Dealmaking

Applying practical tools to the volatile process of negotiating
Prognosticators apply Monte Carlo Analysis (MCA) to determine the likelihood and significance of a complete range of future outcomes; Real Options Analysis (ROA) can then be employed to develop pricing structures, or options, for such outcomes. Richard Razgaitis' Dealmaking shows readers how to apply these powerful valuation tools to a variety of business processes, such as pricing, negotiating, or living with a "deal," be it a technology license, and R&D partnership, or an outright sales agreement. Dealmaking distinguishes itself from other negotiating guides not only by treating negotiations as an increasingly common situation, but also by presenting a tool-based approach that creates flexible, practical valuation models. This forward-thinking guide includes a variety of checklists, case studies, and a CD-ROM with the appropriate software.
Richard Razgaitis (Bloomsbury, NJ) is a Managing Director at InteCap, Inc. He has over twenty-five years of experience working with the development, commercialization, and strategic management of technology, seventeen of which have been spent in the commercialization of intellectual property.

Chapter 1

Introduction 1

Why Another Negotiating Book? 1

Dealmaking™ 3

High Significance, High Ambiguity Contexts 4

The “So What?” Question 8

Valuation, Pricing, and Negotiation 8

Tangible and Intangible Content/Value and the New Economy 9

The I Dealmaking Process 10

Organization of the Book 13

Chapter 2

Negotiation People, Language, and Frameworks 15

Negotiation People 15

A Quest 21

The Nut, the Number, the Bogie, and the Toe Tag 23

Quantification, Rationality, and Hyperrationality 24

Chapter 3

The Box and the Wheelbarrow: What Am I Selling (or Buying)? 31

The Box 31

The Wheelbarrow 36

Dealmaking’s Spine 41

The Term Sheet 42

Methods and Tools 42

Chapter 4

Discounted Cash Flow Analysis and Introduction to Monte Carlo Modeling 45

Discounted Cash Flow Analysis 45

Scenario (DCF) Analysis 50

Monte Carlo Method: An Introduction 64

Closure and Application to Negotiation 72

Chapter 5

Monte Carlo Method 77

A Model Cash Flow Template 78

Income and Cash Flow Statements: 3M Example 79

Monte Carlo Assumption Tools 91

Uniform Distribution: Highest Uncertainty Between Certain Bounds 91

Triangular Distribution 94

The Normal Distribution 97

Other Distribution Functions 100

Monte Carlo Model of the DCF Template 102

Combined CAGR and Cost Ratio Uncertainty Distributions 102

Correlating Assumptions 105

Additional Assumption Distributions 107

Twentieth (and Other) Percentile Valuations 108

Comparison of Monte Carlo Results with DCF (RAHR) Method 114

Scenario Modeling in Monte Carlo 115

Monte Carlo Tools for Determining Variable Significance 120

Final Points on the Monte Carlo Model 121

Appendix 5A: Crystal Ball Report Corresponding to the Results Presented in Exhibit 5.15 for a Uniform Cost Distribution Assumption 126

Appendix 5B: Crystal Ball Report Corresponding to the Results Presented in Exhibit 5.16 for a Double-Humped Cost Distribution Assumption 135

Chapter 6

Introduction to Real Options 147

Perspective 1: Discounted Cash Flow (DCF) View of the Six-Scenario Opportunity 148

Perspective 2: Real Option View of the Six-Scenario Opportunity 151

Perspective 3: A Model for a Buyer’s Counteroffer 154

Black-Scholes Equation for Option Pricing 156

The Black-Scholes Equation Applied to an Option to a Share of Yahoo! 157

What Do Equations Represent? “What Is Truth?” 161

Using Black-Scholes for an Opportunity Valuation 167

Summary of Real Option Realities versus Black-Scholes 171

Chapter 7

Real Options Applied to Dealmaking 175

Beyond Black-Scholes 177

Emergence of Real Options Analysis 179

Introducing the Binomial Lattice for Real Options 186

Calculating Option Values from Binomial Matrices 192

Calculating Option Values Using Decisioneering’s Real Options Analysis Toolkit 196

