The Retrade

The retrades have begun. Since the beginning of the year, I’ve experienced four retrades – two early stage, one growth, and one late stage – and I’ve heard of a number of others.

If you’ve never experienced a retrade, or don’t know what I’m talking about, it’s the situation when you have a firm deal agreed upon or a term sheet signed and are proceeding to closing a deal, when the investor (or acquirer) decides to change the terms of the deal. And, in case you were wondering, it’s always to make the terms worse, not better.

This happens regularly in M&A deals especially with buyers who are buying thinly capitalized companies or ones who don’t care about their long term reputation. It’s very prevalent with buyers who over time get the reputation as bottom feeders and is often something floated during the diligence process to test the conviction of the seller.

However, for the past six years or so, I haven’t seen retrades from VCs or angels investing in companies very often. Occasionally a deal will fall apart in diligence, some famously so, but they rarely have been retraded.

This lack of retrades, however, is not the historical norm. When I started investing in the 1990s, I experienced a lot of retrades from VCs at many different stages. While a term sheet isn’t binding, part of the reason it tended to be long and complicated was to avoid the retrade dynamic and spell out all the terms of the deal explicitly.

In the late 1990s into the mid 2000s, I viewed the risk of a retrade as continuous background noise in any deal – investment or M&A. The notion of deal certainty became important to me and I started spending more time working with investors and acquirers who I believed had a very high likelihood of following through on what they said they were going to do. In contrast, once I found myself being retraded by someone, I noted it and had a higher bar for working with them going forward, since I expected there would be a future likelihood of a retrade if I did something with them.

By the late 2000s, I had stopped being emotional about the notion of a retrade. I viewed it as a normal part of business, which impacted an investor or acquirer’s long term reputation, but was woven into the fabric of things.

And then the retrades more or less stopped. From 2010 forward, the entire VC market shifted into a mode that many describe as “founder friendly.” Investor reputation mattered at both the angel and VC level. Retrades were a huge negative mark on one’s reputation and word got around. As more and more investors showed up, valuations increased, and time to close a deal shortened, there was little tolerance for a retrade, so they disappeared.

As we are now about five months into a broad market reset, both for public and private market valuations, the retrade has reappeared in private investments. The first indicator of it is that it now takes longer for a deal to close. I expect the days of transactions closing 15 days after a term sheet is signed are probably gone for a while. While some lawyers are breathing a sigh of relief, a deal that takes more than 30 days to close often starts to have a little bit of retrade risk. And, when a deal stretches out over 60 days, there’s a lot of risk around deal certainty – both retrade as well as a full deal collapse.

Recognize that I’m talking about investments, not acquisitions. I never saw the retrade dynamic go away with certain buyers and certain type of acquisitions. However, what’s notable to me on the investment side is that the retrade is happening up and down the capital stack.

  • Sam

    Did not realize this was relatively uncommon on the venture side of the house. It’s pretty much standard operating procedure on private equity term sheets.

    Reputation risk is gauged against the norms of the industry. PEs suffer little downside for this behavior because it’s expected.

    VCs should keep this in mind when dealing with first time entrepreneurs. Any perceived “acts of bad behavior” may instead be “acts of ignorance” in terms of the rules and expectations of this particular venture game.

  • Yup, know of a couple. I don’t take offense when I hear about it. Just the market readjusting. I think if it happens, the VC ought to be transparent why. To me, it is a market where bids and asks get moved up or down. Worse is when VCs play two similar companies off each other.

    • I think the bigger challenge is that there are a large number of entrepreneurs who started companies during a period (2010 – 2015) where this was not the norm and are now in for a rude awakening.

  • How much better off is a VC really after executing a retrade like this? Shouldn’t the thought process of “whoa, this may not be worth what we think” be an indicator that you shouldn’t make ANY deal, rather than it should close at a lower price?

    This seems like the opposite version of Peter Thiel’s “a massive step up in valuation is the best opportunity to invest” quote.

    “If you no longer believe in a company, there’s no price cheap enough to enter”

    • I have never understood the philosophy of an investor who was motivated to retrade a deal. If I didn’t like the deal, I’d just decide I don’t want to do it. That seems similar to the Thiel comment.

  • “it’s not real until you can buy beer with it.”

    funny to me that these constant dynamics get labels like “retrade.” I guess we always find vocabulary for everything. in my mind it’s always just been “binding” or “non-binding.” unless you have the former, there’s risk and variability.

    regardless, someone going back on their original investment intent, is a bummer and I’d argue illustrates a lack of understanding or faith in the target. perhaps a “retrade” is a moment for the entrepreneur to walk away from a shifty investor.

    • VCs who do this get a rep for being flaky. Founders talk + for those w/ a strong network, they hear of + avoid ’em.

      If I wanted to deal w/ the 100% certainty of litigation, I’d name names. The upside just isn’t there. As Brad has said in the past, avoiding a public food fight while privately being vocal is the best path. I now share that view.

  • Heather Redman

    I’ve noticed that retrading is more common in some cultures than others. The duty of “good faith and fair dealing” (which is a real legal concept) also seems to have a moral element in some cultures. I’m not saying that one culture is wrong, but it is interesting, and worth being aware of, especially if you are doing an M&A transaction that’s international or have a foreign strategic investor.

