example, where some of your numbers or statements may be slightly suspect. Business information cannot be that perfect or that precise. Honesty enhances credibility, and careful admissions can be most disarming. (Try using such high-powered honesty when battling a cynic; it can melt the most hard-bitten dealmaker.) In preparing a proposal for bank ﬁnancing, for example, a company should enumerate all assumptions precisely, pointing out areas of diﬃculty or ambiguity. Potential problems should be exposed by design, rather than be hidden by default. The honesty shown will be a potent force for augmenting conﬁdence. I'm not advocating, of course, spilling the beans, singing like a canary, hauling skeletons out of the closet, picking through your garbage, turning over all the rocks, and other such tattletale clichés. Taking truth serum is not the idea here. Improving credibility is. You don't have to tell the whole truth, but be sure that whatever you do tell is in fact true. Dealmakers are grown-ups. The rules of the game assume each side carries its own weight. Address Questions Nobody Asked Use this deal-making secret for surprise. But use it cautiously. Few moves are more impressive than when one side brings up sensitive subjects regarding its own position that the other side has not considered. It enhances believability enormously-not to mention how the shock value can disorient the other side. Such “superfrank” actions are good counterattacks to credibility problems. Say your company has fallen behind its sales projections and as a result your bank is beginning to question everything. A daring technique is to show your account oﬃcers something else they missed about the company, say a collection problem with minor accounts. Such credibility enhancers can become credit enhancers. (This technique, be advised, is a bit of brinkmanship; there is danger that your new admission will undercut an already shaky house.) 279 The Art of Deal Making One must be careful not to go overboard. Most people are conditioned to assume that their deal- making opponents aren't telling the whole truth, anyway. Some dealmakers always shave (haircut) projections by 10 to 30 percent. By giving a pessimistic reading as your most likely case, you run the risk of having this low-ball projection subjected to the same ﬁnancial clippers. A double haircut you don't need; baldness in transactions does not mean deal-making virility. Think Image, Not Ego Act as if your deal opponents are your public relations agents. In a way, they will be. No matter how conﬁdential the negotiations, no matter how secret the deal, other people will hear about it. Regardless of how you envision yourself, what circulates about you is how others see you. Your reputation is cast by the look in their eyes when your name is mentioned. Dealmakers' reputations are their most valuable asset. Such an asset is not to be hidden away but made manifest openly. It's in poor taste to parade your supposed superiority. Such conceit will boomerang and slap you on the backside. Whatever you dish out, so will you be dished. It comes down to this: What's your thing getting the edge and puﬃng your ego or building the business and promoting your career? You can win the battle of making one deal, and still lose the war of making many. 280

mergers_acquisitionsadvisorym&amergers and acquisitionsvaluation

M&A Playbook

Categories

Sample Entries

Mergers & Acquisitions E-book, 462 Pages (Part 5 of 5)

Mergers & Acquisitions E-book, 462 Pages (Part 4 of 5)

Mergers & Acquisitions E-book, 462 Pages (Part 3 of 5)