A great deal can change between the letter of intent (LOI) and the term sheet. Business owners who try to be the expert and manage the relationship with private equity by themselves will discover two things.
1. The private equity team may change terms more if they think you do not have an expert by your side to point out changes.
2. The due diligence charges will become a huge issue if you do not close the deal after the LOI. Clarify who is responsible for picking up the tab. If you have an excellent financial advisor, they should have made sure 75% of due diligence was already done.
Here is a story where the business owner thought they should do the private equity themselves.
A business owner asked me to drop by and as I walked along the street to his offices, enjoying the summer heat, I assumed it was more for social reasons. He did speak about his children's issues but quickly moved the conversation to his business and money. He had been successful at getting the banks to give loans and he told me he now had $10M of his own tied up in the company. He was approaching fifty and did not see the need to sell. He was offered $30M by a private equity group, but turned it away. He also had several Angels wanting to invest, he says.
Last year, a well known private equity group approached him and wanted to invest $5M. He retained a lawyer from a top Bay Street firm to assist. He also hired a finance person to do the analytical work. He tells me that he was fine with the LOI and then the due diligence began. He says it took him a great deal of time and effort but seemed to be worth it.
When the final term sheet arrived, he read that it had a Put, which had not shown up on the LOI. He was shocked that this was now being put on the table and did not want to sign a deal.
He said that his financial person wanted her to sign, but the owner believed it was due to the nature of the finance person's fees. The finance expert was paid the lion’s share of fees only if the deal closed. The owner thought that affected his judgement, and did not trust him to act in his interests. In addition, the owner believed the financial advisor would put his financial needs before hers. So he did not believe he had unbiased expert help.
After all that work, he turned down the PE fund. This respectable private equity group have turned around and decided to sue for $120,000 to cover their costs of due diligence. The Bay Street lawyer says he never saw that coming. He did not have it covered either in the paper work.
It was a surprise to me too. First of all, deciding who pays for the due diligence seems to me to be what gets covered in Law 101, and this lawyer was a top guy charging big fees. If this owner had read the last chapter of Money Magnet, that Bear Trap was laid out clearly, along with his other issues. The lawyer was obviously not experienced in private equity deals. Remember to ASK for past experience. I wish I had a dollar for every deal I have seen papered up by lawyers at great expense, only to have it collapse leaving nothing for the owner. The lawyer then is paid again to clean up the wreckage. Great business, law.
This owner had used the finance expert as a book keeper. If you have an agent of status, the private equity group is not going to play these games as they know they will never see another deal again. Sure, the valuation can drop by 15% from start to end but again, that PE group will become a pariah and EMDs learn pretty quickly who plays these games.
As for transaction fees versus pay for hours worked, raising capital is really tough. I would rather have someone who had the same risk to push the deal along.