Advice for Entrepreneurs, Fund Raising, Mergers and Acquisitions, Selling a Business
The myth of the handshake deal
It’s routine in nearly every movie about business — the scene where the two parties hash it out, reach agreement and shake hands. At that point, the deal is all but done and the details are left to the lawyers to work out.
Of course reality is somewhat different. Coverage of the hit show “Shark Tank” provides a glimpse into some of the reality of dealmaking. This Washington Post article on the show sums it up well:
On “Shark Tank,” … hopefuls rattle off the merits of their company … and within moments are given an answer: Yes, I’ll invest $70,000 for a 20 percent stake in your company. Or, No, I’m out.
At least that’s how it works on TV.
In real life, local entrepreneurs who have appeared on the show say the process is much more rigorous. Many of the negotiations last more than an hour. There are detailed questions about valuations and royalties. Even after entrepreneurs and investors shake hands on air, there are weeks of due diligence in which every part of the business is parsed and analyzed before the contract is finalized. A portion of the deals made on air end up falling through for one reason or another.
For the “Shark Tank” participants, there’s value to simply being featured on the show and arguably the process that follows is helpful to the entrepreneurs even if financings fall through. In the “real world” however, the time, effort and money spent on a deal that doesn’t close are painful losses. Committing to a transaction with the wishful thinking that all will go well can lead to missed opportunities and significant deal costs with no resulting deal.
Would you rather commit to close a deal with someone who has done weeks of work getting to know your business, your financials, your market and strategy, or with someone who has heard your “pitch” and makes a quick offer? All else equal, wouldn’t you think that first bidder’s diligence gives you a better chance of actually closing on the negotiated terms than the second bidder’s quick enthusiasm? If there were a way to engage multiple parties in this upfront diligence process, all the better, right?
I do see companies commit too early to a path, foreclosing other opportunities, and leaving themselves with limited transaction options. There needs to be some commitment of time, resources, and focus for deals to happen, but the temptation to jump at the first offer is usually something to be resisted.
The myth of the handshake deal is compelling. How much easier the deal world would be if there were no need for diligence, no room for misunderstanding, no boards, lenders or shareholders to answer to, no prudent man rule, no fiduciary responsibilities. But that’s movie fantasy. That first encouraging handshake really is the start of the relationship, perhaps one of many, and not the close of the deal.
Alan Fullerton is a partner with Mirus Capital Advisors. He works with owners of middle market businesses and can be reached at firstname.lastname@example.org.