Deal Certainty

We’ve seen several M&A deals collapse unexpectedly in the past two months. Each was at the signed LOI stage. There was no warning or evidence of an issue until the moment the CEO got the phone call from the acquirer saying the deal was off. In both cases, the explanation was vague.

I’ve also seen several financings fail to close recently. Two of them were late stage financings that were pulled by the investor at the last second. One of these investors is highly visible for doing late stage deals. The other was an investor I didn’t know much about. The explanation I heard from the founder in each case was again vague.

In contrast, we closed a deal in two weeks last month. The person on the other side was willing to give us a lower price in exchange for “deal certainty”, explicit words that she used. We are very pleased with the deal and the price and appreciated that our reputation for just getting it done resulting in a significantly lower price. Deal certainty has always been important to me and I expect it’ll become even more important in the next year.

You will be seeing a lot more deals that don’t get closed after the handshake, verbal agreement, or even a signed non-binding LOI. This is natural in this part of the cycle, when prices feel high to investors, there is a lot of competition for deals, and a goal of some investors and acquirers is to get an LOI or term sheet signed with an exclusivity period in order to give them time to make a decision.

There are also a lot of unsophisticated buyers and investors out there. They generally don’t value deal certainty, especially if they come from other industries where lots of deals fall apart.

At this stage, it’s very important that the founders, whether they are selling their company or raising money, know the experience of the buyer or investor. You need to know their process. You need to know their investors, especially if it’s a private company buying another private company. Understand the history of their deal execution. Ask about, and understand the process from LOI / term sheet to close.

Basically, don’t be naive. There are lots of investors and acquirers out there who have low to medium deal certainty. There are others how have high deal certainty. Do your work and know who you are dealing with before you engage in the process for real.

  • Another key point – critical, really – don’t make commitments based upon the liquidity you *expect* from the deal. Make those *after* you have the cash.

    Do not ever deviate from this. It is an expensive lesson to learn by experience.

  • Brad does financings at every part of the spectrum. I don’t. I only do seed. What I am seeing in seed is no one wants to move, and then when the deal moves-everyone wants in all at once.

    I get not wanting to write a check until meaningful money is raised. However, someone has to write the first check. If you give a commitment, make sure the entrepreneur can bank on it. Don’t back out. If you are squishy, be honest.

    Entrepreneurs can take one $25k check from an angel and begin to create momentum. If you are a small fund, and can only write checks of 50-150k, cool, but make sure your word is your bond. Also, don’t ask the entrepreneur to save the “last 25 or 50k” for you. That’s not fair to the entrepreneur.

    • As a trader you know the value of options. I am always amazed at the number of people that want me to give them an option for free.

      You want a 90 day exclusive period? Ok, what is the value of that? It certainly is not $0.

      “Save me the last $50k” what is the value to that??? Again certainly not zero.

      • Ha. Perhaps we ought to educate entrepreneurs to retort, “Want a free option? If you invest you get one with the next round!”

        A different story but a good metaphor for startup investing. I was hemming and hawing about getting engaged to my wife. My boss, Harry Toussaint smiled and said to me, “I guess it’s time for tie or bye.” In other words, make a decision, don’t look back. Respect the other person enough not to leave them hanging.

        Same goes for people like me that invest in startups. Respect the entrepreneur enough to be honest, direct with them. If you can’t write a check or aren’t interested, a quick no is better than a maybe. If you can invest, want to invest, but have some reservations, clearly state what they are. If they are met, do the deal.

        • Seriously, this is the biggest thing that has amazed me. People say: tell me if somebody else is interested. I always say I won’t need to tell you, you will see the deal has been done and at that point why do you care???

          They say: Well then I’m interested, and I say again, why do you care??? There is no room for you at that point.

          • Yup. I always let entrepreneurs know it’s okay to let people know if I am willing to be in. Most of the time, seed funding is a Byzantine General’s problem. Either everyone is in or everyone is out. It’s a waste to write a check unless they are going to raise meaningful money. At the same time, don’t say you are in and then decommit. That sucks.

