I’ve been blogging recently about the M&A process from the perspective of an early stage company positioning itself for acquisition by a larger company. My most recent blog described the process through the signing of a term sheet or letter of intent. What happens once the term sheet is signed? Read on!
Many buyers assume that after the term sheet is signed, the next step is for the buyer’s counsel to prepare the purchase agreement. However, that comes later; the next step is that the buyer will want to conduct extensive due diligence (DD). Typically the buyer will have completed significant amounts of DD before signing the term sheet, which often leads the company into believing that DD is mostly done and that finalizing the sale will be quick and easy. That belief often turn out to be off-base, as the extent of DD that remains is consistently substantial.
The typical DD checklist at this stage will be a 25+ page document requesting large amounts of detail on every aspect imaginable. Typical requests are for detailed information in such areas as company operations, customers, suppliers, company product and services, current and former employees, current and former contractors, ownership of intellectual property, corporate record keeping, issuance of equity and any related agreements, financial issues, and a large array of legal compliance (for example, privacy, information security, export compliance, and taxes). Because of the extensive details requested in DD at this stage, the company should assume that it will need to devote substantial resources to fulfill the DD requests in their entirety.
Buyers typically will not provide a detailed purchase agreement until DD is largely complete. Once the initial draft of the purchase agreement is provided, many items will still need to be negotiated. This is the stage where a “thin” term sheet (i.e., one lacking in many details) turns out to be a problem, when the seller reads the first draft of the purchase agreement and is surprised (and often horrified!) at terms such as how much of the purchase price goes into escrow, how long after closing the noncompete restrictions will last, and for how many months (or years) after closing that the seller has potential indemnification obligations to the buyer. Depending on the size of the transaction and other factors, a properly detailed term sheet could shorten the process of negotiating and finalizing the purchase agreement to as little as three weeks from when the buyer receives the first draft. If the term sheet was thin, this process will be considerably longer.
After the purchase agreement is signed, you’re done, right? Maybe yes, maybe no. The purchase agreement could be a sign-and-close, in which case the transaction is completed upon execution of the purchase agreement. However, particularly with larger transactions, the purchase agreement commits the parties to close the transaction but it does not constitute a sale of the company per se. There are several potential reasons for signing a purchase agreement with closing to occur at a later date. One reason is that the buyer may need time to arrange its financing of the purchase price (assuming a cash sale). If the transaction is a sale of assets rather than a stock sale, the company often needs time to obtain consent from third parties to assignment of various contracts. In addition, regardless of the structure of the transaction, the approval of regulatory authorities may be required.
I hope this series of blogs has given the reader a better understanding of the many stages of an M&A transaction and how a company can best prepare itself for sale of the company. I’ll be on to a new thread next time – stay tuned!