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Why You Should Always Make The First Offer In A Negotiation

by on May 28, 2014
Offer

Watch the video of this post on YouTube

So the time has come.  You’re in the middle of negotiations and one question is on everyone’s mind – Who will make the first offer?

The buyer is doing their due diligence.  They’re wondering what is the least amount it will take to get this deal done?

The seller is wondering what they’re going to offer and will it be worth going through all of this trouble?

FEAR

The fear for each other is the same – If I make the first offer am I hurting myself somehow?  

If I’m the buyer and I make the first offer, would the seller actually have accepted less? Essentially, I’m setting the floor and I’m afraid it’s too high.

If I’m the seller and I make the first offer, would the buyer have offered more? Essentially, I’m setting the ceiling and I’m afraid it is too low.

What Happens

What happens is that the buyer asks the seller what it will take to get a deal done.  The seller responds by replying that it has a number in mind but that it’s up to the buyer to determine what it is worth to them.

So both parties dance around the subject.

Why?  Because the common wisdom is that the party that goes first loses.

But is that really the case?

The First Offer Has the Advantage

Contrary to the commonly held wisdom, people who make the opening offer in a negotiation have the upper hand.

The advantage is owed to something psychologists call the anchoring principleIt’s a cognitive bias where people rely too much on the first piece of information they have.

The opening offer helps orient the other person’s perception of the value of what’s being negotiated for.

This was written about in a recent article in Inc. by Drake Baer of Business Insider.

Tips on Making the First Offer

Okay, so you’re convinced that making the first offer is the right move.  But how do you do it?

You want to get the best deal but an overly aggressive opening offer risks derailing negotiations if it causes the other side to question your credibility or to wonder whether agreement is even possible.

Because it is hard to know what your counterpart will view as absurd, anchoring with a relatively inflexible, extreme offer increases the probability of reaching a stalemate.

Provide a Flexible Anchor

Anchoring instead with a flexible but extreme offer gives you a lower-risk opportunity to favorably shape your counterpart’s perceptions of the possible range for getting a deal done.

Rather than placing firm offers on the table the most effective anchors merely introduce relevant numbers.

Example

Here’s an example.  The CEO of a small company is trying to raise money when he’s approached by a large company that wants to use his product and is thinking about buying it.

So they ask, “What will it take to get a deal done?”

He could have said it will take $X Million.  But he has no idea how the potential buyer will react.

He could say, “What do you think it’s worth?” And we’re back to the original problem, who goes first?

What he did was to provide some relevant numbers as an anchor.

He told them that they would discover this in due diligence so in the spirit of full disclosure he let them know that they are raising $X million on a pre-valuation of $Y million.  And they’re close to getting a deal done.

Their last round was at $Z post-money valuation 18 months ago.

That revenues were forecasted to be $XX million, and those numbers did not include the potential buyer as a customer.  Similar companies in the industry were acquired for revenue multiples of some number over future revenues.  And of course his product was better than those other companies products.

By framing the valuation discussion this way, the CEO effectively anchored the bottom number and provided market data for comparable transactions for an upside.

He didn’t actually answer the question but the potential buyer now has numbers to think about.  He has affected the buyer’s perceptions of what it will take to get a deal done.

Each deal is different but the PROCESS for EVERY deal is exactly the same.

Make Your Deal a Great One

Thinking about buying another company or possibly selling your own and want to learn more about making your deal a great one?  Contact Mike Rogers today for a complimentary, no obligation, initial consultation to determine if he is the right person to help you reach your goals.  No matter what, you’ll walk away from the meeting with him more confident about your future!

If you’re wondering how you build a company that you can sell for a premium in a few years, contact me to discuss the Valuation Amplification Process.

I also invite you to download the white paper and learn the 5 step process on How to Quickly Increase Your Valuation by Thinking and Acting Like A PE Firm.  http://www.therevenuegroup.net/free-offer.html

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From → M&A, Strategy

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