INTERVIEW: TOP MISTAKES SEARCHERS MAKE

SEARCHFUNDER INTERVIEW OF JON HERZOG, PART II 

We spoke with Jon Herzog of the Goodwin Proctor law firm about common questions that we hear from searchers. In this Part II, Jon discusses deferred fees; common searcher mistakes; provides guidance on how to work with lawyers; and more.

What are the top mistakes that you see?  

The first that comes to mind is a lack of transparency with investors. Some folks take on a “salesy” attitude that they are selling an interest in the fund as opposed to starting a partnership with a group that is going to help them succeed. When you have that sales mindset, it carries through to your descriptions of opportunities, where you are selling it to your investors, not transparently disclosing the issues about the business that keep you up at night. Figuring out what those issues are and solving them is what makes you successful. You can do that with the help of the investors and the board. If you keep it from them and try to present them as a “can’t miss” opportunity, it puts folks on guard. Sometimes the deal doesn’t even happen as a result.

The second is what I might call confirmation bias. It occurs in two places. At the LOI stage, -- maybe I wouldn’t call it confirmation bias there but -- being so eager to sign the LOI that you basically agree to everything the seller sticks in there. That letter of intent shapes the leverage between the two parties going forward. If you’re rolling over on everything there, it will be hard to start showing a backbone after it’s signed. Similarly, as you get close to what you think the closing date is, you have to keep in mind your goal posts and why you initially thought this would be a good deal. Because, as you start seeing additional cards that may be less favorable, it’s the natural tendency to say, “We can manage around that.” When, in fact, if you had seen that card before you signed the letter of intent, you wouldn’t have signed the LOI. I’ve seen great searchers fall into that trap.

The momentum of the closing causes them to minimize a red or yellow flag?

Exactly. To look at a yellow flag and decide it’s green. Or, look at a red flag and decide it’s yellow, where it would have been unacceptable risk 2 months earlier.

Any trends that you see that are favorable or unfavorable for searchers?

There is a slight movement (and there are articles on the searchfunder.com website) toward a different type of vesting on the performance tier. It’s hard to say whether that ultimately will be favorable or unfavorable. People are now talking more about performance include some element of what is the multiple on invested capital, which some people believe aligns incentives better. If they are right, it will be beneficial to searchers.  

A second trend that is favorable, I think, but we’ll see is …. Two years ago, there was concern about not having enough investors to sit on all the boards generated by the huge influx of searchers coming into the space. A lot of investors have come into the space since then. You are not hearing about that concern. At the same time, those investors haven’t been on boards in this community for years. So, whether they will be additive and help grow great companies is up in the air. No reason to think they won’t, but they just haven’t been in the space doing it. If they are, it’s a great thing for searchers.

An unfavorable trend might be the sheer number of searchers pursuing opportunities. We have had some clients bump into each other on opportunities. We had one deal in which 3 different clients were looking at it at the same time. It doesn’t happen frequently, but it used to never happen.

Would you consider deferred fees for searchers?

It’s the only way to run this business. We have to defer our fees. Even if a deal busts we can’t collect, because it would put the client out of business at a time when we are rooting for them to go out and buy a different business. We only get paid if and when they close an M&A event. Of course, there is some risk in that. We don’t charge a premium to take the risk. We’d rather have honest communication with the searcher conversation about the likelihood the deal will happen, which is why we talk to a couple investors as well.  

Anything else that a searcher should know about you or the search process from a legal perspective?

Let me answer in terms of how to work with lawyers in general. We are professional advisors. It is not our job to tell you can’t do things. Good lawyer should not tell you, “You cannot do that” unless what you are proposing is illegal. We are supposed to assess risk – assess the likelihood of the risk and the size of the risk. You are supposed to make the decision as to whether you want to take the risk. Any lawyer can say, “Don’t do that.” If they do (and it’s not illegal), then that person is not a good lawyer. If you get an answer that is “No, you can’t do it” and it’s not illegal, ask for another answer.

Summary of Insights

Here are our a few of the key takeaways from our discussion with Jon in Parts I and II:

• It’s never too early to contact your attorney

• It’s best to consider the likelihood of the deal happening before spending money on a quality of earnings report and attorneys.

• A common mistake is having a “salesy” attitude during the process, rather than clearly identifying business issues and risks that keep you up at night.

• Another common mistake is allowing the momentum of the deal to cause you to downgrade risks.

• A good lawyer helps you assess the nature and size of the risks