“What you are shouts so loudly in my ears I can’t hear what you say”
~Ralph Waldo Emerson~
The sale or leveraged recapitalization of your business will likely represent the single most important financial and business decision of your lifetime. Choosing the right advisors to represent you is second only to choosing the right private equity firm as your partner. Building a business takes years or decades of effort, often involving personal sacrifice and the undertaking of significant financial risk. If successful, the value of your business will typically represent 90% or more of your net worth. With so much at stake, the sale of a company can be an emotionally charged, not to mention hectic, process.
Once the decision is made to explore a liquidity event many sellers forsake the quick, painless process of contacting MCM Capital in favor of engaging an investment banking firm to assist in the sale. Taking the protracted and potentially disruptive approach typically results in interviewing investment banking firms, drafting a memorandum, preparing a management presentation, populating a data room, and multiple management presentations all of which take place while simultaneously running the business. In addition to selecting the right Investment banker, it’s critical to retain an experienced deal attorney adroit in the art of the deal.
Despite all the time and effort put forth by the investment banker and the company’s management team to reach the letter of intent milestone, the negotiation of the purchase and sale agreement is perhaps the most challenging aspect of the transaction. In fact, the ease or difficulty of completing the deal will largely depend on the personalities of the parties to the transaction. Over the past two decades of negotiating purchase and sale agreements, as both buyer and seller, we have witnessed the good the bad and the ugly. As a banker friend of mine once said, “There’s always a jerk in the process, and if you can’t find him, it is probably you”. Character plays an enormous role in all interpersonal relationships, and is extraordinarily apparent during purchase and sale agreement negotiations.
Steven Covey, in The 7 Habits of Highly Effective People, described the foundation of successful people is “character ethic”, an individual’s primary traits or principles such as those of fairness, honesty, integrity, courage, justice and patience. Covey contrasts character ethic with personality ethic, which are secondary traits or practices which include specific skills one is required to possess in order to perform in specific situations. Principles contrast with practices as principles are universal while practices are situation specific.
In the context of a recapitalization transaction, character ethic is of paramount importance. In many respects a recap is like a marriage, typically for five to seven years. To paraphrase Warren Buffet, from a private equity investor perspective, there are three attributes we look for in a CEO/partner: character, intelligence and energy; for without the first one, the other two will kill you. For the CEO’s evaluation of a PE partner, the same should hold true.
In the context of negotiations, an attorney, advisor, CEO, or private equity principal may be a strong tactician, but if he lacks the character ethic it will make for a difficult (but lucrative for the attorneys and advisors) transaction. Over the years we have seen this play out repeatedly. Attorneys who are combative and fight every issue to prove their value to their client truly undermine their client’s end goal of a successful outcome. Because we do this for a living, we are on better footing than the “once in a life time business seller” inexperienced in M&A who will likely rely heavily on his legal counsel.
Negotiating a purchase and sale agreement is principally about risk allocation. A buyer wants representations, warranties and indemnification provisions as airtight as possible. Conversely, a seller wants to be certain that the monies received in the transaction aren’t at risk of forfeiture. All attorneys are paid to protect their clients from risk, but a skilled deal attorney should possess a balanced perspective and sound judgment.
If the parties to the transaction employ a few of Covey’s “habits” the transaction negotiations are likely to result in a successful deal, in less time, with less stress, and lower legal costs.
Begin with the end in mind:The buyer and seller have reached an understanding and both are motivated to complete the transaction. In the heat of battle, the advisors should always remember the goal of completing a deal for their clients.
Seek first to understand, then to be understood: Perhaps the most important trait of all is the ability to be a good listener. Many people hear but don’t listen. They may allow the other side to speak, but their body language reflects how busy they are in formulating their response to be understood. Active listening and understanding the other party’s position as though you were in their shoes demonstrates you care and hopefully leads to reciprocation. Active listening creates an atmosphere of caring, respect, and positive problem solving. The worst outcome is you agree to disagree.
Put first things first: In every transaction there are high priority issues for each side. Separate the important from the trivial and be willing to compromise on those issues that aren’t high priority.
Think win-win: Strive for mutually beneficial solutions. A “win” for all is ultimately a better long-term resolution than if only one person in the situation had gotten his way. Unfortunately, it appears that many attorneys seem to be genetically predisposed to win-lose arrangements. The importance of striving for win-win is particularly relevant in a recapitalization transaction where the selling shareholder/CEO and private equity firm are going to be partners going forward. The ability to remove emotion from the discussion and view issue as a mutual problem to collaboratively solve will likely yield a better outcome.
MCM Capital Partners is a Cleveland based micro-cap private equity fund investing in niche manufacturers, value added distributors and specialty service businesses. For more information on our private equity firm and investment principles, contact us today.