This guest post is written by Mike Gasparro of AxialMarket. You can also view the post on AxialMarket’s blog.

We recently sat down with several middle market mezzanine funds to discuss market views. We wanted to share perspectives on current market conditions and the impact on entrepreneurs. Consensus is, if you are looking to raise capital, but not happy with current equity valuations, mezzanine capital is likely worth considering.

If you need an intro or refresher on mezzanine finance, Peter [from AxialMarket] wrote a helpful post, “A Tutorial on Mezzanine Finance for Entrepreneurs“. In the current marketplace when equity valuations are down, mezzanine capital provides several potential advantages to business owners looking to raise capital:

1. You can use the capital for things that a typical commercial loan will not allow, such as growth capital, a dividend/special distribution, a recapitalization or buying out current shareholders.
2. The covenants/restrictions placed on the company are less stringent to those of the typical commercial loan.
3. Mezzanine capital is much less dilutive than private equity/venture capital since only a portion of the mezzanine investment has an equity component. At a time when valuations are below average, this can be a big deal for entrepreneurs who want to preserve their equity.

Generally speaking, mezzanine funds look for the following when considering an investment:  

• A Credible Debt And Exciting Equity Story: Mezzanine funds must be convinced that the company can meet its interest payment obligations (just like your commercial bank loan officer), but they ALSO want to be excited about the future growth prospects of your company (similar to an equity investor).
• Clear Use of Proceeds: Make it clear what you plan to do with the capital, and the impact it will have on your company’s P/L and cash flows over a 2-4 year period.
• EBITDA Greater Than $5 Million: There are mezzanine lenders that will focus on companies with lower EBITDA, but $5 million is the typical minimum size for most mezzanine capital providers.

Terms are constantly changing and are always going to be situation-specific; however, a general guide to current middle market terms (as of April 2010) are:

• Maximum Senior Debt to EBITDA of 2.0 to 2.75 – This measures the how many years of EBITDA (the proxy for cash flow) it will take the company to repay its senior debt. Senior debt includes all the outstanding amounts on revolving lines of credit plus any other short term and total long term debt which is secured by a first lien on the company’s assets. It does NOT include accounts payable or accrued expenses.
• Maximum Total Debt to EBITDA of 3.0 to 4.0 – Same concept as the previous ratio, except it measures how long it will take a company to repay all of its debt. Total debt includes all senior debt plus all subordinated and mezzanine debt. Note, this is also includes the new mezzanine debt that the fund is considering investing.
• Cash Interest 10% to 14%
• Paid-in-Kind Interest (“PIK”) 2% to 6% – PIK represents a portion of the interest payment that is not paid in cash. Annually or quarterly, this amount is added to the principal.
• Includes some warrants – Warrants give the fund the right, but not the obligation, to purchase shares of the company in the future at a pre-determined price.

As with every piece of capital, there are pros and cons to raising mezzanine capital. During times when valuations are down, mezzanine capital can be a compelling alternative to raising equity capital.

This is the first guest post at The Private Equiteer. We’re trialling these to provide a broader perspective of life in private equity.

By The Masked Financier @ TexasHoldemInvesting.com

In the ongoing quest to spread the gospel of Texas Holdem Investing, the Masked Financier is always looking for external validation from respected commentators.

I recently discovered some great material for validation from the famed Fred Wilson of the AVC blog. Fred is a well known venture capitalist (VC) and managing partner of Union Square Ventures in New York.  Fred has developed a significant following through his honest and insightful writing about the VC world on his blog.

Fred first wrote about poker in 2004, in “The Poker Analogy”, where he gave a detailed description of the similarities between poker and the VC investing process. Although I think he may have missed some points on the analogy, it is an excellent discussion by an experienced VC practitioner with a successful track record.

Fred states that once the cards are dealt in poker the situation is out of your control. But he states that the difference with VC is that you can improve your situation through altering management, strategy, and tactics.

However, I believe you can alter your situation in a game of poker, even in the face of the cards, through your betting tactics. Just consider Microsoft’s tactics in dominating the OS business, despite being dealt a poor OS technology.

