Avoiding Vulture Capitalists: Why You Need an Expert Advisor in Proprietary Deals

Crooks exist in nearly every industry. We’re believers in the goodness of people, ideas and integrity in finance, but unfortunately the subtle few wreak havoc on and taint the good name of entire industries by their ill-executed and pillaged exploits. With so many venture, PE and other groups seeking for greater-than-market returns for their clients, it can be difficult to see who is really on your side. Those who run their own companies, often referred to as the “proprietary sellers” can often become victims of targeting as they’re less prone to go through the business sale process with an advisor. It represents a further detriment to small business owners who are used to doing things on their own without assistance. After having built excellent companies over decades of work and learning nearly all the nuances of starting, owning managing and even selling products many business owners feel they’ll be able to successfully execute the sale of their business. Seller beware: institutional buyers are looking for deals when they shop proprietary deals. With this  in mind, here are a few pointers on what to look for and how to avoid a trap.

Overall Lower Valuations

The entire motivation of the vultures–so called–is to push for a lower valuation. Like any opportunist, they’ll be attempting to buy low and sell high, knowing the best money is made in the purchase, not necessarily in the subsequent sale for the higher value. With this in mind, recognize every potentially frustrating component of the proprietary deal process includes some annoying hoop whose intent is to lower the overall amount paid for your company.

One of the most egregious ways to lower the value of your company is to eliminate competition. It is unwise to allow for an exclusive contract, at least until you know you are going to get a good value for your business. Exclusivity only guarantees less bidding parties to your business which, in turn, will bring a substantially lower price. Exclusivity coupled with the acquiring entity advising against representation is a combo for disaster. Firstly, an advisor would have warned against exclusivity in the first place. Second, an advisor has connections and can find multiple bidding parties. And all of us know higher demand for your company means a higher eventual closing offer.

With multiple offers and courting acquirers entrepreneurs will at least be sure they’re not leaving more money on the table or feel they are forced into a fire-sale. This is very important to the business owner who may be attempting to monetize his/her life’s work in a single liquidity event.

Drawn-out Due Diligence

If you do end up agreeing to go with your initial contact and you sign your exclusivity agreement, allowing for due diligence, be advised it could last a very long time. In proprietary deals, it is in the best interest of the acquirer to drag out the due diligence process. It does several things–all of which can have negative consequences for the target company.

First, drawing out due-diligence gives the acquirer the ability to find something, anything that would hint at a lower valuation. The lower they are able to prod, the easier it will be to find the chinks in your company’s proverbial armor. Secondly, target owners can often get impatient, frustrated and anxious to get their business sold. They may not have anticipated due diligence to drag on for months at a time, but the longer it goes on the easier it can be to push an entrepreneur over the edge. Finally, it is much easier to perform last minute price drops and counter offers on a company that has had to wait a very long time.

Wholly Unfavorable Terms

Being the smaller fish in the frog fight makes it more difficult to avoid unfavorable terms in the deal. While unfavorable terms don’t always have immediate monetary impacts, they can often slow the process, cost you time, hair and stress. Avoiding such is often worth a few Benjamins. Here are some potentially unfavorable terms:

  • Large escrow payments. Entrepreneurs required to put large sums in escrow for legal and other transaction fees not only tie up capital, but they make it unfavorable in the event that trigger events do or don’t happen, depending on how the terms are structured.
  • Higher-than-normal working capital requirements. You leave more money they you necessarily need to in the business as a requirement for “working capital.”
  • Unrealistic earn-out requirements. If a portion of the sales price is contingent on some performance in the future that is altogether unrealistic, it can be very detrimental to the total amount an entrepreneur is able to obtain for his/her business. Cash is king. Even discounted cash up front is king over unrealistic earn-out clauses.
  • Employment/consulting contracts. Buyers can attempt to initiate or cajole sellers into consulting contracts. Fees for consulting and employment, other than a standard retainer agreement are usually superfluous and simply line the buyer’s pocket.
  • Risk issues and indemnification. Seller warrants to the buyer clauses are most often wholly unnecessary. While they may not give a lower valuation, they just make the process that much more difficult for the seller.

Avoid Buyer’s Remorse

Having buyer’s remorse when you purchase a radio or sell your car on Craigslist is one thing, having a pit in your stomach when selling a business you may have taken years to build is quite another. Being in the know, knowing which traps to avoid and finding multiple offers is perhaps the very best opportunity any entrepreneur could look for. Not all venture capitalists are evil, but business is business. They’re not in it to make friends, they’re in it to make money. Remember, you’re their target, not their wife.

Business owners and entrepreneurs seeking to sell their business through a Seattle business broker are encouraged to contact us.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.
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