Know When to Walk Away From A Deal: Six Rules to Follow
It was about 4:30 on a Friday afternoon when Matt, the owner of a small business, was anxiously awaiting a response to his counter offer from Tom, a potential buyer. Tom had until 5 p.m. to respond.
Tom had sent Matt a fourth revision to a Letter of Intent a week earlier. Up to now, negotiations had been tough. The deal terms and conditions in the last LOI weren’t much better than the previous LOI, but Matt was still hopeful that most of their differences could be worked out. The biggest stumbling block was the purchase price.
Tom had offered $2.8 million for Matt’s company – $1.7 million lower than Matt had expected. Earlier in the year, Matt had sought an outside, independent valuation firm to provide him with a certified Opinion of Value. The valuation firm stated that the fair-market value of the firm was $4.5 million.
Matt was beginning to sense that this deal may not close. He was nervous because only 30 minutes were left before his response to Tom’s last LOI would expire. From a deal standpoint, it was technically dead if Tom didn’t respond by the deadline.
Matt didn’t know what to do. Should he call to inquire if Tom was going to meet the deadline? Or, should he just wait it out and see what happens? So far, Matt and his advisers had spent a lot of time, money and effort to get this far in the negotiations and yet it seemed that little progress had been made. It appeared to Matt that every time the two parties got together, the negotiations felt like a “beat down.” Yet, Matt thought that he “just needed to keep moving forward” – that, in the end, the deal would work out.
In reality, chasing a bad deal, whether from the seller’s or buyer’s point of view, rarely works out, even if the transaction closes. The result of a bad deal closing usually results in a costly mistake. According to a Harvard Business Review report, the failure rate for mergers and acquisitions sits between 70 and 90 percent. Therefore, one of the most powerful pieces of knowledge is knowing when to walk away from a deal.
Below are six rules that Matt should have followed when negotiating with Tom.
1. Establish your “walk-away number” before negotiations begin
Think through the purchase price and the terms and conditions carefully before the transactions process begins and stick to it throughout the negotiating process. “Walk away” simply means the time and place when it no longer makes sense to continue the negotiations. For example, one deal structure that a buyer may propose is called an “earn-out.” Earn-outs favor the buyer far more extensively than the seller. Earn-outs are generally used more during poor economic conditions. If a buyer insists on an earn-out structure in today’s market, that is a red flag and it may be time to “walk away.”
2. Think like a buyer
Write down what you think is fair — and what is not — before the heat of the moment takes over. If you do this in the context of thinking like a buyer, seeing your thoughts in black and white often tempers your demands. Next, develop the rationale to support what you think is fair. If you do this, you’ll know when deal terms and conditions are going too far out of the range of acceptability and when the deal structure and price is unfair.
3. Develop the Best Alternative to a Negotiated Agreement (BATNA)
BATNA is a concept developed at Harvard’s negotiation school. Think about what alternative you have if your deal goes south. What will you do if this negotiation doesn’t work out? In the simplest terms know how strong and likely your “Plan B” is. I have a simple saying the drives this point home: “The person that can’t walk away loses.” If you aren’t ready to leave the negotiation table, you are going to lose.
4. Keep an eye on your walk-away number during the negotiation process
As you get into the negotiation process, always look back to that “walk away number” that you set before the negotiations began. Are we still in the bounds of a possible agreement or is it time to consider leaving the negotiations? How far have we gotten to our goals versus how close we are to the walk away number?
Matt, small business owner, felt compelled to “keep on going” to put this deal together, even though all the signs of a bad deal were there. But he didn’t have a walk away number or a Plan B alternative to move on and find another potential buyer that will be able to justify Matt’s $4.5 million purchase price.
5. Know when you are acting on emotion
Selling your business is one of the most emotional times in a business owner’s life. It is almost always a one-time event, so it is important to keep emotions in check. The problem is that emotions often come in to play while negotiating and cause owners to push hard for the deal. We have to get that “win”. When emotions take over, both sellers and buyers often strike bad deals.
6. Reassess, if it doesn’t feel right
If you are in the middle of negotiations and it just doesn’t feel right, it probably isn’t. So, if it doesn’t feel right, think about why you are feeling that way. Write down the reasons and ask yourself, “Am I uncertain about closing this transaction because I lack confidence, or do I actually see legitimate red flags?”
Many studies have shown how perceptive human beings are. Ignoring these perceptions and feelings in a deal will not help you in the long run. Believe in your intuition. Trust that “little voice” inside you. If you see the wrong things preventing the transaction process from moving forward, then back out and start over again with a new prospective buyer. It’s a big world out there and plenty of buyers are looking to buy well run companies. It’s OK to walk away.
Matt did not get a call from Tom on that late Friday afternoon. When Matt and Tom did connect, Tom informed Matt that unless he could agree to his purchase price, he could not go through with the deal. In the end, Tom increased the purchase price by another $200,000 stating that was his final offer. Matt accepted the deal believing that he had no alternative. In fact, Matt didn’t.
Matt falls in that group of business owners who are dissatisfied with the sale of their businesses. According to Gold Family Wealth, more than 50 percent of sellers are dissatisfied with their post-sales results — especially the financial results (including the valuation, the agreed-upon sale price, the tax hit and the residual proceeds).
Having a “walk away number” and an alternative Plan B is key to knowing when to walk away from a deal.