when Value is not Tangible
Negotiations in the technology and software industries can be
because the company's value is often uncertain. Companies merge before
they have established a record of earnings and value typically depends
earnings. Multiples of earnings or revenues are simply not relevant.
theory gives us some insights on how to negotiate when the value is
How do you negotiate when you are unsure of your company's value?
Negotiating the value of a company whose significant assets are
intangible is different from most other negotiating situations.
Negotiating intangibles requires greater market understanding, an
in-depth knowledge of the other party and skillful bargaining. At the
end of the day, all prices are negotiated.
Asking the value of a
software company is like asking the value of Elvis' guitar. The answer
is whatever someone will pay you for it.
Value in the software
and technology industries is becoming more extrinsic, and less
intrinsic. Many companies are worth less as standalone entities than
they are as integral parts of other firms. The value of a standalone
business is a function of its profits. Without an earnings history, a
firm's value depends simply on how much a buyer is willing to pay.
Rules of Thumb
for a simple answer? Sorry, there really aren't any rules of thumb that
are of any merit. Ratios calculated after the fact are rarely
applicable to other transactions. Only in industries where companies
have similar cost structures and operating characteristics (such as
garbage collection) do revenue multiples make sense. Everyone likes
rules of thumb because they make life easier. But by making life easy,
they make life inaccurate.
presume that Microsoft went ahead with its acquisition of Intuit for
six times revenues. Does this imply that other companies competing with
Quicken are also worth six times revenues? Actually, if the merger were
completed, competitors would probably have a value of about zero. Who
could compete with Quicken, especially if it were owned by Microsoft?
This valuation reflected the importance of market position and
installed base. The price was negotiated. Comparing this revenue
multiple to other situations is simply not meaningful.
negotiators make a number of common mistakes. Deal structures are made
that are inefficientother structures could have been made that would
have been preferred by all participants. Unseasoned negotiators often
have unrealistic expectations. They see only their side of the
situation, cling to their assumptions and are not good listeners; they
don't fully understand the other party's point of view. Another mistake
is letting a large problem engulf and mire the discussions.
Approaches to Value
traditional methods for determining value include the Market Approach,
the Income Approach and the Replacement Cost Approach.
Market Approach uses multiples of earnings or revenues of similar
companies in the same industry to calculate value. This is typically
the best way to measure value; however, in the fast-moving software
industry very few companies are similar enough for comparisons to be
The Income Approach projects future cash flows and
discounts them by a rate that reflects the degree of certainty of
achieving those cash flows. The drawback to this approach is that its
assumptions are highly subjective. This method is better suited for
generating ballpark estimates than for determining an accurate
The Replacement Cost Approach involves estimating the
magnitude of the development effort and the work required to replace
it. The company's market position is not considered, however, which
limits the method's usefulness.
The most common measure of value
in the stock market is the Price Earnings (P/E) ratio. The average P/E
ratio is currently 20 times earnings. For a company earning 5% after
tax, this imputes a revenue multiple of 1.0 times. (20 x .05 = 1.0).
The median Fortune 500 company has profits of 4.8% of revenue and its
stock trades at 0.9 times revenue.
Measuring value in the
software industry is problematic because companies either aren't
profitable or they are too dissimilar for valid comparison. Software is
still a nascent industry in which many companies have yet to achieve a
record of earnings. In the long run, a company's value will be measured
by its earnings. One day even Netscape will be valued on its profits.
A Few Strategy Tips
strategy is best for negotiating when value is intangible? Generally,
the most useful negotiating strategy is one with high realistic
expectations and with small decreasing concessions. The savvy
negotiator should have a realistic sense of what can be accomplished.
He chooses from a range of strategies and tactics to fit the situation
and the stage of the negotiation.
Negotiations are dynamic
situations—the tone and balance can change dramatically throughout the
discussions. The perception of value can change as well. It is
difficult to prescribe a set strategy before negotiations begin;
however, a few fundamental points are worth mentioning.
first step is to examine your company and understand your strong
points. Learn as much as you can about the other party's strengths,
weaknesses, market and customers. Understand why your technology and
intangible assets are important to them.
and plan a few in advance. A no-concessions strategy is dangerous,
since concessions are usually expected. Don't compromise too early, but
have a few in your bag. For example, you might request a promissory
note early on and eventually concede to a royalty payment. A smart
negotiator compromises by giving up something in order to get something
Determine your indifference curves ahead of time.
Think about what combinations of price and terms you are indifferent
to. Would you prefer $8 million cash and $3 million in stock, or $4
million cash and $15 million stock? This is not about the total amount
of the payment, but about your relative preference for different types
of payment. A few other strategy tips:
• Keep the focus on areas of mutual interests. Emphasize the
common ground. Asking for too much could sour the atmosphere.
