A Failed Direct Deal?

Quite often our firm is hired to establish a value for a company through an independent accredited fair market valuation, but then we find the company's owner attempting to sell the company on his own.

Quite often our firm is hired to establish a value for a company through an independent accredited fair market valuation, but then we find the company's owner attempting to sell the company on his own.
"The concept of 'doing a deal' directly might be enticing and perceived as a good way to save a broker's commission," says Achim Neumann, President A Neumann and Associates, LLC, New Jersey. "However, the truth is that the occurrence of any one of a number of events will most likely wipe out any anticipated savings."

Specifically, there are numerous factors that jeopardize the efforts of a direct sale.

No Proper Buyer Qualification Process
Most often, when we are requested to advise a seller on a transaction "who currently is talking already to a buyer," most often we notice that a formal qualification process has not been conducted; in other words, the buyer's investment/income criteria, management qualifications (from a lender's point of view), decision timeframe, balance sheet and bank account statements have not been requested. Further, at best, a one-page buyer Non-Disclosure Agreement (NDA) was signed, and not a detailed NDA as utilized by professionals in their day to day dealings with buyers.

Not only is the seller jeopardizing confidentiality through the lack of a proper NDA, he is doing so with a "buyer" who may not even be able to execute a deal, and the buyer will never know this until the deal reaches the closing table.

No Sense of Urgency
Another significant issue is, that if buyers sense they are the "only game in town," they will typically take their time to wear the seller down on price and other terms. This is characterized by consistent and multiple requests for documents, taking his "sweet time" to decide on every issue, and just simply dragging out each step toward deal closing. The seller's attempts to "force a decision" by setting a deadline will carry little impact because the buyer knows there is no other seller.

Bottom Fishing
Along the same lines, doing a deal directly will make it more difficult to obtain a full price offer from the buyer - even with a third party accredited valuation report. Buyers will simply disregard the validity of such a report, and the seller is often not sophisticated enough to counter in detail the points that the buyer may bring up with respect to such sophisticated valuation report. The outcome is that the buyer will likely only offer a fraction of the true market value.

Lack of Financing
Every buyer uses bank financing to acquire a company, typically for 50% (or more) of the asking price. We have seen again and again that a buyer relies on our organization to match him with the proper financing sources to obtain such funds, as specific lender risk assessments differ widely between different market segments.

Ironically, the buyer needs to present himself initially to the seller as a very well-funded investor in order to engage with a seller, but will then have to concede at a later stage that he/she does not have the funds for a deal. Consequently, a seller often wastes 2 to 3 months of his/her time until a deal collapses due to insufficient funds. Furthermore, a seller will find himself in a very unfavorable position to request financing details, as the buyer will perceive this as mistrust.

Adversarial Process
By it's very nature, any type of negotiation is an adversarial process with opposing objectives: the buyer wants to pay as little as possible, while the seller wants to obtain the maximum price. And whereas this might not have any long-term implications in a real estate transaction, it will have a significant impact in the business transfer process. Simply stated, a real estate transaction is the transfer of one asset class with few contingencies. However, the transfer of a business includes many asset classes, and more importantly, it often has often a number of contingencies post transaction (i.e. seller note, consulting agreement, royalties, earn-outs, etc.), for all of which the seller and buyer will depend on each other's goodwill in the future. Thus, it would not be a smart move to take a too direct an adversarial stance in the negotiation process; however, not doing so will deprive a seller of the maximum benefit. Only the use of a broker - as the middleman - will ensure maximum benefits and facilitate a deal.

Confidentiality Breach
When a seller deals directly with a buyer, then he/she clearly signals that they are ready to sell. The mere public knowledge of such intentions can be bad news for the competitive position of the company; for example, there would be significantly decreased chances for a banquet facility to book weddings, if it is known that the facility is up for sale. Competitors will exploit such uncertainty, no question about it, and competitors nearly always find out about direct negotiations. It is a similar situation when the employees or suppliers become aware that the "business is on the market". The seller looses leverage with both groups and reduces the goodwill value of the transaction.

Seller Negotiation Position
The moment the seller deals direct, he/she is "on the spot"; in other words, if the buyer puts a proposition forward, the seller has to immediately react to it. With a broker, such reaction does not have to be immediate, and thus, allows for a better negotiation position on each side. For this very reason, we never engage sellers into direct sale price or deal structure negotiations with a buyer. It simply not wise to allow direct contact between two parties who may be negotiating the most significant deal of their life without proper representation.

In sum, the concept of a direct deal might be appealing. However, it only works in very few scenarios. As a matter of fact, most brokers will make adjustments in their commission schedules for existing buyers, and it is always smarter to have a dual process. It's a win/win: if a potential buyer with whom the seller is currently dealing direct feels "pressured" by the presence of a qualified broker on the sell side and walks, a decision was (finally) obtained - with this buyer having never been a realistic buy side candidate to begin with. If the current buyer at hand will move forward, however, the seller will not only obtain close to full asking price but will do so in a speedy transaction - most often having received benefits that greately exceed any broker's commission expense paid in the process.