I recently saw a post that quoted George Bernard Shaw, who said “Two things define you: your patience when you have nothing and your attitude when you have everything.” It reminded me of a description of investor behavior when a company approaches the decision to go to market for a corporate sale or financing. Often, at this moment, financial investors exist in only one of two states: Fear or Greed.
Following an initial investment in a venture there is usually euphoria and enthusiasm about the bright future ahead. That quickly turns to cautious optimism if things are going well, or pessimism if the venture is not quite living up to expectations. While the business is progressing, investors exhibit the full range of emotions, but generally they remain supportive and encouraging toward management. However, once the decision is made to sell the business, or seek additional new funding, things change.
If the decision is being driven by needs that have arisen due to under performance, then the dominant emotion is fear. Investors fear that they will not get a satisfactory offer, or worse, they will be forced to invest more money or risk losing their investment. Fear and uncertainty drives doubt and cautious behavior which manifests itself in reduced expectations for valuation. We start to hear things like “we are open to all offers,” meaning we do not expect much, but let’s just get this thing sold. This is when the first part of the George Bernard Shaw quote becomes relevant, investors need “patience when [they fear that they] have nothing.”
However, a funny thing happens the minute an external buyer/investor expresses interest. Fear immediately turns to greed. Whatever the offer is, “we can get more.” This is when the second part of the Shaw quote becomes relevant, and investors should check their “attitude when you have everything.” This whipsaw in perspective from fear to greed can leave management confused, and demoralized. If the company is struggling and looking for any port in the storm, and the investors have made their fear well known, a sudden turn to greed when a ‘port’ is on the horizon is at best confusing. Greed creates unrealistic negotiating positions, and puts the CEO in the awkward position of having to explain why the value is what it is, or forces the CEO to undermine an offer with aggressive negotiations because the investors have become intransigent.
A better path is to hold a board discussion at the start of the process to agree on the parameters of what will be an acceptable transaction, and what the alternatives are if an acceptable offer does not materialize. If a banker is involved, they can be helpful to guide the conversation with comparable deals and current market conditions. Unfortunately, bankers often paint a rosy picture to entice the company to sign up, like a realtor telling you your house is worth more than it actually is, but the banker is at least a somewhat neutral referee to help guide the discussion. The key is not to overlook the warts. Every business has its weak spots that detract from its beauty (the warts). If you have ever gone online to see what your car is worth, most sites show the price for comparable cars, but then ask how many miles your car has been driven and what condition it is in. If you are honest about the dents and dings and worn out parts, the implied value of your car may be well below the average market price, but closer to reality.
The same is true about selling a business. Just because you show a positive trend with a few good quarters, if the performance before the good quarters was problematic, you have to recognize that it will influence a buyer’s perspective on valuation. If the company had outsized churn in the past, or has significant technical debt these are all warts. If the company was forced to slim its workforce to preserve cash or reach better profitability, and if it was done close to the sale process, it is often viewed as an attempt to put lipstick on the pig, and the positive result is discounted. There are any number of weak spots the board needs to acknowledge that may result in an ultimate transaction value below the top quartile of market comps. The purpose of the honest assessment is not to become pessimistic and give the company away. Rather, it is to be clear eyed about what you are selling, and to establish rational expectations and behaviors when the impulse will be to flip from fear to greed. When everyone is on the same page about an acceptable outcome, the deal will invariably go more smoothly.