Unfair Deals

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Seesaw1What is an unfair deal?

There was an interesting article in the Australian Financial Review on Friday 29 October 2010 entitled RHD backs “unfair” PeopleBank bid” (see AFR Article).  The article is about the board of a recruitment company backing a takeover offer despite an independent expert finding it is not fair.

This reminded me very much of a situation we encounter frequently in larger deals involving a single large investor where an entrepreneur thinks that their company is worth much more than the investor is willing to pay. The entrepreneur then says that the proposed deal is unfair, the potential investor is trying to steal the company and other similar statements. The question is then put back to us about whether we think it is a fair deal.

This all comes back to a consideration of price in general i.e. what should the price, or value of something be? Well, of course, you only find out the “correct” price of something when there is a willing buyer and a willing seller in a well informed market with many buyers and many sellers. The problem with large investors is that there are many attractive projects and not many investors and, therefore, investors know that there is a power imbalance and that they can drive a hard deal.

What then should an entrepreneur do in these circumstances?

Assuming that there are no realistic likelihood of another investor coming along which is frequently the situation, then the question is where will the entrepreneur be if the investor walks away? If they can struggle through and reach the next milestone in their company/product development, then the entrepreneur is in a reasonable position and there may be some benefit in refusing the investor’s offer as, at the next stage, there will be more certainty as presumably some of the risks will have been removed or reduced.

However, that is a very unusual situation. The normal situation is that the entrepreneur has spent all of their available funds and cannot progress to the next stage without the investors money. If that is the situation, then the entrepreneur is in a weak position and really must accept the investor’s offer but not exactly as offered as there is still usually a way of getting more reasonable terms.

What do I mean by that?

One example would that investors will frequently say that, although they like the business, there is no guarantee that the forecast financial results will be achieved and that they have, effectively, discounted the results in their own mind to take account of the risks involved, whatever they may be.

Our solution?

We try to negotiate with both parties so that the investor gets what they want up front, or close to it, but that the entrepreneur gets the right to earn back part the equity foregone by achieving certain results, which could even be better than their original position. That way there is mutual benefit.   If all goes well, both parties can end up in a better position than either of them expected.??  Of course, if the investor was right and the forecasts were too optimistic, then the investor still gets a good deal.  The entrepreneur has a smaller share of something rather than 100% of nothing, which is what would have happened if the investor had not invested in the first place.  The deal must be fair, reasonable and practical for both parties.

Are you negotiating fair and reasonable deals?  Are your potential investors including unclear or unfair terms? Would you like our help to negotiate a fair deal? Please call on +61 2 9258 1972 or go to our Contact page.

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