This article has been adapted from How To Buy A Good Business At A Great Price, a course written by Richard Parker at RichardParker.com. To gain access to the full course, which walks through the entire process of purchasing a business and breaks down these negotiation tactics in further detail, click here.
In this lesson, we will study the negotiation process, strategies to use and the Offer to Purchase document, which is the contract between you and the seller. No matter how experienced you may be in negotiations, there is a lot for you to digest in this chapter.
Most deals fall apart because one party simply cannot negotiate effectively past a certain point and all deals fall apart because two parties could not reach agreement on something. This is an important point. No matter what the details are, this is the only reason why a deal is not reached.
Buyers and sellers can begin to feel overwhelmed or, in many cases, enter this stage terribly nervous because of their lack of experience. While this may seem understandable, there really is no reason to feel this way. Even if you have never been involved with this type of negotiation, you already possess many of the negotiating skills that are required.
Whether it was a dispute with a friend or trying to get out of a detention with your teacher, you’ve been negotiating your entire life. You have done so in each and every job with bosses and coworkers. In fact, most people negotiate something every day of their lives! So let’s take a look at negotiating in the context of buying a business.
How to Be a Good Negotiator
The difference between average/good negotiators and great ones are that the great ones consider all of the options and possibilities beforehand and continue to do so throughout the process. They educate and prepare themselves fully before they begin the process. They consider their options and the seller’s potential responses to each of the choices. Successful negotiators play the “what if” game all the time; “If I do this, what will they do?”
Whoever does a better job of selling the other party is the ‘winner’. “Win/Win” may be a great philosophy but it’s not reality in these deals, and I hear it used too much. The buyer almost always assumes more risk than the seller in these deals and so your strategy in the negotiations without being arrogant must be: The buyer wins – the seller is reasonably happy.
There is one strategy I have used in the past that you could try - which a couple of people (who I respectfully disagree with) have told me they think is unethical. This is by no means illegal, and when it comes to your money, you have to be crazy to not look for ways to get the best deal possible.
Get a friend to play the role of another interested party. In the case of a business, have them visit the business and then table an offer that is about 20% lower than what you are prepared to pay or may have already offered. When they do meet the seller, make sure that they do not duplicate your set of questions, but ask some basic ones. Even if the seller rejects the offer outright as “insulting” it will help set the stage for you as a point of reference for the seller, and can help you achieve a much lower price for the business. I have used this technique to buy houses, cars and businesses and can tell you it works very effectively.
Understanding Your Own Mindset – and the Seller’s
We know that two parties are required for any negotiation (unless you’re talking to yourself). There are always psychological considerations, but most of the seminars, podcasts and videos that talk about negotiation tactics focus on understanding the person you are negotiating with. They fail to convey the importance of your own mindset, which is of equal or greater importance.
Consider your emotions and how they impact your interactions with people. How do they lead you to react in a certain way to things that people may say? How do you handle the situation when individuals may have opinions that are opposed to your views?
For example, if you are extremely passive, not argumentative, and you trust everyone at their word, you may find yourself terribly disappointed. If you express all your thoughts openly and honestly, you may be taken for a ride by a seller who may not deal with the same level of honesty. Understand that you are dealing with them as much as you are dealing with yourself.
You cannot be expected to know the seller’s emotions intimately and suggesting that they undergo a psychological evaluation is not a good way to begin negotiations. This is an emotional time for the seller, so consider the emotions that they are experiencing. Regardless of their reason for selling, they do have an emotional attachment to the business.
Pay attention to their actions. Are they argumentative on every point? Are they defensive about questions, comments, or concerns that you express about their business? Are they impatient? When you sense their attention span waning, do they give in easier or become more combative? Don’t give in to a point because you are impatient and want to move on to the next detail. Know who you are, understand your assets and be smart enough to know your liabilities.
The Timeline of Negotiations
There are several different milestones in the negotiation process. Remember that the negotiation/purchase agreement phase precedes the due diligence phase in the example below, which is typical of a small business transaction. In multimillion/billion-dollar deals, the process may be reversed.
- Letter of Intent and/or Offer To Purchase
- Negotiation begins
- Agreement in principal
- Finalize Offer to Purchase
- Due Diligence
- Renegotiation (if necessary)
- Final Agreement
- Removing contingencies (i.e., contract and lease assignments, financing, etc.)
- Closing
Due to recent market trends, there are more people than ever looking to buy a business. 90% will fail, but that stat is almost reversed for our clients. The flip side of this is that sellers/brokers may be inundated with prospects. Recently, I have heard more and more stories about some business brokers (and even a chain of broker offices) that will not provide any buyers with any financial information until they make an offer.
Personally, I think this is ridiculous. Although I understand (or at least think I do) the thought process to this as being a mechanism to weed out the ones that aren’t serious, I still believe that this is a flawed approach. To me, the brokers should simply be doing a better job of pre-qualifying prospects.
Get yourself into the habit of making offers. Don’t mess around forever looking for more and more information and conducting research. Good businesses sell fast. As long as you include the right language to rescind the deal, if necessary (see templates in the course and be sure to review with your legal advisor), you have no risk in presenting offers. Which brings us to the next section…
Letter of Intent (LOI) or Offer To Purchase Agreement
After you have taken all of the necessary steps to gather information, review the financials, determine the value and price that you are willing to offer, and have discussed the situation with the broker, lawyer and accountant, it may be time to prepare an offer. How exciting! This is only the first stage and since the seller only knows of her asking price you should be prepared for a rejection. Don’t worry; it’s all part of the game.
On this note, never, ever be afraid to ask the seller how they arrived at their asking price. This will give you good insight into their thought process (or lack of it). Personally, I believe that if you can get to and through at least a good part of the negotiation and direct discussions with the seller, or at least have enough information to present a full-blown offer, then that is the best road to take as opposed to a non-binding simple Letter of Intent.
The two huge advantages that a detailed Offer to Purchase Agreement has over an LOI is:
- There’s no more demonstrative proof that you’re a very serious buyer – sellers and brokers get all “giggly” when they have a real offer in their mitts
- It will serve to immediately identify the seller’s pain. Their counteroffer will have to detail everything about the deal that they don’t want. It will clearly indicate their “hot buttons,” and what’s most important to them. Oftentimes, the down payment can be more important than the total price. Or the closing date can be key for them if they have specific plans set. A detailed offer outlines all of the deal particulars and will put everything on the table for both sides. That’s why I always suggest you try to get to this point quickly, instead of using a Letter of Intent.
How Much Should You Offer?
There is no absolute formula for establishing the offer price. Even though you have completed the valuation process, the question remains about how much to offer and what your down payment should be. You have two options:
- Offer a price close to your valuation.
- Offer an amount quite a bit less than you are prepared to pay and go back and forth.
I believe the first method is better, because it shows you are serious, and allows you to move on to other issues in negotiation quickly. If you give the impression of a ‘low-ball’ offer, the seller will get the impression that they can keep negotiating every point in the agreement. The seller’s response will also dictate if, and how much, they are prepared to move down.
With these considerations, the suggestion is that you offer 10%–20% less than the valuation you’ve arrived at.