Don't be afraid to introduce a few trial proposals. The other party's
response can be very illuminating about their preferences and
• With creativity and an open mind, a large
problem can often be broken down into smaller issues that can be solved
• Be aware of emotion as well as logic in
both your and the other party's arguments. Never underestimate the
power of emotion in negotiations.
• The corollary to
asking good questions is keen listening. Listen for things that give
clues to the other party's assumptions.
contains uncertainties. Each party will have a different perception of
those uncertainties and have a different attitude toward risk. A
skilled negotiator will recognize these differences and exploit them in
order to achieve a joint solution.
Examine Your Value
in-depth understanding of your company's strengths is imperative. What
are the drivers of value in your company? Is it technology? Market
share? Name recognition? Installed base? Distribution channels?
Development capability? Can you quantify these strengths?
additional revenues will you bring to the buyer? Are there
cross-selling opportunities? What about recurring maintenance revenues?
What people strengths do you contribute in development capability or
Know Your Opponent
as much as you can about the other party. Visit the company, tour their
facility and meet as many managers and employees as you can—you'll
learn more than you might think. Understand their market. Who are their
customers? Why do their customers buy from them?
casual questions can be a highly effective means to gather information
for negotiations. For example, "In what areas do you need to improve
your technology?" Polite probing can uncover all kinds of clues that
give insight to the other party's mind set and what they might be
willing to pay.
Probe to learn why the buyer is interested in
your company. What is your key strategic value to the buyer? Can they
find this technology elsewhere? How can the buyer transform your
intellectual assets into earnings? Quantify it as much as possible.
is the buyer's framework for evaluation? How do they see your company
complementing their strengths? Often their view will be different from
Try to understand how they view value. Ask how they
arrived at their price. It is much easier to sway someone using their
reasoning and assumptions than it is to convince them that your
reasoning is correct.
Companies pay large premiums to have
immediate access to key technology and to avoid the time and cost to
develop it. What would it cost for the buyer to develop your technology
on its own? Determine what their alternatives are to doing a deal with
you. Don't forget the competitive aspect—by
acquiring your company, the buyer keeps you out of the hands of a
The Opening Gambit
should make the first offer? It is commonly believed that being the
first to mention price puts you at a disadvantage. This is not as big a
disadvantage as is often thought. There is an expectation that the
party initiating the discussions should be the first to mention price.
Go ahead and tell the other party a range of price and terms that you
expect. Don't be afraid to ask for top dollar as long as it is still in
the ballpark of reasonableness. Offer two price alternatives, such as
$8 million cash or $12 million in stock.
The advantage of
initiating the price discussion is that it gets the price issue on the
table and it is now the other party's turn to respond. You can learn a
lot about the other side's thinking by how they respond. The anchoring
phenomenon also may come into play, in which subsequent discussions
tend to center around this initial value. This subtlety can work in
theory is the study of competitive interaction and how people try to
outsmart one another. By thinking in terms of game theory, you learn to
think several moves ahead and to anticipate the actions and reactions
of your competitor.
Game theory stresses the importance of
focusing on the other party's competitive actions and needs. Problems
are viewed from two perspectives—yours and the other party's. It is
human nature to focus primarily on your own position. The best
negotiators analyze the opponent—not just from a business perspective,
but from a psychological standpoint as well. What are their hidden
psychological and emotional needs?
Conversely, the other party
will attempt to discover what your alternatives are, such as selling to
another buyer or continuing on in business and possibly raising capital
for growth. They will likely offer a price that is slightly higher than
what they perceive as your best alternative. How you posture your
company and its opportunities can be very important.
In the end,
the price depends on the buyer's perception of your alternatives and
the impact of the acquisition on their business. It is critical to
understand how they perceive your alternatives and how they perceive
your impact on their business.
Using a Third Party
the idea of using a third party to help you negotiate. An intermediary
can minimize extreme posturing and help defuse unreasonable claims. An
experienced third party can more objectively gauge reactions, devise
compromises, and draft structures that meet the objectives of both
parties. He can keep the negotiations moving forward without the seller
appearing too anxious to sell. An intermediary can be effective in
negotiating employment contracts and salary issues when the parties
will be working together after the transaction closes. The benefits of
using a third party often outweigh the cost.
negotiating the sale of a company with intangible value is a challenge.
The savvy negotiator studies his opponent and understands the market
for his technology. The final determination of price will depend on the
bargaining skills of the two contenders. The value you get is the value
By the way, Elvis' guitar sold for $152,000.