Trust Key Element of Business Deal
Unlike a piece of property or real estate, a business has non-physical intangible assets. The value of a company’s intangible assets such as goodwill, branding power, name recognition, customer base, and employee relationships change over time and is not easily discerned. It requires subjective judgments as to the level of future earnings that will be generated. This judgment is generally based on the business’s financial statement, the industry in which it operates, and any competitive advantages. Agreeing upon the price and terms of a business deal may be contentious, requiring compromise and reasonableness from both sides. Without trust – or the firm reliability on the word of another – between the principals, compromise is almost impossible. Trust is best obtained in a business transaction when there is absolute transparency, organized and clear financial records, and consistent honest communication to reduce buyer risk.
Trust Important for Buyer and Seller
Both the buyer and seller must feel they trust the other side in order for most business deals to result in a successful closing. Buyers must feel they can generally trust the seller’s word as to the current state of the business. Trust is especially important for many buyers who require the seller’s help and assistance after the closing in order to ensure a smooth transition. While buyers may require some seller-financing in order to help gain the seller’s assistance, few buyers close on a business deal without trusting the seller. Sellers in turn must trust the seriousness of the buyer in successfully closing the deal without wasting their time. A buyer who has been financially qualified and has signed a Non-Disclosure Agreement still needs to earn the seller’s trust. Absent trust, a seller is less willing to compromise.
Letter of Intent Built on Trust
- Both principal parties to a business deal must have some degree of mutual trust in order to agree upon and abide by the terms contained in a formal offer or Letter of Intent (LOI).
- Prior to signing a LOI, the buyer and seller should meet (typically in person) in order to discuss and clarify the material aspects of the business.
- The business broker should facilitate and encourage an honest and open dialogue at the meeting in order to best establish trust between the parties.
- Once a buyer is then ready to submit a formal offer via a LOI (and a refundable deposit), the buyer should trust that the information provided thus far is largely accurate.
- The seller should also trust that the buyer is serious and prepared to execute a successful closing and take the business over.
- The results from negotiating the LOI frequently depends on the trustworthiness of both sides.
- For example, if the buyer is fully comfortable that the seller will help with a smooth hand-over of the business operations and key relationships after the closing, then the buyer is more likely to agree upon a higher price or more favorable terms for the seller.
- Although the LOI is not the purchase contract governing closing (to be negotiated later), both parties must trust each other to not change the already negotiated terms contained in the LOI.
- If a party to the deal changes a materially significant deal point already agreed upon in the LOI, then they will generally lose the trust of the other side.
- As a practical matter, change to a deal must be justifiably based upon newly discovered facts uncovered during the formal due diligence process.
- Otherwise the party seeking to change the deal will be accused of not dealing fairly and in all likelihood the deal will fall apart.
Trust Critical During Formal Due Diligence
The general purpose of the formal due diligence process – a contingency of closing – is verifying the accuracy of the presented financials and business information by whatever means the buyer wishes to pursue. Historical financials such as tax returns or profit and loss statements are invariably analyzed and interpreted by the buyer to his or her satisfaction. Since many business owners attempt to shield their tax liability, the taxable net income seldom matches the actual crash flow or adjusted owner benefit. Further, personal expenses of the owner are frequently counted as business expenses (and therefore are ‘added back’ to owner benefit) on the tax return or financial statement. Whether or not the buyer is satisfied with the formal due diligence process often comes down to trust and believing that what the seller is saying is reasonably accurate and makes sense.
Buyer Meeting Employees Involves Trust
In order to successfully accomplish formal due diligence, the seller must also have some level of trust in the buyer. Sellers often must incur a high level of expenses and time in order to comply with a lengthy and involved formal due diligence request list. Under such circumstances, sellers need to trust that the buyer is well intentioned and able to close. Further, some buyers insist on meeting key managers or employees of the business as a part of the formal due diligence process. Many sellers will refuse this request as they do not want to jeopardize the confidentiality of the sale until closing. In the case of sellers who trust the buyer’s good intentions, however, a reasonable compromise on this issue may be reached so long as limitations are placed on the scope of discussions.
A professional business broker should always engender trust between the parties to a business deal. Forthrightly addressing all material issues up front – before a Letter of Intent or purchase agreement is signed – allows for an honest and open dialogue and is the best way to instill trust on both sides. A buyer and seller who do not basically trust one another seldom come to the closing table.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.