      • P Donohue

        “You want a 90 day exclusive period? Ok, what is the value of that? It certainly is not $0.”

        For every thing else in life, exclusive has a cost and it is not cheap. Why should this situation be different. Time is the most irreplaceable thing, because it is literally one’s life going down the drain. Therefore, 30,60 or 90 should get more expensive every week in a logarithmic escalating manner.

        For what century are we living in? If an investor can’t manage to do their thing and make up their mind in 15 days then they should move on or pay for the time. Thirty days out of circulation means that opportunity has passed by.

        There are more people now that have 50 million USD. net of debt, in the world today than ever before in the history of Credit Suisse. That means more possible investors than ever. And as long as there are IPO’s more will be created.

        So, there is competition that is growing as far as investors are concerned.

        Tell me if I am wrong, but there seems to be a trend to get into the most unicorn like thing as early as possible. People seem to be working the odds. But, they are also hedging by helping the supposed fledgeling Unicorns take flight as much as reasonably possible. Like Peter Thiel and his dropout program.

  • Matt Kruza

    Good reminder and heads up to everyone. Any commentary on rough boundaries of what exclusivity periods an entrepreneur should agree to? General sense I get is 30-60 days? Anything more is very extreme and hard to get a deal with no exclusivity period before check in hand? Any thoughts on this? And would assume the later stage of the company generally the longer period here as the case can be made much more to vet?

    • You get what you negotiate. If they only thing you are getting is an non binding offer you need to put in really strict gates. I.e. here is what happens at 30 days, and then there is a breakup cost to get the next 30 days, then here is what happens at 90 days.

      At the top and bottom of the cycle people are looking for options.

      • Matt Kruza

        Cool. Appreciate the feedback. Makes sene

  • It’s a shame there aren’t greater and more immediate consequences for people going back on their word.

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    • It’s worth realizing that this issue has been around since the beginning of the human race.

  • JT

    “There are also a lot of unsophisticated buyers and investors out there.” God.. I wish I had the time to document my experiences over the last couple of months dealing so many folks that call themselves “Seed Investors”, “Startup Adviser/Investor”.

    Recently had a experience with a investor who convinced that we don’t have to spend time pursuing others.. and bailed out in the last minute. He demanded that he get 30% equity for 1/3 of the money promised. Wish we had yelp for investors.

    • This is why there is qualification requirements that so many people hate. I cannot tell you how many times people want to talk to me even though I expressed no interest, and explained if I have not worked with you and have some operational control I will NEVER (caps meant) invest.

      Is that bad or good?? I really don’t care.

      Lying is a cooperative act.

      You have to be willing to be lied to and many entrepreneurs want to be, because it is easier than being told the truth.

  • The deal’s not done til the money’s in the bank. And sometimes not even then. Words to live (and forecast) by.

  • The same thing is valid for selling your product/service, right? Don’t count on it until the contract is signed and the money is in the bank.

  • I had a very similar experience to what you described on the investment side. It seems as if both parties were more publicly optimistic than was internally accurate. The biggest cost here is the loss of momentum and morale. The beautiful part is that you learn, get to share an experience with the team that makes us stronger and rally around a *vision* rather than an external decision. And, we’re still going! 😉

  • Pacific Alliance

    You are comparing apples and oranges. It is easy to spray and pray your way through early stage investments, as you expect to succeed in only a fraction of the deals. You are focusing on the upside in the equation (% chance for success times expected upside).

    In M&A situations, the buyer is expecting the deal to succeed, not to represent a portfolio of possibilities. In the m&a situation, price is often a lower priority than expected success…so due diligence is more important at the later stages of the deal and is much more likely to produce a break in the deal. (Buyer is focused on the chance of success over the prospective upside).

  • Me

    Yeah, only fools rush into an LOI w/o knowing what they are getting into. Happens more than people think.

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