Betting correctly can actually improve your situation, even in the face of superior competition based on cards alone. And bluffing is possible in the VC world, although probably not as obvious and blatant. Bluffing can be likened to creating the best impression of a company that is for sale. And it depends not only on your bluffing ability (ability to present and tell an investing story well), but also on your reputation (past record).

Let’s face it, if someone from Sequoia Capital tells another investor that a portfolio company is good, they’ll get more traction than someone from “StartUp VC LLP” who set up 6 months back.

Fred then seemed to take some time off on the poker-investment train of thought but has come back recently with a vengeance.

Firstly he wrote “Double Down, But Only On The Right Hand”, where he  discusses the current Google vs. Yahoo “search wars” using some poker metaphors. Fred’s commentary is based on Jason Calcanis’ “Yahoo Committed Seppuku Today” article.  From what Fred says, it looks like while Yahoo had the better hole cards (a big head start and huge audience), the flop favoured Google (the web got really big) and Google bet very well (invested sweat and money on better search technology).

However, the turn and the river are yet to come between these two. And let’s not forget the other player at the table, who came along with a gigantic stack and hasn’t played too well so far, but hasn’t mucked its cards yet either… Microsoft.  We should keep watching this game.

And finally, just recently, Fred posted “Sports and Card Analogies“, where he states that he prefers the card analogies in the context of business (and gives Casino Royale a mention too).  Fred talks about how Texas Hold’em Poker can be great for teaching investing and business skills. (It sharpens the mind and can help explain concepts to a wider team without the need for jargon or complex theories.) And then he gives a poker-based insight into venture capital decisions regarding how and when to represent your capabilities using the example of how to bet with your hole cards.

One of his most important points is about how decisions get very hard when there is money on the line. And this is one of the most important elements of being a good investor – being able to make decisions when money is on the line. This skill is something that you can learn quite inexpensively through poker in preparation for entry to the real investing world, where not having this skill can cause serious problems.

So thanks to Fred for drawing (much more) attention (than the Masked Financier currently can) to Texas Holdem Investing the theme of Texas Hold’em Poker as a tool and environment for learning about investing.

The #1 ingredient to success in business has nothing to do with ideas, execution, education, connections, or locale. It’s something much cheaper, much easier, and requiring much less skill. In that sense, success in business is much like keeping fit and healthy.

Back in the ol’ days, it took a lot of effort to get enough food to maintain health. You had to chase animals, kill them, skin them, cook them, etc. Now, you just dial Dominos and can over-eat to your heart’s discontent. So ironically, rather than chase animals to keep healthy (which is very hard work), we just have to stop putting nasty food into our mouths (relatively easy). Sounds crazy in the context of Sub-Saharan Africans dying from starvation. But I digress. Success in business is very similar; it’s more psychological than physical or skillful.

So here it is, the #1 ingredient to success in business is … Hustle, which generally means being resourceful and uninhibited in going after what your business needs most. Not what you’re willing to do most, but what the business needs most (big difference). I know what you’re thinking, “I already do that.” Well, I bet you don’t. But don’t worry, neither do I. And since admission is the first step to recovery, we’re making good progress. Consider the following to demonstrate this concept:

• Make a list of the things your business would most benefit from
• Forget convention, forget inhibitions, even forget morals, laws and ethics (for a moment)
• Items may include, contact Steve Jobs, get PR via popular TV show, paint your company name onto the side of Air Force One, call the CEOs of all your competitors, call your top 100 customers, run naked through the streets handing out PR material, etc.
• Items shouldn’t include, update CRM, do SEO, lodge my tax return, post on blog every day, make a couple of sales calls, etc., they MUST be things that will add MASSIVE value to your business (e.g. Gary Vaynerchuk getting onto Conan O’Brien)
• Don’t ponder the items, just write them down before you find reasons not to add them; forget reasons, just think “value”
• Now, look at the list, consider each item and watch yourself rationalise not following through

If you “had your hustle on”, you’d do most of the items. If you don’t have your hustle on, you’ll make excuses. ”Oh, Steve Jobs won’t answer my email. That TV show won’t have me on. I’ll do that task tomorrow. I’ll be arrested and charged with treason. Etc.” If you had your hustle on, you’d think, “there is no tomorrow, there’s only right now!”

