Tip 8: Be Honest and Humble

It was the ancient Greek storyteller Aesop who said, “Honesty is the best policy.” Honesty can also become your #1 weapon when selling your business, if you know how to use it.

Does that mean you can’t conceal a few warts on your business from buyers during the sales process? And if you do hide a few material facts that you should have disclosed, does the buyer have recourse if they find out about these facts after the closing? Well, both Aesop and I think being honest about your business will be better in the long run than either of these misdirections. 

Honesty is an underused tool in M&A transactions. Trust is critical to successfully selling your business, and the easiest way for you to build trust is to be honest in all your dealings with buyers. Acquiring a business is a risky endeavor for any buyer. And the value of a business is directly related to risk. 

If the buyer doesn’t trust you, they may seek to reduce their risk by:

• Increasing the scope of reps and warranties.
• Structuring part of the price as an earnout or a promissory note, subject to a right of setoff.
• Increasing the scrutiny or length of their due diligence.
• Reducing the purchase price (re-trading).
• Changing other material terms of the transaction, such as demanding they talk to key customers or employees, even if they previously agreed they would not do so.

Being honest saves you time and can potentially increase the value of your business. It can also reduce the thoroughness of a buyer’s due diligence and make negotiations far less contentious. Any buyer who senses you’re dishonest will either head for the hills or triple their level of scrutiny during due diligence. They may also request holdbacks or other forms of protection. Honesty can pay off handsomely when selling your company. If the buyer believes you to be forthright, they’ll perceive your business to be less risky, and negotiations will likely go more smoothly as a result.

Why Honesty Is the Best Policy

Saves Time: Being authentic and forthright saves you time from having to remember any half-truths you may have told during the sales process. It gives you freedom because you have nothing to hide.

Eases Due Diligence: Building trust through honesty and proper disclosure can reduce the intensity of the buyer’s scrutiny during due diligence and can reduce the possibility of re-trading. Speaking the truth prevents you from having to recall what you may have said, which reduces the stress of due diligence.

Maintains Integrity: Selling a business is a protracted endeavor and concealing material facts is difficult. It’s nearly impossible to conceal material facts in perpetuity. Your odds are slim-to-none for concealing a material defect all the way to the closing table and even less after the closing. A sophisticated buyer will perform excruciating due diligence and is likely to discover any material facts that may exist in your business. If the buyer discovers a fact you failed to disclose during due diligence, you’re doomed. I guarantee you that the terms of your transaction will change. 

Limits Exposure: Buyers have recourse for issues they find via reps and warranties. As a seller, your exposure can last years due to reps and warranties and other safeguards buyers often include in the purchase agreement. If the buyer discovers a material misstatement – even after the closing – they may seek damages pursuant to the reps and warranties you signed in the purchase agreement. Even worse, they may offset any payments due to you via a set-off.

Lowers Perceived Risk: Honesty reduces a buyer’s perception of risk. Reducing risk increases value. How do buyers assess risk? They use a combination of legal, financial, and operational due diligence, along with gut feelings. Different buyers use “gut feel” to varying degrees. For example: 

• Less experienced corporate buyers may be willing to take risks, but they will be sensitive to any signs of untrustworthiness. If they sense you’re anything less than completely straightforward, they may include safeguards in the purchase agreement or transaction structure to reduce risk or drown you in due diligence requests.
• Financial buyers are sophisticated. Many have completed dozens of transactions. The ability of these buyers to judge a seller’s character has been carefully honed from experience, and they’re likely to be adept at pruning out untrustworthy individuals. Consider how you speak to different buyers and modify your conversation as needed, but keep in mind that it’s critical you’re honest regardless of who you deal with. 

Trust Streamlines Negotiations

Even after the closing, you will need to have a relationship with the buyer. Honesty builds trust and serves as the foundation for this relationship, and frankly, it’s easier to negotiate with a friend than a foe.

I can recount dozens of transactions in which the buyer told me they trusted the seller and agreed to expedite due diligence and immediately move to the closing. I often hear the same from sellers – it’s refreshing to hear when a seller trusts a buyer and has built a strong relationship with them. If the seller trusts the buyer, the seller is often more comfortable disclosing sensitive information during due diligence, which can speed up the due diligence process. This would not be possible without trust, honesty, and disclosure, which are the foundations of building a solid relationship.

Put yourself in the other party’s shoes. Who would you feel more comfortable writing a $50 million check to? 

• Vinny: A shady, unscrupulous business owner who paints an unrealistic and overly optimistic view of his company’s future, who claims revenue could easily triple in three years with a little effort, and who attempts to hide numerous material facts and never gives a straightforward answer to a question, or 
• William: A forthright, trustworthy business owner who voluntarily discloses his business’s weaknesses and always gives a straightforward, honest answer when asked.

Here is how William and Vinny would likely respond to the following scenarios:

What was your revenue last year?

• Vinny: Well, you shouldn’t look at the numbers. Let me tell you the real story behind the numbers. First of all, there’s a lot of cash (wink, wink) in the business. 
• William: $27 million.

Who is your top competitor?

• Vinny: Haha, we don’t have any real competitors.
• William: Gekko & Co. They’re a great company. I know the owner, and they do a few things better than we do, but I think we have one major advantage over them – our return policy. If you aren’t happy, simply bring back your purchase, and we will …

If you’re a buyer, who are you going to be more likely to do business with, all other factors being equal? Being transparent and honest can go a long way.