Using Real Options Analysis Toolkit Software in Dealmaking 201

Calculating (or Estimating) Option Volatility 204

Calculating the Option Value of Options on Options 210

Conclusions and Observations 212

Appendix 7A: Real Options Equations 215

Chapter 8

Knowledge and Unertainty 219

Future Knowledge 219

Dealing with Uncertainty 221

Standards 226

What About Truth? 229

Chapter 9

Deal Pricing 233

Simple Pricing 233

Box Pricing 235

Wheelbarrow Pricing 236

Total Cash Payment 236

Cash When 239

Cash Maybe 239

Cash As 240

Cash Substitutes 240

Term Sheets 241

Chapter 10

Negotiation Perspectives and Dynamics 243

Negotiation Perspectives 243

Negotiating Sequencing 246

Issue Explosion 249

Negotiating Values 252

Deal/Agreement Complexity 252

Chapter 11

Plan B 255

Auctions and Betrothals 255

Plan B Analysis and Tools 257

Plan B Implementation 265

Plan B Caution 266

Plan B from the Buyer’s Perspective 267

Plan B and Life 267

Chapter 12

Conclusion 273

In Theory, In Practice 273

Value Creation by Dealmaking 274

A Final (True) Story 278

Bibliography 281

Index 283

RICHARD RAZGAITIS is a managing director at InteCap, Inc. A recognized leader in the field of licensing and valuation, he has over twenty-five years of experience working with the development, commercialization, and strategic management of technology, seventeen of which have involved the commercialization of intellectual property. "The underlying purpose of this book is to empower negotiation for business-to-business dealmaking of business opportunities using analytical tools and planning procedures. The focus on practical tools and procedures that can be justifiably used in a business context distinguishes the book from a vast catalog of other negotiation books."
–From Chapter 1

Business negotiation is often characterized as a "take it or leave it" battle of wits between buyer and seller. But it is much, much more. In reality, business negotiation involves two parties–perhaps business adversaries or perhaps business allies–faced with reaching a reasonable value-enhancing agreement from a range of possible options.

Dealmaking Using Real Options and Monte Carlo Analysis details how you can employ two of today’s most powerful decision-making tools–Real Options Analysis (ROA) and Monte Carlo Analysis (MCA)–to effectively prepare for every negotiation by comprehensively and rationally representing myriad possible futures. This uniquely hands-on book outlines a step-by-step process for determining what you want, learning why it is reasonable to hold such a view, and successfully communicating that knowledge to both internal stakeholders and those on the other side of the negotiation.

Richard Razgaitis, an influential thought leader in the field of licensing and valuation, walks you through the tools and approaches of ROA/MCA joint usage, including:

• Real Options Analysis–sometimes referred to as "Black-Scholes" analysis, it is valuable for determining pricing structures, or options, for such outcomes
• Monte Carlo Analysis–an increasingly popular tool for determining the likelihood and significance of a complete range of future outcomes
• Checklists, case studies, web site addresses–for further business and negotiation resources

In the no-quarter world of business negotiation, a patient and methodical inquiry into all relevant matters is not practical. At the same time, rapid analysis may not provide the data required to satisfy all parties. What is needed is a model that takes into account the speed and urgency required to effectively prepare for a negotiation while allowing rational and defensible analysis of the numerous real options.

Dealmaking Using Real Options and Monte Carlo Analysis introduces that model. This practical, results-based book unveils a negotiating system that achieves the dual goals of speed and reasonable certainty, and is destined to become the method of choice for reaching outcomes designed to satisfy all parties in the negotiation.

An Innovative, Tool-Based Process for Creating More Rational, Creative, and Mutually Beneficial Deal Structures and Valuations

Real Options Analysis (ROA) and Monte Carlo Analysis (MCA) are two of today’s most significant tools in the valuation and negotiation of high-potential-value, high-ambiguity deals. Dealmaking Using Real Options and Monte Carlo Analysis outlines a new approach for creating flexible, practical valuation models by combining ROA and MCA into one innovative and proven successful process.

This results-based book takes you beyond uneven, rule-of-thumb negotiation tactics and strategies to discuss how you can:

• Accurately evaluate the potential costs of going forward with–or scuttling–a business project
• Ensure that both sides in every negotiation work from similar valuation terms and processes
• Develop and implement efficient strategies for bringing negotiations to closure

In preparing for any business negotiation, the goal is to identify opportunity and characterize risk; during the actual negotiation, the goal is to capture value while arriving at terms that are favorable to everyone. Dealmaking Using Real Options and Monte Carlo Analysis introduces a process for achieving both goals, by focusing on practical tools and procedures that take into account the full range of opportunities–and lead all sides to the identification and selection of optimal choices.