Of course you shouldn’t do anything too illegal, but err on the side of taking chances (certain jails are way too horrific to teach you any worthwhile lessons). And before you get all holy-than-thou on me, remember it can be illegal (in some places) to put up posters, market to the public, run around naked, and even search the web using Google. But I very much doubt people will go too crazy; the real risk is in being too mediocre.

I guarantee if every day you made that list and did everything on it (that didn’t lead to a Colombian jail), you’d be many times more successful. Just like keeping fit and healthy, success in business doesn’t depend on skill, it depends on excuses (or lack thereof). What do you think? Am I talking nonsense?

I’ve received a lot of email asking, “What’s the story, are you leaving PE?” The answer is, Yes, I am… I’ve had a great run working as a private equiteer and my time in PE has been exceedingly enjoyable, but it’s now time for a change and time to be true to myself.

You’re probably thinking, “what does that even mean… be true to yourself?” Well, I’ve come to realise a career in private equity is tangential to my overarching goals. I know, I know… that sounds very self-help-esque, but you’ll be glad to hear the result involves a very exciting startup venture (stay tuned).

So, what’s the future for The Private Equiteer? Well, as the title of the post suggests, I’m just leaving the building, not the blog. Conceivably, my new material will be refreshed by a different perspective of private equity; an “ex-insider’s now-outsider’s” view, if you will. I’ll also continue to post responses to your comments/emails and share all new thoughts on PE and VC.

I received the following question from a reader and wanted to share my answer for a couple of reasons: 1) to make sure I’m giving him the right advice, and b) it seems like a very simple question, but it’s actually a little complex. This second point is the reason I started this journal, because it’s rare that things are as they seem in private equity.

The Question: There is a company with 100 outstanding shares and the market price of each share is $10. Now, if the company issues 10 shares through a private placement at price of say $12. Everything else (i.e. debt, cash etc.) remains same. What will happen to Enterprise Value? Will it increase or decrease? Why? How will EV be affected if the private placement is done at discount to current share price (i.e at $8)?

An Answer:

EV is generally used as a proxy for market value. So it really depends if the issue of shares is adding to the market value of the business. At one extreme, if you issue the shares and set fire to the cash you just raised, then EV will stay the same and your individual shares will just be worth less. At the other extreme, if you buy a distressed competitor for $1, and synergies mean you double the value of your business, then EV will roughly double, meaning your shares will increase in price.

So the important distinction is that we tend to work backwards with the EV equation. That is, we work out EV (often using a multiple of cash flow or earnings), then we subtract net debt to find the equity value. This makes it a “market” valuation. We generally don’t add up the book value or par value of shares and add the book value of debt, because that would be a “book” value and not necessarily represent what people will pay in the market.

So, let’s work through some numbers.

1. If the equity is issued for no reason, just to increase cash for a rainy day, then there is no affect on enterprise value (EV). Theoretically, equity increases, but so does cash, which offsets debt to give net debt. Intuitively, if you sell the business the day after raising the money, the cash is just used to pay back the people that just funded the new issue. Practically, it could be a little different. If you raised money at a premium, the new shareholders will get less back as the new cash is shared between everyone (either by paying down debt or via a capital return). The opposite happens if you issue at a discount.
2. If the equity is issued to invest in the business, then the affect on EV depends on the profitability of the investment. Remember, we’re working with market value. If the “market” values the investment at cost, then it cancels out. If they value the investment at zero, the EV stays the same, the equity value stays the same, but you have more share, so the per share price drops. If they value it above cost, then the opposite happens.

Does this sound right to everyone? Any comments?

I haven’t posted anything opinionated for a while (except suggesting you should quit your job every 6 months), so what better way than suggest I have the mid-market private equity ’recipe for success’.

