Five Mistakes Entrepreneurs Make in Dealmaking – Part I

by Scott Edward Walker on September 29th, 2009

I’ve been doing deals as a corporate attorney for over 15 years, including nearly eight years in the trenches at two major law firms in New York City; and during that period, I have seen certain mistakes made by entrepreneurs (and inexperienced deal guys) over and over again.  The purpose of this post (which is part I of a series) is to discuss the following five basic mistakes made by entrepreneurs in connection with corporate transactions: (1) the failure to diligence the guys on the other side of the table; (2) the failure to build a strong transaction team; (3) the failure to run the negotiations through the lawyers; (4) the failure to check their emotions and to remain disciplined; and (5) blinking first.  The video version of this post is set forth immediately below.

Mistake #1 – The Failure to Diligence the Guys on the Other Side of the Table

Whether the entrepreneur is doing a venture capital financing, a partnering agreement with another company or is selling his company to a private equity firm – he must investigate the guys on the other side of the table.  This means determining the reputation of both the company/firm (if it’s not a marquee name) and the particular individuals with whom he is dealing.  Who are these guys?  Are they good guys or are they jerks?  Can they be trusted?  When they say they are going to do something, do they do it?  Do they add value?  Remember, in certain deals (such as a venture capital transaction), the entrepreneur will be, in effect, married to these guys for a number of years.  Accordingly, at a minimum, the entrepreneur should get references and speak with other entrepreneurs or CEO’s who have done deals with the guys on the other side of the table in order to make an informed judgment as to whether they are guys with whom the entrepreneur should be doing business.

Mistake #2 – The Failure to Build a Strong Transaction Team

Every successful entrepreneur knows the importance of building a strong team, yet they often ignore this rule when putting together a transaction team.  Now is not the time for the entrepreneur to being using his buddy the divorce lawyer or the attorney who wrote his will to negotiate his financing or acquisition; nor is it the time to use his bookkeeper to handle tax and accounting issues; nor is it the time for the entrepreneur to play lawyer and start pulling forms off of the Web.  As I learned first-hand in New York, the quarterback of the transaction team should be a strong, experienced corporate lawyer – he’s the guy who is going to drive the deal, watch the entrepreneur’s back and help the entrepreneur build-out his team.

Mistake #3 – The Failure to Run the Negotiations Through the Lawyers

The entrepreneur should do what he does best — i.e., build companies — and leave the deal negotiating to a strong corporate attorney (or an investment banker in the acquisition context).  Entrepreneurs are generally no match for sophisticated venture capitalists or private equity guys or corporate development guys who do deals for a living.  Accordingly, a smart entrepreneur will stay above the fray and let his corporate attorney run the deal – and business issues can easily be handled at an all-hands meeting (whether in-person or via conference call).  Experienced deal guys on the other side of the table may try to do an end-run around the entrepreneur’s lawyers, but the entrepreneur must remain disciplined and simply advise the guys that all negotiations are being run through his lawyers.

Mistake #4 – The Failure to Check Their Emotions and to Remain Disciplined

Entrepreneurs (particularly those who haven’t had much deal experience) often become emotionally wedded to a particular transaction and are unable to maintain their objectivity the further along they get in the process.  Too often, an entrepreneur will fall in love with a particular deal — like the first-time home buyer — which will lead to poor decision-making and risky positions.  As I saw first-hand in New York City representing big, successful private equity firms, the best deal guys are masters at taking their emotions out of transactions and being extremely disciplined.  Indeed, they will generally walk from a deal if they get out of their comfort zone (e.g., with respect to the risk profile, price, etc.) — regardless of how much time and money they have expended.  It is critical that the entrepreneur understand this dynamic — and that’s why it is so important to develop a game plan early on — because once the emotions start playing havoc, you have to stay disciplined and stick to your plan (your dealbreakers, etc.) and be willing to walk, if necessary.

Mistake #5 – Blinking First

There comes a point in time in just about every deal where both sides have dug into certain positions and the question becomes which side will blink first; e.g., in a venture capital financing, perhaps the issue is the liquidation preference or, in an acquisition, perhaps the issue is carve-outs to the cap on liability.  Whatever the issue, the lesson for the entrepreneur is clear (albeit difficult to execute): in order to maintain negotiating leverage and credibility, the entrepreneur should not blink first.  Indeed, if the entrepreneur has flatly stated that “this issue is a dealbreaker,” but then blinks and nevertheless agrees to go forward with the transaction despite not getting what he asked for, he will have completely undermined his credibility and will have his clock cleaned with respect to any other significant issues.  Like poker, if your bluff gets called, it will be difficult to bluff again.  Which brings us back to the important tip in #4 above: run the negotiations through an experienced corporate lawyer (or an investment banker) who does this stuff for a living.

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8 Responses to “Five Mistakes Entrepreneurs Make in Dealmaking – Part I”

  1. Scott -

    Good post, but like a lawyer, it took too long to get to the point. :) Kidding! One thing I think you are missing here is “failure to understand the deal.” In speaking with many entrepreneurs, I find it interesting how few of them actually understand the terms of the deal. Yes, lawyers help with that, but they have a responsibility to themselves to understand the subtleties of the deals.

    Here's an excert from an old post of mine: http://www.manyniches.com/entrepreneurs/the-vc-

    “I had a conversation with Andrew Warner, of Mixergy, about my last company. This is a guy who built a very, very successful business with a nice exit (he even bared his soul and showed the financials in a blog post – wow) and even he was completely clueless about the venture funding process (he never raised money – there’s a lesson in there kids), and what goes into a security that investors buy. This was astounding to me. What I take for granted is a black art to even the most successful of entrepreneurs. I suggested that he get the book Terms Sheets & Valuations, by Alex Wilmerding. This is a MUST HAVE for anyone who is thinking about raising capital.”

  2. Thanks Brandon – excellent point. Indeed, Chris Dixon addressed this issue in a recent post here: http://www.cdixon.org/?p=702. Moreover, I made a similar comment to your solid interview with Andrew Warner on mixergy.com (http://bit.ly/dVkS1):

    “Lesson #3: understand the deal terms and run models as to what happens under various scenarios. Fenwick & West puts out a quarterly survey of market deal terms in venture capital financings (see, e.g., http://www.fenwick.com/publications/6.12.1.asp?…). At a minimum, the entrepreneur should understand what is “market” and how each deal term plays out in a liquidation. For example, in Q1 ’09, participation only occurred in 51% of the Silicon Valley vc deals and 40% of those were capped.”

    Thanks again.

  3. caseyallen says:

    Scott-
    Just beginning my first round and find your stuff to be a huge help. Raising money feels like a very lonely process, mainly because it's one of the few events in which the pressure is 100% on me, the CEO, and nobody else.

    You're like a verbal Cliff Notes for year 1, and the reason you're clutch is that you hit on things most other entrepreneurial blogs don't. Keep on doing your thing, and if I didn't already have counsel, your entrepreneur-centric approach would've had me.

    (Plenty concise, I might add. What does Brandon know? He's an ex-private equity guy. He demands short conversations because he's always got a tee time less than an hour away (sweet Mixergy interview, Brandon.))

    I'd love to hear an entry on partnerships. Not LLPs, but between founders. I'm sure you've seen a failure or two and witness when and where the stress points typically are.

    Keep on riffing, I'm sending people your way.

  4. Thanks Casey – good suggestion re founder issues (and good luck on the money trail)

  5. Great tips, Mr. Walker!

  6. Great tips, Mr. Walker!