    For the most part, execs in the US think that a deal is not legally (and maybe not ethically) binding on them until the last agreement is signed, but there’s been at least one recent case that held that an email expressing agreement on docs (sent by the lawyer not the client by the way!) created a binding contract. Retraders, there may be some legal as well as reputational risk.

  • Unfortunately, this is very common in Dallas with local investors… both angel and VC. I’ve had it happen to me 3 times, causing me to walk away from deals and I’ve heard of a number of other founders experiencing it with their deals.

  • Definitely worth noting those who have concluded large deals after Feb 5 (so presumably on Dec/Jan term sheets). Speaks well. ActiveState, ThousandEyes, enSilo, DataDog, and others. Pretty sure at least some closed, not just announced, in Feb.

    But… I’ve also seen 3 term sheets that fell through in Jan and Feb when founders refused to renegotiate – either tightened their belts or just shut down vs being squeezed and having to partner w/ people who were squeezing.

    If it gets worse, perhaps there’ll be a Yelp version of The Funded, or The Funded will pick up again.

    • Eh – I’m not sure the dynamics around reputation from a Yelp version of The Funded are actually that impactful, or even accurate.

  • What about adding language that creates a significant financial penalty for retrade activity?

    I’m not an attorney, but perhaps something like “liquidated damages’ where the penalty figure is predetermined and non-negotiable, immediately payable whether the transaction proceeds or not. Of course (defined) material adverse changes in the business being acquired or funded would be exempt. I’m sure there would be other unintended consequences to consider…

    • This will never happen. There used to be the notion of a breakup fee (in M&A) if the deal didn’t close, but this is generally limited to the time between signing the definitive agreements and closing, and almost only for very large deals.

      The retrade is part of business. It’s just something that a lot of people haven’t experienced in this cycle, and it’s back …

  • How often do you see retrades as a result of something substantive discovered in the diligence process vs. the acquirer discovering they have more leverage than they originally thought (e.g. the target’s cash position isn’t as strong as initially believed).

  • Thanks @bfeld:disqus, I wonder if there is a graph that shows the relationship of deal processing time vs number of deal failures.. I bet it’s a pretty clear relationship as you’ve hinted to.

  • Joy

    Brad, “retrade” is a mild word. In my own personal experience, which led to me being forced to file a federal lawsuit, it’s actually fraud. Not that I am bitter, I won the suit. I call it fraud because it simply means that the buying party is attempting to change the deal away from the term sheet after they believe they have already secured that which they’d wanted, and not give what they had promised in return for it. In my situation, the term sheet was incredibly clear, they were getting 30% of the venture for a specific amount, PERIOD. They made a few initial payments and we started moving on our plans, but they delayed the final closing papers. When we finally got to the closing papers, they’d twisted the deal into a beast. Now they wanted us to agree that if we so much as farted, we’d lose everything to them. Continued payments were now dependent upon us signing these new draconian closing documents which had no relationship whatsoever to the original agreement. We said NO WAY. They then behaved as if we HAD agreed to their entirely new terms and began fraudulently assigning our intellectual properties directly to themselves!

    So I immediately assigned the IP back to us through the USPTO, filed a lawsuit, and also obtained an injunction to prevent them making any claims to our IP during the suit. I was up against 5 different law firms during this battle, self-representing as an inventor. They just kept throwing money at it, clogging up the case. It took me awhile, but they finally waved the white flag and we settled with them getting nothing and not getting their initial money back either.

    It was outright fraud, not a “retrade”. If someone agrees to something in exchange for something, and then attempts to collect without paying their part, this is FRAUD, a cheat, theft. We can call it whatever we want to, but by any other name, it still smells as foul.

    A written agreement is only as good as the word of the one who signs it.

    • James Mitchell

      Joy, this is not fraud. Fraud is making a false statements, which you knew or should have known to be untrue, in order to induce the other person to do something, and that other person reasonably relied on your false statement. What happened to you is breach of contract.

  • This happens in all sorts of deals not just investment. You can be negotiating a deal with a customer, give concessions agree to a deal and then when it comes to closing the person comes back and wants to get one more “pound of flesh” http://www.bothsidesofthetable.com/2012/02/26/everybody-wants-their-pound-of-flesh-how-to-negotiate-with-buyers/

    When there was huge FOMO it was hard for the investors to execute, because somebody else would step in. The shoe is now on the other foot and some entrepreneurs are going to feel like a one legged man in an ass kicking contest.

    The only thing I will say is once you have given your word that is when negotiating needs to stop and people need to work on making it successful. The risk you run on re-opening it is that if you do close the other side will always remember and given the chance will make you pay for it.

    • Exactly.
      The minute you come back with surprises, you’ve started to hurt the relationship.

  • In my (limited) experience, when you’ve spent a bit of time upfront getting to know each other, and you both work diligently on a term sheet in good faith, the risks of retrade could be minimized.

    But if you’ve done a fast term sheet, there will be surprises before you close.

    • Navin Pai

      William I am in broad agreement with you. But in case of one partner in the transaction with suspect integrity/intentions, then it doesn’t matter whether the work done was detailed enough nor time spent was sufficient. Sadly you will know only when the person/entity calls you wanting to do a retrade.