The role of a mid-market private equiteer is divided into, 1) Origination, 2) Analysis, 3) Dealmaking, and  4) Consulting. In simpler terms, 1) you find investees, 2) analyse them, 3) close deals with them, and 4) improve them. (Of course, you then need to exit your investments, but I classify that as dealmaking.) All of this is done to achieve target returns for investors, but more importantly, so you can take lots of carry home.

To find the recipe for success, we just need to deconstruct each of these roles and understand what is most important to achieve good outcomes.

Origination

This refers to finding leads that may turn into investments. You can sit back and wait for bankers to bring you deals, or you can use your resourcefulness to go in search of good deals. Both work, and both have their ups and downs, so it’s best to keep your nets spread wide and options open.

The main problem we face in proactive deal origination is just getting a few minutes of a business owner’s undivided attention. The recipe for success is to be amiable and tenacious. That is, be genuinely friendly to everyone (including receptionists) and try to contact business owners over and over again (not necessarily the same ones; just keep active). I guarantee, if you are nicer and more genuine than your colleagues, and you make MANY more calls than them, you’ll trounce your colleagues in terms of lead volume and quality.

Analysis

This refers to appraising a business before making an investment, plus the analysis required to help improve the investment later. The main problem is boiling the ocean. What I mean is, spending too much time building pretty (useless) financial models. The recipe for success is to ask yourself what matters most and just focus on testing a handful of related hypotheses. Are earnings maintainable and real? Do earnings translate well to cash flow? Are there any anomalies regarding Capex or working capital? Are exit opportunities plentiful? Etc. It shouldn’t take more than an hour with the information already at hand.

Keep in mind, great financial models don’t make great investments; great businesses make great investments. And great businesses aren’t found using financial models; they are found by getting away from the computer and developing your entrepreneurial intuition.

Dealmaking

This refers to turning a lead into an investment. The main problem is losing a deal due to a gap between your offer and the vendor’s expectations. The recipe for success … well, it really depends on the situation. Your offer doesn’t just include a monetary value. It may include prestige, future returns, profitable ideas, strategic synergies, and even friendships. If you deconstruct this, you’ll realise that a vendor is influenced by all of these ’soft’ offerings, and they may choose a lower price as a result, by monetary value is always a trump card. Depending which way the wind is blowing, a vendor can suddenly forget the connection you made and go for the highest price; that’s human irrationality.

But I don’t want to sit on the fence with this one. If I had to say there was one thing that constitutes a ‘recipe for success’ in dealmaking, I’d say it’s transparency. People are blown away when you’re amiable and transparent, especially when they’ve been dealing with ‘bankers’ all day. This theory is in stark contrast to some of my previous theories, but hey, it’s 2010 (that’s my official reason for everything this month).

Consulting

This refers to giving advice to help improve it your investee. I call this consulting because that’s what it is. You’re not employed by the business, you’re only on the board (or not even that in some cases). And the board is there in an advisory capacity. The main problem is actually making a difference. Too often, private equiteers mess with the mojo of their investees by trying to implement textbook McKinsey concepts in a world they’ve never operated in. The recipe for success is to acknowledge your relative inexperience in the investee’s industry and listen to what people say (and talk to them). Then, deconstruct the investee’s issues by focusing on what matters most to desired outcomes. It’s that easy.

Above all, work with your investees, roll your sleeves up and get your hands dirty. Become one of them, earn their respect and be diplomatic with ideas; form ideas together and implement them together. Don’t be the private equiteer that drives up in his/her Porsche and walks around with some superiority chip. You don’t effect change unless you can connect.

You join a new firm and immediately think, “Wow, these people are freakin’ geniuses.” And it seems that way because you’ve just entered a different world, a world in which you’re a newborn. You observe these people, what they do, how they think, and you accept it all as your new religion. You use the same lingo, adopt the same mannerisms and start to think the way they think.

Then four, five or six months later, it all slows down. Now, you’re essentially one of ‘them’… and they don’t seem like geniuses anymore. In psych-speak, you’ve hit a learning plateau. You’ve learnt 80% of what there is to learn (at that particular firm) and you’ve realised these geniuses are just like everyone else; they only seemed like geniuses because they knew something unique.

