Two of my recent blogs discussed various actions that companies should undertake to prepare for sale of their business (with a diversion last month for a post discussing the SEC’s changes to the crowdfunding rules in Regulation CF). Returning to the subject of sale of the company, when the preparatory items I mentioned in those previous blogs have been addressed, the company should be ready to dive into the nitty-gritty of pursuing sale of the company.
Before sharing any information with potential buyers or other interested parties, the company should first obtain a mutual nondisclosure agreement (NDA) from potential buyers and anyone else involved in the sales process. The NDA needs to be properly prepared by legal counsel to ensure that it fully protects the company against the many forms of potential misuse of the company’s information by possible buyers.
The sale process begins with identifying the buyer. In some fortunate cases the company receives an unsolicited offer from a strategic partner or other third party. However, in most cases, the company will need to engage a professional sales advisor to assist in the process of marketing the company and identifying potential buyers. For extremely small businesses, a business broker may be the best option, as they typically serve small companies that will likely be sold to an individual buyer rather than a corporation.
The next level of business sales professionals are M&A advisors. While most M&A advisors set boundaries for the companies they serve based on the value of a company or the industry and geographic region, they generally fill the gap by advising small to medium-sized businesses. The “sweet spot” for many M&A advisors are transaction values greater than $2 million but less than $50 million. Higher transactions are typically handled by investment bankers, although the minimum transaction size for investment bankers varies substantially from firm to firm.
Once the company identifies and retains the appropriate business sales advisor, the process of marketing the company and reaching a preliminary verbal agreement on the terms for sale of the company begins. After discussions with potential buyers, which generally involves some level of the company providing due diligence information to one or more potential buyers, typically the company selects one purchaser to continue the dialog.
Working with its sales advisor, the company should then reach a preliminary nonbinding agreement with the selected purchaser. Initially this agreement will be reached verbally via meetings, phone calls, and emails – i.e., there is no written agreement at this stage. Once the parties come to a verbal agreement, the next stage is to agree on a term sheet (sometimes called a letter of intent). Although most of the provisions of a term sheet are non-binding, a term sheet is still an integral part of the process. The key legal substance in the term sheet should be a moderately detailed description of the key terms of the transaction. The majority of the provisions of the document are nonbinding, with the exception of a few provisions such as governing law and (typically) a no-shop restriction.
I’ve blogged separately about the key aspects of a term sheet, but to summarize that discussion, at a minimum the term sheet should include:
- purchase price,
- details of earn-out, if applicable;
- timing of transaction,
- whether the seller receives stock of the buyer company or cash;
- amount and timing of escrow (if applicable);
- whether the purchase price will include an earnout or be paid in full at closing;
- role of the founders in the buying company once the sale has been completed; and
- details of the noncompetes that the principals of the company will be expected to sign.
Given the vital importance of the term sheet, companies often err by not involving counsel when a term sheet is issued. This typically results in a document that is poorly drafted, fails to address key terms, or gives away key negotiating points.
Whether called a term sheet or letter of intent, after the document is signed both parties, the real fun begins! Stay tuned for my next blog for what happens next.
