The Mirror Image: Understanding the Misalignment of Incentives in M&A
For a founder, the decision to sell a business is often the culmination of years of relentless effort. It is a moment defined by reflection, pride, and the anticipation of a life-changing liquidity event. You view your company through the lens of what you have built: the proprietary technology, the loyal customer base, and the culture that held it all together during the lean years.
However, when you sit across the table from a prospective buyer, you are not speaking to a mirror image of yourself. You are speaking to an entity whose incentives are often diametrically opposed to your own.
Whether the buyer is a strategic corporate acquirer or a private equity firm, their objective is not to reward your past hard work. Their objective is to secure future cash flows at the lowest possible risk-adjusted price. Understanding this fundamental disconnect, and the specific incentives that drive buyer behaviour, is the most effective way to navigate a transaction successfully.
By dissecting the machinery of the deal from the other side of the table, we can move beyond the friction of negotiation and understand the financial logic that dictates terms.
Valuation: Past Performance vs. Future Risk
The most common source of frustration for founders is the gap between their perceived value of the business and the buyer's offer. This usually stems from a difference in timeframe.
Sellers tend to value their business based on the "blood, sweat, and tears" equity they have invested, or the linear trajectory of their recent growth. You might look at your Annual Recurring Revenue (ARR) and apply a top-tier market multiple, assuming that your future growth is guaranteed.
Buyers, however, value businesses based on risk-adjusted future cash flows. They are not buying your past; they are buying the probability that your future projections will materialise without you at the helm.
To a buyer, every operational imperfection is a discount factor. If your customer concentration is high, the risk to future revenue is higher, lowering the multiple. If your technical debt is significant, the cost of future maintenance is higher, lowering the valuation.
The Incentive: The buyer is incentivised to highlight every risk factor to compress the valuation multiple. They are looking for reasons why your "hockey stick" growth chart might flatten.
The Implication: To bridge this gap, you must present your financials not just as a record of success, but as a defensible proof of future stability. You are not selling a history book; you are selling a predictable annuity.
Due Diligence: Confirmation vs. Retrading
Founders often view due diligence as an administrative hurdle, a process of simply verifying that the bank statements match the management accounts.
For a buyer, due diligence is an investigative process with a specific financial incentive: risk mitigation and price reduction. In the industry, this is often referred to as "chipping" or "retrading." Research published in Harvard Business Review, based on a survey of 250 international executives, found that only 30 per cent were satisfied with the rigour of their due diligence, and half said their processes had failed to uncover major problems.
Once a Letter of Intent (LOI) is signed, the buyer has exclusivity. During this period, their team of accountants, lawyers, and consultants will scour your data room. Their incentive is to find discrepancies between the marketing materials and the reality. If they find that your Gross Margin was calculated without fully loading the cost of customer support, they will recalculate your EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) downwards.
The Incentive: The buyer is incentivised to find problems after the price has been agreed in principle but before the deal is signed. This gives them the leverage to lower the price or demand a larger indemnity escrow. The same HBR research found that half of executives surveyed discovered their acquisition targets had been "dressed up" to look better for the deal.
The Implication: Preparation is your only defence. A sell-side advisor will often conduct "vendor due diligence" before going to market. We identify the skeletons in the closet and address them, or disclose them explicitly, before the buyer finds them. You cannot be retraded on a fact you have already disclosed and priced in.
Deal Structure: Cash vs. Alignment
Perhaps the most tangible clash of incentives occurs in the structuring of the consideration. Sellers almost invariably prefer cash at closing. It is clean, tax-efficient, and provides immediate separation.
Buyers, particularly in the mid-market, prefer structure. This often takes the form of an earnout or deferred consideration. According to analysis from the Harvard Law Forum on Corporate Governance, earnout usage rose from 15 per cent of deals in 2019 to 30 to 37 per cent in 2023, before settling at approximately 22 per cent in 2024 outside life sciences.
Defining the Earnout: An earnout is a contractual provision stating that the seller will obtain additional compensation in the future if the business achieves specific financial goals, such as a revenue threshold or an EBITDA target.
- Seller's View: An earnout is "at-risk" capital. You no longer control the chequebook or the strategy, yet your payout depends on the company's performance.
- Buyer's View: An earnout is an insurance policy. It aligns the founder's incentives with the company's transition. It protects the buyer from overpaying if the business collapses the moment the founder leaves.
The Incentive: The buyer wants to defer as much cash as possible to ensure you remain committed to the transition. They also want to shift the risk of underperformance from their balance sheet to your bank account. The Harvard Law research notes that earnout-related litigation nearly doubled in early 2023 compared to the previous year, highlighting how frequently these arrangements lead to disputes.
The Implication: If you are confident in your forecasts, an earnout can yield a higher total valuation. However, the metrics must be difficult to manipulate. We advise tying earnouts to top-line revenue rather than EBITDA, as buyers can easily impact profitability by loading the company with new overheads post-acquisition.
The Clock: Urgency vs. Optionality
Time acts differently on buyers and sellers.
For a founder, time kills deals. The longer a process drags on, the higher the risk of a leak, a market downturn, or simply distraction from running the business. You are incentivised to close quickly.
For a buyer, time creates leverage. Once you enter exclusivity, competitive tension evaporates. You can no longer speak to other bidders. The buyer knows that every week that passes makes it psychologically harder for you to walk away. You have mentally spent the money; you have told your spouse; you are fatigued.
The Incentive: While buyers do not want to waste money on legal fees for a dead deal, they are rarely in as much of a rush as the seller. They can afford to wait for the perfect data point or the final approval from their investment committee.
The Implication: You must maintain momentum. This is achieved by having a prepared data room before you start, and by ensuring competitive tension is real before granting exclusivity. The fear of losing the deal to a competitor is the only thing that aligns the buyer's clock with yours.
Post-Close Reality: Legacy vs. Synergies
Finally, there is the emotional incentive regarding the company's future. Founders care about their legacy, their brand, and their employees. You want to believe the buyer will "take the business to the next level" without destroying its soul.
Strategic buyers and Private Equity firms operate on the logic of synergies.
- Cost Synergies: Reducing duplicate roles (often in finance, HR, or admin) to improve margins.
- Revenue Synergies: Cross-selling products to a wider customer base.
The Incentive: The buyer is incentivised to maximise the Return on Invested Capital (ROIC). If merging your unique culture into their corporate machine increases efficiency and output, they will do so, regardless of the emotional cost.
The Implication: If the legacy of your staff and culture is a red line for you, it must be assessed during the selection of the buyer, not the negotiation of the price. A financial buyer may leave the team alone to drive growth, whereas a strategic competitor is more likely to absorb and rationalise operations.
Navigating the Disconnect
Understanding these incentives does not mean you must accept them passively. Rather, it allows you to negotiate with eyes wide open.
When a buyer pushes for a heavy earnout structure, they are not necessarily questioning your honesty; they are managing their risk exposure. When they scrutinise your churn metrics, they are not being difficult; they are stress-testing the asset's durability.
The most successful transactions occur when a seller understands the buyer's constraints and solves for them, while strictly protecting their own interests. It is not about convincing the buyer to be less risk-averse; it is about providing the data and structure that renders their caution unnecessary.
If you are thinking about an exit and would value a discreet, no-pressure conversation about how these dynamics might apply to your specific business, get in touch with our team.