With sports, music, and other discrete skills, smashing through the learning plateau separates the hobbyists from the champions. But entrepreneurship isn’t a discrete skill; it’s a collection of many discrete skills. And from my observations, entrepreneurs are rarely specialists; they become masters of many domains, even if originally they specialised in one. So, what does this mean?

The significance is as follows: The effort to move from 80% to 85% competence for a particular skill, could reasonably get you from 0% to 80% in a new skill. So, especially for an entrepreneur, it can be much more fruitful to string learning curves together (compared to smashing through a plateau). This would suggest you’d learn much more by joining new companies every 6 to 12 months, unless your environment (at the same firm) is constantly changing.

This won’t be a particularly popular view, but technically I think it has merit. Sure the process of becoming an expert is educational in itself, but that last 20% of competency is so easily lost once you change focus (and it requires so much more effort), that for future entrepreneurship, it rarely paves the road to success.

In private equity, despite counterarguments about ‘investing in the future’, we aim to spend less because we see so much waste on a daily basis. This doesn’t mean we’re allergic to investing for growth; rather, our experience shows reducing waste is a more fruitful endeavour (at least at first). We’d love the exposure of running global ad campaigns or buying corporate jets, but in private equity we deconstruct everything with our mind firmly on the exit.

Consider your exit as the day you can do anything you want: create startups, invest in other businesses, join boards of listed companies, or travel the globe. In order to apply private equity principles to achieve a better ‘personal exit’, you must learn to want less (and like it). This sounds like compromising, but it isn’t. As in private equity, keeping your mind on the exit helps you to see the real value (approximately none) of instant gratification. This is the characteristic that creates successful entrepreneurs, investors or even Olympians.

This concept of deconstructing a problem with a firm view on the exit or desired outcome isn’t new. Tim Ferriss talks about it incessantly and shows some very interesting real world examples (see his TED talk). And while you may see this as just self-help nonsense, consider that it’s built an enduring multi-billion dollar industry (the private equity industry, not the self-help book industry).

It seems I’ve ruffled a few feathers with my previous post, Private equity returns are misleading (lots of emails and even a few comments over at Seeking Alpha). The main point of contention is that limited partners (LPs) don’t hold committed capital as cash from day one. Someone even suggested it was ludicrous to make this assumption and that the premise of my argument collapses as a result.

However, that’s not the point I was making. Of course LPs time their cash flows across their portfolios, which is probably the reason why so many have defaulted on capital calls recently. If anything, this supports my argument rather than refutes it. So let me make my points a little clearer (I concede my last post was a little rushed):

If you hold all of the committed capital in cash from day 1, then you are exposed to the normal risk of a private equity investment. However, the return of the investment must take into account the risk-free rate on the cash for the entire period it is held in cash (before it is called).

If you do NOT hold all of the committed capital in cash from day 1, then you increase the risk of the investment. If you default on a call, you destroy massive amounts of value (except in rare cases). Therefore, the risk you are exposed to is not just the risk of the private equity investment and hence the return should be considered in light of the higher overall risk. Even then, any loses or gains from activities designed to meet capital calls should be accounted for in the overall return.

I’m certainly not suggesting private equiteers are misleading LPs, but more that we all mislead ourselves through blinkered analysis. Investment returns must be risk-weighted to mean anything and to be compared like-for-like. It’s convenient for most of us to forget the risk of default, even in the wake of the GFC when such ludicrous assumptions led to cataclysmic outcomes.

Let’s start with a few standard private equity terms:

• Committed capital: this is money “committed” to the fund, but not necessarily paid. So when you hear about a firm raising a $1b fund, it doesn’t mean they’re in receipt of $1b in cash, it means that investors have contractually promised to invest $1b as (and if) needed. Be aware that management fees take a big bite out of the $1b. At a 2% p.a. fee, you’re looking at a minimum of $100m (equalling 10% of committed capital over the life of the fund) and a maximum of $200m (it would be less than $200m in practice as investors don’t pay fees on distributed capital).
• Called capital: this is money “called” from investors to fund investments in companies. A fund only calls money from investors when it’s ready to invest that money. It typically takes a fund five years to “call” most of its capital (not including the cash required to pay management fees). This is a primary difference between a mutual fund and a private equity fund. (You commit and invest all capital simultaneously in most mutual funds.)

