5 Traps to Avoid When Negotiating

The Denver Post | Business

Gary MillerBy Gary Miller – Managing Director, Consulting Division, SDR Ventures

Bill had been thinking about selling his company for a couple of years. He and his wife, Carol, wanted to spend more time with their grandchildren and travel together to make up for all those years when they couldn’t.

One day Bill received a call from George, a friend and business competitor, who wanted to discuss a deal.

George’s timing was perfect. Bill had built a distribution company generating $25 million of annual revenues and $4.8 million of earnings before interest, taxes, depreciation and amortization, or EBITDA.

It was a solid company with strong management, consistent growth and earnings and opportunities for expansion into new territories. Bill expected a high purchase price.

He had decided that he didn’t need professional advisers with strong transaction experience. He believed that his regular accounting firm and corporate law firm could handle any deal he negotiated. He had previously made one small acquisition on his own and felt he was perfectly capable of selling his own firm.

After several discussions, Bill and George finally came to an agreement. George had his deal team present Bill with a term sheet specifying several items yet to be negotiated. As Bill found out, the problem with negotiating the deal yourself is the same problem a lawyer has in representing himself: He has a fool for a client.

About 75 percent of business owners who go it alone emerge at the end of their sale like Bill, regretting the deals they made.

There are risks that a business owner negotiating his own deal can bring to the table. Industrial psychologists define them as cognitive biases and they can be mitigated by using professional advisers who maintain their objectivity through the transaction process.

Here are five major biases that can ensnare owners when they negotiate their own deals:

Framing bias: This is context in which the buyer’s presentation to the seller significantly impacts his or her impression of a deal. The deal is framed so positively that the seller’s impression is “this deal could really work.” It can make the seller more relaxed and risk-tolerant.

If the price looks good, the remaining items in the term sheet look like they’re easy to be worked out. Take care to react to the quality of the complete deal — not the quality of the presentation.

Anchoring bias: This is the tendency to rely on the first piece of information in the term sheet. Most people tend to use an initial piece of data as the strongest reference point, or the “anchor,” for the entire term sheet. It can be particularly impactful when negotiating valuations of your company. For example if you are told by an investment banker, accountant, or a valuation company that your firm is worth 6.5 to 7.5 times EBITDA, you likely will remain pegged to those numbers. If you fixate on the price, you might rationalize away the rest of the deal’s points.

Confirmation bias: This is the tendency to favor information that reinforces or confirms a person’s existing beliefs. It can become particularly problematic for buyers during the due-diligence process. The bias to purchase can cause the buyer to selectively remember information that supports the desire to close the deal. If the opportunity seems strong, the buyer will seek out evidence to support its strength. Professional advisers can help by conducting objective and complete due diligence.

Cognitive dissonance bias: This occurs when your initial hypothesis is challenged, perhaps by conflicting sets of information. In the deal process, the bias most often appears when a disappointing realization develops — such as discovering a risky skeleton in the closet of an otherwise seemingly perfect company. You can either satisfy the dissonance by believing that the risk is not that great, or by backing out of the investment. If you choose to stay in the deal, make certain you understand the full impact of the skeleton.

Groupthink bias: This is the tendency for an individual to adopt the mind-set of a larger group. The pressures of conformity and the desire to fit in often drive those with minority opposing opinions questioning the deal to silence their doubts. Fix it by conducting thorough due diligence and reporting the findings to senior managers. Give them the chance to express any concerns, doubts or reservations about the deal.

Gary Miller is managing director of Denver-based SDR Ventures’ consulting division. SDR is an investment banking firm that advises privately held middle-market businesses. He can be reached at 720-221-9220 or gmiller@sdrventures.com.

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