Use Honesty and Disclosure To Build Trust

Disclose Material Facts Early: This gives you the opportunity to put a positive spin on any problems before the buyer discovers them. Doing so allows you to go on the offensive. The alternative – being defensive – always makes you look bad, regardless of the veracity of your position. 

Disclose Before the Buyer Asks: This gives you the opportunity to put your own spin on the situation and engenders trust. If a buyer uncovers a material fact before you disclose it, you could experience a loss of trust that might take weeks or months to regain. Full disclosure prevents this possibility and builds trust. 

Avoid Hype: If you wish to introduce positive opinions regarding the state of your industry, do your research. Find articles that have been written by, or quote, trustworthy sources, and share them with the buyer. If caution is in order – if, for instance, the author of a particular article is overly optimistic – say so. The buyer will respect your discreet perspective.

Build a Strong Relationship: If you focus on building a strong relationship first, everything else is more likely to fall into place as the transaction progresses. Naturally, different buyers have different feelings regarding the importance of the relationship, and you should adapt your approach accordingly. 

Put Your Best Foot Forward: Point out the positive traits regarding your business, but be sure to balance these with a discussion of any potential downsides. As an entrepreneur, you’re likely an optimist, but you must temper your optimism with realism. Show humility when possible – there’s no better tool for building trust than humility.

Beware of Unscrupulous Buyers: It’s wise to modify your position and style depending on the type of buyer you’re negotiating with. If you lack M&A experience, it’s best to rely on an advisor’s opinion. A skilled advisor will know when a buyer is acting aggressively or taking advantage of you. You must know when to modify your position and style based on the buyer’s approach, and you must know when to dig in. 

Be Careful What You Put in Writing: Put only facts in writing. Always convey subjective information through a phone call or a face-to-face meeting, not in writing. Your CIM should contain a careful analysis of your business and industry. It may include definitive statements regarding the state of your industry and the potential for growth. You’ll have ample time for this document to be scrutinized carefully and refined by your team of advisors – including your attorney, CFO, M&A advisor, and others – before it’s released to a buyer. Imagine anything you put in writing before a judge. Collectively, your statements could be used against you post-closing if the business fails or if there’s a material misstatement or other breach of contract. 

Let the Buyer Form Their Own Narrative: Provide the raw material that’s sourced from third parties, as discussed above, so the buyer can come to their own assumptions that serve as the basis for any projections. In other words, tell the buyer where the tortillas, beef, lettuce, and cheese are in the kitchen, but let them prepare their own burrito. Give the buyer the facts and then let the buyer tailor them to their specific needs, desires, or tastes. Their conclusions will have more credibility and be more meaningful in their minds than any assumptions you’ve spoon-fed them. Here’s an example of a wrong approach and a right approach:

• Wrong: If we introduce our new product “XYZ” to the marketplace, it will generate $20 million in revenue.
• Right: There are 500,000 potential customers for XYZ. This product could be priced at $500, and the market penetration for most products in this space is 8%. The product is currently being user-tested, and we expect to begin production in 90 days.
• Comment: Every buyer will do the math, often in their heads, while talking to you. I couldn’t help but do the math in my head as I was writing this. It’s a natural instinct for most business people. In this case: 500,000 people x 8% penetration = 40,000 customers x $500/each = $20 million in revenue. There’s a vast difference between the two scenarios, especially if you delicately handle the conversation so the buyer has the opportunity to extract the raw data from you. 

The trick is to get the buyer to ask you what the ingredients are and let them assemble their own recipe. For example, let’s say you mentioned you have a new product in development. 

• Buyer: “What do you think you’ll price it at?” 
• You: “$500. I think the market for this is pretty big.” This is a vague statement designed to entice the buyer to ask for specifics. 
• Buyer: “Interesting. How big do you think the market is for this?” 
• You: “The ABC Association estimates the market at 800,000 people for XYZ, but that might be too optimistic. I think 500,000 is more realistic. But that’s obviously just the potential market – I think our penetration would be much lower.” 
• Buyer: “What do you think your penetration would be?” Here you’re teasing the buyer with the goal for them to ask you follow-up questions for specifics regarding key assumptions they’ll use to perform the math.
• You: “Well, the EFG product had a market penetration of 14%, but I think 8% is more realistic.”
  • Note: In this scenario, you capitalized on two immutable human traits – curiosity and greed. The buyer may want to get in on the action before other buyers do, also known as the fear of missing out (FOMO). By teasing the buyer with information, you entice them to ask you for specifics. They may then perform the calculations in their own head – or on the back of the proverbial napkin – often employing dramatically more aggressive calculations than you may have offered. Again, whose projections are the buyer more likely to believe – yours or their own?

Any buyer who senses you’re dishonest will either head for the hills or triple their level of scrutiny during due diligence.

Conclusion

The ability to create leverage for yourself during a deal is integral to maximizing the price of your business. Understanding the ebb and flow of leverage throughout a transaction, as well as the negotiating pitfalls of sunk costs and emotional objectivity, is crucial. If you can master these skills and create a strong position for yourself, you’ll be well on your way to a successful transaction.