So, what does this have to do with anything? Well, most sane investors put aside the entire committed amount from day 1, because it would be very risky to commit more capital than you currently have. Why? Because if you default on a “call notice”, you could lose your entire investment without reimbursement, or at best, have it sold at a heavy discount to a secondary buyer.

And, how does this result in misleading returns? Well, private equity funds use the internal rate of return (IRR) on cash inflows and outflows as their return metric. The implication is that the return doesn’t account for you having to hold cash. A fund may not even call a dime until year nine, then return double your money in year 10, and then quote a 100% return for the fund. The fact is, you held that cash for nine years at a negligible rate, and achieved an overall return of only a few percent on the commitment (certainly not 100%).

This issue isn’t so black and white because,

1. no one is forcing you to hold that money at low rates of return
2. no one is forcing you to hold the money at all since the fund only needs it when it needs it

However, you really do need to hold the cash if you want to limit your risk to the risk of the investment itself. And you really do need to hold it in a risk free investment, again, if you want to limit your risk to that of the private equity investment. Ipso facto, the return from the risk free investment should be included in the overall return.

So what effect does this have in economic terms? Well, most private equity firms look to return 2x the original cash investment. But remember, 2x cash is a 100% return, not a 200% return. Now, if my math from many years ago serves me well, that’s a ~7% return for a 10 year investment. Of course, that’s too conservative as you receive distributions well before the 10 years is up. So let’s take an average of five and 10 years. That equates to about 10-11% p.a. Certainly not what most private equiteers espouse.

Sure, my methodology and math isn’t going to win any prizes, but I’m sure you get my point.

In private equity, we make primary investments and bolt-on investments. A primary investment is a direct investment of cash into a new business (often in a new industry). A bolt-on investment is an investment via an existing portfolio company into a business that presents strategic value (usually in the same industry).

Primary investments get most of the press. But, many private equity funds spend just as much cash on bolt-on investments. And, bolt-ons have the potential to create much more value (I’ll explain why later). So, it pays for a private equiteer to give up some of the glitz and glamour of primary investments to become a quiet achiever through bolt-ons. Here are a few of my thoughts:

• Bolt-ons are usually smaller businesses, which attract lower multiples with better terms
• Bolt-ons provide the chance to create instant value (by acquiring lower multiple businesses using a higher multiple vehicle – see Public versus Private multiples)
• Bolt-ons often require less work because they are smaller and attract less competition
• Bolt-ons offer strategic value (revenue and cost synergies), meaning you can pay a little more and be more successful in an auction process
• Bolt-ons provide for easier due diligence since you have access to industry experts in your primary investment vehicle (access to this experience is invaluable)
• Bolt-on owners are more likely to do a deal with a larger industry player, since there is prestige in being part of a leading firm (compared to being gobbled up by financial vultures)
• Bolt-ons give you access to a whole new market of potential investees as certain mandated restrictions (regarding size) don’t apply

With that said, there are countless studies lamenting the destruction of value that occurs daily via mergers and acquisitions. So, it’s imperative to maintain focus on likely integration issues and ensure there’s a cultural fit. See my post in which I describe most bolt-ons as clip-ons (citing their failure to integrate and lack of strategic fit.)

Most private equity firms are meritocracies. And merit is largely founded on investment success. We can improve the chances of investment success by paying lower multiples, commanding preference coupons, investing in favourable structures and making smart strategic decisions. But by far, investment success depends on the price at exit.

So, here are a few tips to getting the best exit price for your business:

The Buyer Pool

Financial buyers (e.g. private equity buyers) look mostly at cash flows and likely investment returns. Strategic buyers (e.g. competitors, customers and suppliers) look at synergies, strategic value and brand power. But, don’t only focus on strategic buyers; keep financial buyers in the pool to increase competition and keep options open (financial buyers regularly forgo rationality and become competitive too).

