The con man refers to his target as a “mark” – easy prey to be exploited.
Private Equity (PE) guys are too polite to refer to their victims in such pejorative terms, but, as I learned this week from my friend Dewey Hammond, a partner at Chattanooga-based Four Bridges Capital Advisors, PE firms now have a saying for a business owner who is an easy target: The Proprietary Deal.
When acquirers use the term “proprietary deal” they are referring to buying a business directly from the owner without the hassles of a “greedy” investment banker driving up the price by soliciting – or threatening to solicit — competitive bids for your company.
Falling victim to the proprietary deal is easy. You get approached by a partner in a PE firm or a senior person from a big company in your industry you know and respect. They shower you with compliments about your business, invite you to a fancy lunch and then ask if you’d consider selling. Once you agree to a conversation, they convince you there is no need to involve an advisor to represent you – why pay the money, they’ll say, to some guy or gal who has done nothing to help you build your business – we’re friends after all.
But becoming the mark in a proprietary deal is much more expensive than having your wallet pick pocketed by a street crook. Here are five reasons to avoid being the target of a proprietary deal:
You’ll get a lower price
Obviously with nobody else bidding for your business – without even the threat of a competitive offer — the price an acquirer will pay is lower in a proprietary deal. Nothing drives up the value of your company faster than the possibility of two or three acquirers fighting over it.
Due diligence becomes protracted
Once you agree to negotiate with one buyer, they will force you to sign an “exclusivity agreement” which allows the buyer time to do their due diligence. When a buyer knows they have a proprietary deal, diligence often gets dragged out for months.
Not only will due diligence become excruciating for you, proprietary deals often get discounted with the buyer lowering their offer price after you’ve agreed to a set of deal terms. The longer and more painful they make the due diligence, the weaker you become to defend against a last minute price drop.
The last time I was in Marrakesh I bought a rug. The street vendors must have seen me coming from a mile away with my camera slung over one shoulder, map in my hand and goofy NIKE sneakers on my feet. I was convinced I was going to show them who was boss. By the time our negotiation was finished, I had bargained the price of the rug down by 50%. I walked away proud of my negotiating savvy until, on the ferry back to Spain, I learned one of my fellow travellers had got his rug for 80% off the asking price.
When you sell your business, you’ll ponder whether or not you got a fair price for your life’s work. That’s natural but if you fall victim to the proprietary deal, with no other buyers bidding for your company, you’ll go to your grave never knowing if you were taken.
Out of market terms
Four Bridges Capital partner Hammond explains some of the less obvious dangers of the proprietary deal, “Another buyer tactic in a proprietary deal is to keep the price agreed to in the Letter of Intent the same but asking for “out of market terms” on other economic issues that have the net effect of lowering the sellers take from a deal”. Hammond continues, “Buyers running a proprietary deal can ask for an abnormally large escrow (a whack of cash you need to give to a lawyer to hold for a year) or working capital requirement (the amount you need to leave in your company when you hand over the keys). Other areas where buyers can peck away at value include the structure of earn-outs, consulting or employment contracts, or risk issues like how indemnification works for various representations that the seller must warrant to the buyer.”
At first blush, negotiating on your own with one buyer can look simpler. Life is short afterall and you might argue it’s better to make a quick sale to a friendly buyer even if you leave a few bucks on the table. But the illusion of the easy deal can quickly turn into what amounts to a one-sided swindle.