When considering liquidity options for their business, many entrepreneurs seek out deal structures that allow them to sell most of their ownership to a financial investor while remaining in a management capacity and retaining a stake to get the proverbial “second bite at the apple.” Having been exposed to many such deals, as both buyer and seller, our experience has shaped our perspective on the key considerations for entrepreneurs to ensure they select the right financial partner and avoid the shortcomings of capital raising processes.
Selecting a Financial Partner is an Opportunity Fraught with Risks: Typically, a structured capital raising process introduces the entrepreneur to a limited number of financial investors in the course of a few weeks in the investment banking equivalent of “speed dating.” From these heavily-orchestrated meetings and the resulting indications of price and other deal parameters, entrepreneurs are expected to select their preferred financial partner with which to “go exclusive.” The importance of this relatively early decision point is not to be underestimated, as it starts a time-consuming and expensive diligence process prior to attempting to consummate an investment transaction – and it is very difficult to change the selection at a later point without badly impacting the entrepreneur’s negotiating position or waiting an extended period of time to restart the process.
We have observed that this process of partner selection tends to over-emphasize raw cash price and likelihood of expedient closing rather than a more balanced assessment of total value and alignment to the needs of the entrepreneur, typically for three reasons:
- Limited awareness by the entrepreneur about the investors. While much information will have been given to the investors about the business and entrepreneur, there typically has been much less reverse dialog in regards to the financial partner and its people – making it hard for the entrepreneur to make a decision other than by intuition based upon limited interactions and perspective from key influencers. In comparison, we have seen entrepreneurs invest more personal time and effort into selecting key employees than into the selection of an investor to become their financial partner.
- Basic motivations of key influencers around the entrepreneur, such as the financial advisor, lawyer or accountant. They tend to be price-focused by the commission or success nature of how they are primarily paid and have personality types to match. They are the primary interface with the investors and typically prepare and lead the discussion of the entrepreneur’s options, thereby giving substantial weight in the entrepreneur’s decision process to the key influencer’s perspective. If the key influencer works as part of a larger institution, they may also have secondary objectives related to their employer’s other product lines which can influence their actions and recommendations.
- Structure of the process itself, often with a linear schedule geared around milestones and timeframes designed to move the selection and diligence process forward expeditiously and manage the large number of people involved in the working groups.
While these factors help drive the momentum required to get a deal closed, the pressures they create in the crush to “get the deal done” make it easy for the entrepreneur to lose sight of the fact that they are going to have to spend the next 5 to 10 years of their life in a potentially hastily-made partnership selected primarily on the basis of price rather than other and equally important long-term criteria. Only after the transaction is done and the euphoria fades does the realization set in that the deal’s finish line is really only the starting point from which the entrepreneur must then develop a meaningful partnership with the often relatively unknown, and now in control, financial investor.
Key Financial Partner Selection Criteria: For those entrepreneurs looking to get their “second bite at the apple,” and provided a reasonable and market-based price is offered, the following are important upfront considerations in selecting the right financial partner for a valuable and constructive long-term relationship:
- Value-Add: A financial partner who contributes the most towards enabling the entrepreneur’s and the employees’ future success, with the highest degree of certainty. This is the most important consideration because the potential to recover the rolled-over equity stake and the new “value creation” is dependent upon future results. Therefore, the best financial partners contribute strongly to development and implementation of strategy, fostering the development of high quality people and the optimization of processes, systems and proactive behaviours.
- Good Character: The constitutional qualities entrepreneurs must look for in their financial partners include high integrity, open-mindedness, humbleness, self-motivation and hard working. Great financial partners also need to be results-oriented, transparent and equitable – qualities which are essential to maintaining balance in the management-investor relationship. Actions always speak louder than words in this regard, and thetrue picture of character often emerges best through small anecdotes and stories about past deals and experiences that demonstrate integrity and consistency of approach – particularly in the face of adversity. Independent references are also a key final test, but should be used to confirm, rather than form, the entrepreneur’s view of a financial partner’s character.
- Personal Fit and Consistency of Personnel: Personal chemistry is critical, as entrepreneurs will be spending large amounts of time with their new financial partners. From shared interests to a sense of humour, there must be more to the relationship than just the business. Also critical is whether the decision-makers involved in forging the deal with the entrepreneur will be the same as those overseeing the investment throughout its multi-year lifecycle – uncertainty in this regard is a significant issue.
- Strategic Alignment: There are many ways to grow a business. Alignment enables the entrepreneur and his team to confidently deploy resources and execute plans to implement the agreed strategy. In contrast, a material mis-alignment in strategic intent will delay progress and waste time and resources while the business’ direction is debated. Furthermore, such a mis-alignment can even fracture the sought-after partnership as the investor exerts their control over the company and entrepreneur. Having a shared understanding of where, as partners, you collectively want to take the business and how you are going to do it over the next 3 to 5 years is an essential pre-condition to selecting the right financial partner.
- Financial Alignment: Entrepreneurs should require the same strong degree of alignment with the financial partner’s decision-makers as they require of the entrepreneur – the surest sign of which is a substantial cash investment from their personal accounts that puts meaningful dollars at risk on the same terms as the entrepreneur.
Conclusion: Naturally, it is hard for entrepreneurs to avoid being swept up in the whirlwind of making a deal and to maintain focus on long-term criteria such as value-add, character, fit and alignment, when those around them may be focused on short-term factors such as cash price and speed to closing. However, such a long-term focus is essential to choosing a partner for a relationship meant to encompass much of the entrepreneur’s remaining professional career and have the best chance to realize the “second bite at the apple” the entrepreneur set out to achieve. Great financial partners are hard to find; focusing on the right selection factors throughout the process is the key to choosing the right partner.
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