Competition

Competition is good for bidding up prices. But, competition can also deter financial buyers who don’t want to compete with strategic buyers on price. You should maintain ambiguity in the early stages of a sale process and allow buyers to become emotionally attached to the business before stirring competitive tension. Don’t be the real estate agent who announces there are hundred of interested parties. Some buyers will flatly pullout if you announce competition. (Be especially careful with other private equity buyers; they don’t like competition.) Irrespective of the buyer though, focus on the value above maintainable cash flows to elicit the best price.

Expectations

High price expectations can drive potential buyers away. But, low price expectations can set a psychological cap on the price. Again, be ambiguous at first, but aim to set a floor on the price early without actually naming a price. Talk about similar transactions and other subjective measures that help plant the seed for a higher price. This is difficult, but if you’re too ambiguous, buyers will justify a lower price in their own mind and find it hard to move upwards later. Communicate methodically and try not let anyone hasten you.

Metrics

In the early stages, try to negotiate in multiples, as it leaves more room for flexibility. If you set a price at $xm, you give the buyer power to manipulate the deal (e.g. around cash, inventory and debt levels) while maintaining the price at $xm. Sure, you can increase a price, but you want to avoid setting unnecessary psychological caps. However, if you find the buyer is fixated on paying a certain multiple or price, adapt and put your efforts into negotiating on inclusions.

Inclusions

With both metrics, multiple and price, there is a lot of room for manipulation. So, be prepared for various discussions about inclusions, which include fixed assets, cash at bank, earnings normalisations, etc. Understand these subjective factors before talking to buyers and make sure your arguments are rational. Also, make sure you keep a few bargaining chips up your sleeve. (See this post for exactly what to do to prepare your business for sale.)

Integrity

Above all, maintain your integrity, be friendly, be honest, but remember, this is a once in a life time opportunity, so don’t be overly generous. However, if you’re too tough and manage to get an unfair price, you may benefit now, but you may also witness repercussions later. As a private equiteer, you already have more than most, so don’t take unsophisticated buyers (in a transactional sense) for a ride. Keep your spine, be decent, be one of the good guys. This is a controversial point, but I stand by it.

There’s much more to negotiations, but these are the points I thought especially salient for private equity.

Dealmaking may seem to be all financial figures and legal terms, but ask any experienced dealmaker what the most common cause of failure is and they’ll generally point to people issues. Admittedly, many of these are vendor versus investor issues, but behind the opaque cloak of private equity, you’ll also find many failures attributed to intra-team issues.

Image: Dealmaking, just another game of chess [source: Shutterstock]

I’ve found three common intra-team issues that can lead to deal failure:

• Deal Envy - it’s not so much the envy that damages the deal, but the actions that result. Excessive negativity (as a result of envy) can wear down even the most enthusiastic private equiteer. So, it helps to give your team buy-in as early as possible: share the idea, ask others to become involved, and try to lead with an open mind. As soon as you appear evangelical, your team will likely position themselves to shut you down.
• Deal Disputes – the best way around disputes is to prevent them in the first place. Ensure your arguments are fact-based and keep an open mind. If you appear to have made your mind up without sufficient evidence, your team will likely position themselves to prove you wrong. Also, try not to implicate your team or their actions in your reasoning. People are naturally defensive. So, try not to put them in that position in the first place.
• Deal Fatigue - even a deal evangelist suffers from deal fatigue if a deal subsists long enough. But, deal critics suffer from fatigue much sooner, so it’s important to keep a deal moving if you plan to garner support from the team. Make sure you respond and gather supporting evidence quickly and meet with your team regularly and consistently. A quick deal has many other benefits, but mostly it reduces fatigue.

In summary, there are a few measures you should always take to prevent the above issues: facilitate buy-in to reduce envy, keep an open mind to prevent disputes and maintain momentum to close the deal before fatigue sets in. Of course, the investment has to have merit in the first place, but if you keep one eye on intra-team issues, at least your deals won’t fail for a lack of leadership and skill.