As competition for quality deals keeps intensifying, investors are working hard to ingratiate themselves with founder-owner sellers to be perceived as their investor of choice. Yet no matter how much investors desire to capitalize on founder-owner demographic trends, many investors lose out on founder-owner deal opportunities because they often misunderstand them.
The fundamental difference between investors and founder-owner sellers goes beneath the surface to how each conceives of value. Investors must understand how sellers conceptualize value and what’s needed to align with them. If not, investors risk talking past them and missing out on profitable investment opportunities.
Two Different Concepts of Value
Investors and founder-owner sellers each have fundamental beliefs regarding the value of a business. These internalized beliefs are born out of different cultures and form a frame of reference for how each approaches a transaction. These beliefs often go unnoticed until valuation discussions begin.
To highlight the difference in how each conceives value, let’s overgeneralize each case. On one hand, the investor, an MBA graduate trained in finance at a top business school, approaches a business valuation through an economic lens. For example, the investor is familiar with the industry. The earnings and risks are largely known and quantified. A multiple is determined. Therefore, valuation is fairly cut-and-dried.
However, the seller conceives of value much differently. For instance, many founder-owners built their businesses from the ground up. They vacation with customers. They employ friends and family from the community. For them, value isn’t merely economics—it also is deeply personal.
This isn’t to say that economics are unimportant. They’re very important. However, there’s a personal aspect of value that’s harder to quantify and often overlooked. The challenge is understanding how this personal aspect of value is assessed by the seller and reconciling the two perspectives.
A More Robust Understanding of Value
To understand the founder-owner seller’s view, let’s step back to consider the general purpose of business, which isn’t to maximize profits but create value. This doesn’t mean profit is incompatible with value creation. In fact, it’s consistent with it. However, the ultimate goal of any business is to create value. The byproduct should be profit.
With this in mind, the concept of stakeholder theory can help one understand how a founder-owner conceives of value. Stakeholder theory suggests a business should be holistically viewed as a network of countless interactions between various stakeholders, including employees, customers, vendors, management, investors and others.
When founder-owners contemplate the value of their business, they do so with a collective mindset. That’s because weaved into the business’s cultural psyche is a preoccupation with sustainability—a concern for the effect on themselves and others if the business doesn’t succeed. When the founder-owner contemplates a potential transaction, he or she expects additional value will be created for themselves and other stakeholders. We call this expected transaction value (ETV).
As a founder-owner seller internally calculates ETV, he or she implicitly gives different degrees of priority, known as saliency, to different stakeholders. As the expected value created for these various stakeholders, including sellers, is considered, an internal weighting is applied and the cumulative value for all stakeholders is discounted back at a certain discount rate. In theory, if the ETV is greater than the perceived current value of the business, the seller will proceed with the transaction. As expected, sellers will choose the investor who can maximize their ETV.
Not surprisingly, every seller wants three things: the highest price, best terms and right partner. More and more, auction processes are first run to identify the right partner and then to leverage the competition to push the right partner to the best terms and highest price. Consequently, it’s become increasingly important to demonstrate to sellers you’re the right partner. The question is how to do so.
The Need for Stakeholder Intelligence
Intelligence comes in different forms when purchasing a business. Intellectual quotient may help quantify the economics. Emotional quotient can assist in deriving the seller’s personal aspect of value. But, it’s the Stakeholder Quotient (SQ) that will help position you as the right partner. SQ is the stakeholder intelligence needed to understand yourself and align with the seller’s personalized concerns. To enhance your SQ, consider the following:
1. Assess Identity
Stakeholder intelligence requires an accurate understanding of yourself and the seller.
Self-Awareness – Most investors never pause to examine how personal patterns of thinking, emotions and disposition affect investment outcomes, but they should. Each of us tends to overestimate our strengths and underestimate our weaknesses. As a result, gaps exist in how we’re perceived and who we really are.
Investors should ask themselves penetrating questions and allow an honest assessment of their motives, values, strengths and weaknesses, to develop a more accurate assessment of their identity. The result is increased deal adaptability and a more attractive posture when wooing sellers.
Seller Awareness – Seller awareness also is important. There are three main elements investors should consider to drive a deeply personal conversation about what a seller wants out of a business transition: legacy, involvement and values.
- Legacy – What does the seller want the business to say about him or her in the future? This often is tied to family members remaining in the business.
- Involvement – How much energy can a seller commit to a transaction? Or, how much involvement does a seller want post-close?
- Values – What are the underlying values that inform his or her decisions? This could involve religious faith, service, community or other deeply rooted beliefs.
2. Align Behavior
Stakeholder intelligence requires examining your behavior as an investor and your interaction as an investment partner.
Self-Management – Behavior is the measure by which most sellers judge investors. Who we are affects how we behave, and founder-owners can quickly sniff out disingenuousness. For investors, this means being aware of and managing your own behavior patterns and those on your team. To the founder-owner, even the most seemingly insignificant actions, such as constantly checking a phone during a meeting or crowding a management presentation with too many of your colleagues, become clues you might not be the best partner.
Relationship Management – It’s not only important how you act as an investor but how you interact as an investment partner. True partnership is like a marriage. Investors and sellers are joining together to achieve a mutually beneficial outcome. If the seller perceives you’re more committed to your own agenda than the partnership, there will be problems.
Relationship management is the ability to empathize with sellers to create win-win partnerships. This includes but goes beyond seller-sensitive deal structures to how investors handle bumps along the road. Investors can gauge their effectiveness by whether the founder-owner’s trust in them increases or decreases after these difficult conversations.
In the end, investing with founder-owners is difficult but worthwhile. To position yourself as the right partner, you’ll need to understand that value is more than economics—it’s deeply personal. As such, you’ll need to quantify the personal aspect of total value while also introspectively assessing your identity and aligning behavior.
By doing so, you’ll differentiate yourself from other investors and connect for more meaningful and higher return investments.
Steve Martin, partner, and Patrick Gilbert, director, assist founder-owner sellers and private equity buyers for BKD, LLP, a national CPA and advisory firm.