The decision to sell a business is a major event. For many business owners, they’ve spent years building a professional legacy that has value that extends well beyond dollars and cents. And yet, as big of a milestone, as significant of an event a sale is in the lives of owners, many don’t treat it as such. Rather than seek the expert guidance they would for other major decisions, a sale is often treated like another task on a typical to-do list—something owners can handle themselves.
This kind of thinking can be risky, with repercussions that can sour a seller’s exit plan. Here, I break down some of the common misconceptions that surround proprietary deals, giving a gentle (though much needed) reality check to the go-it-alone mentality too many owners cling to when considering selling their business.
What Is a Proprietary Deal?
First things first: let’s align on what I mean when I talk about proprietary deals. A proprietary deal involves a seller and buyer negotiating directly with each other. Communication is on a one-to-one basis, and—most crucially—without the presence of other competitive buyers or an investment banker advising the seller.
Perception vs Reality in a Proprietary Deal
There are a few common assumptions many owners make when contemplating selling their business themselves. If this were a shorter article, I could boil all these misconceptions into a single one: proprietary deals are simpler.
And that thought makes some sense on the surface. If two people can get into a room and hash out a sale, isn’t that better—and simpler—than having to involve teams of advisors? In a perfect world, sure. But the reality is that very few sales involve this idealized one-to-one negotiation. On the seller side, even a small independent owner-operator will consult with an accountant, lawyer, wealth advisor, family, friends, neighbors, and probably even the first-baseman on their neighborhood softball team. On the buyer side, most groups actively seeking acquisitions are large, sophisticated organizations. These firms employ teams of experienced, expert analysts and investment bankers who compile reams of financial workbooks, models, and valuations going into every deal. What this creates is an information asymmetry, a reality that totally shatters the illusion of that idyllic one-to-one negotiation.
So hopefully I’ve put to rest the assumption that a proprietary deal can be simple. Now let’s talk through a few more common misconceptions many small-business owners make about proprietary deals:
“I’ll save money.”
Reality Check: While sellers might save on fees in a proprietary deal, without an investment banker commanding a favorable valuation on their behalf, the seller is almost certainly losing out on the final sale price. When considering the value an investment banking firm can bring to a deal on a seller’s behalf, there are two important things to keep in mind.
The first is that a good investment banker creates a sale that operates as a hyper-competitive auction, where buyers bid against each other in order to win. For sellers, this is a lucrative environment, and one which does not just organically appear out of thin air. Investment bankers specialize in preparing companies for sale so that their value to buyers is both salient and enticing.
The second point here concerns protecting that valuation. After a winning bid is accepted in a competitive auction, an investment banker will then ensure that price is maintained throughout the sale process, ushering the valuation from due diligence to closing, and protecting it from any last-minute attempts by the buyer to reduce the price or change the terms. I’ve seen deals where a buyer’s quality of earnings team can halve a valuation. Without an investment banker to prepare and defend your EBITDA and financial projections, expect to see the buyer present a reduced view of your EBITDA and accordingly reduce the purchase price.
So while fees are certainly not something to dismiss outright, they can often pale in comparison to a diminished final valuation that often results from a proprietary deal.
“I know my business better than anyone.”
Reality Check: Owners know how to operate their businesses like no one else. But do they know the market? Do they understand what kind of buyers have entered the space and what factors drive the offers they make?
Now to be fair, most investment bankers couldn’t run a business. Nor could the private equity firms that invest in those businesses. Business owners and investment bankers both possess specialized capabilities specific to their fields. And in the case of investment bankers, that capability is preparing a company for sale and running a sale process better than anyone else.
While owners have a thorough knowledge of their business, most may not be able to articulate value with as much impact as an investment banker. The financial statements for an average business—at least as reported on tax returns—generally do not reflect the future income stream a buyer can expect. So KPIs owners track to keep tabs on a business from month-to-month or even year-over-year don’t tell the whole story, particularly when it comes to forecasting future earnings.
In 2021, this point has never been more important. Did shutdowns in 2020 affect business? Certain industries were hit harder than others, but few escaped without incurring some kind of new costs. Are these new costs temporary or permanent? In any given year, it’s critical to report investments in the right light, making clear that a short-term earnings hit will likely pay off in long-term growth. Factoring in these kinds of considerations is crucial in prepping a sale, and investment bankers possess that specialized capability to best maximize a valuation.
“I have an accountant and a lawyer, which is enough of an advising team.”
Accountants are experts at financial reporting and all things taxation. Lawyers are experts at contracts, liability, and all things inside a courtroom or around the legal system. However, neither profession is expert at selling a business.
Many serial entrepreneurs I’ve worked with grasp this concept quite easily—they would balk at the idea of selling a business themselves. But plenty of owners still have a hard time seeing the value in specialized professional services, like investment banking. They might assume that because accountants deal with numbers, they’re also valuation experts who make it their job to keep tabs on market activity. Same for lawyers: since they write up and review contracts all the time, surely they can also negotiate the terms of a business sale.
In reality, the optimal deal-team is a triumvirate of investment banking, legal, and accounting. Together, the three professions play critical roles in maximizing value, structuring an efficient transaction, and protecting the seller’s interests. Just like you wouldn’t want an investment banker to prepare your tax return, you wouldn’t wish for an accountant or attorney to run a hyper-competitive auction, tasked with keeping tabs on hundreds of potential buyers, simultaneously charged with understanding these individual buyers’ unique estimations of what will drive value.
“I have time.”
Reality Check: Do you? Not to be flip, but I know very few business owners who would bemoan the amount of free time they’re afforded. Most are swamped! They’re burning the candle at both ends, often charged with growing their companies while overseeing the day-to-day business operations. And selling a business that many have worked a lifetime in building is not something to rush or to multitask. Just like owners are experts in their field, investment bankers are experts in the sale of businesses, a task best left to experienced hands.
Most of the industries in which Caber Hill Advisors operate involve rapid consolidation of smaller companies by large, intensely competitive buyers. These groups invest great resources—like in business development teams and quality of earnings teams—that give them an edge. It’s how they maintain that information asymmetry.
And it’s why they spend a considerable amount of their time, money, and other resources to source proprietary deals. They know they have the upper hand in such a deal, especially when the seller is that hands-on owner, swamped with the daily demands of running a business. So the best way to level the playing field—to give yourself the best shot of winning a sizable sale price so many owners have spent lives working for—is to get great investment bankers onto your team.