By Rajnish Puri |
Part two of a four-part series.
In this four-part series on the subject of selling your business, I plan to share with you, based on my experiences, the various stages an owner of a privately-owned business can expect to go through when considering an exit strategy.
Once a seller has completed the initial steps in deciding to sell its business (please see last week’s article) and also has identified the most suitable buyer, generally speaking, the first formal expression of interest between the two parties to carry out the sale and purchase transaction is memorialized in a Letter of Intent. Traditionally, the buyer prepares and submits the signed letter to seller who, after consultation with its team of experts, elects to either accept the proposal as presented or provide modifications for buyer’s consideration. In certain situations, prior to executing the Letter of Intent, the parties may enter into a confidentiality agreement to facilitate exchange of information about seller’s business for buyer’s preliminary evaluation. As is implicit in its title, the Letter of Intent is a medium through which a willing seller and a willing buyer communicate to each other their respective “intent,” and not a definitive promise, to enter into a transaction under certain terms and conditions. Nonetheless, with the exception of certain provisions (discussed below), the commitment, though primarily non-binding at this stage, is sophisticated enough to convey that each party is serious about pursuing the deal. Letters of Intent may vary in style, length and the extent of details included, but often address the following primary matters.
Establishing the Principal Framework. Depending on the nature and size of the target business, its history and ownership structure, parties make an early decision to agree on the structure of the proposed transaction, with the primary choices being an asset or a stock purchase transaction. When uncertain, parties defer the decision on the structure pending further evaluation of the business by buyer. The purchase price buyer is willing to pay to seller is the next key component of a Letter of Intent, as are the associated conditions, such as expectations about the level of debt to be assumed by buyer and adjustments to the purchase price based on the working capital available at closing. The timing of payment of the purchase price – what portion is to be paid at closing and how much is subject to a holdback or linked to the post-closing performance of the business – is another aspect the parties tend to describe at this stage. Finally, if buyer has engaged in prior, even if limited, due diligence about the business, buyer sets forth the conditions it expects to be completed prior to closing the proposed transaction.
Non-Binding v. Binding. Because buyer has plenty to investigate about the target business before legally committing itself to go through with the proposed transaction, with the exception of select provisions, a Letter of Intent is predominantly non-binding. A binding commitment between the parties is expressed in a definitive agreement, typically entered into between the parties following buyer’s due diligence investigation. From buyer’s perspective, some of the prerequisite investigations imposing demands on its time are understanding the financial statements, contracts and ongoing obligations of the business, evaluating third party relationships, and understanding employee matters and related aspects – all of which could impact buyer’s decision on the structure and financing of the transaction or, in some cases, whether or not it is even prepared to move forward. The provisions that are typically binding in a Letter of Intent are the obligations of the parties to bear their respective expenses, ensuring confidentiality of information shared by seller (although it could be addressed through an independent non-disclosure agreement), granting buyer and its team of advisors extended access to information about the target business, and buyer having exclusive rights to evaluate the business for a limited period of time.
Due Diligence and Confidentiality. Unless previously addressed in the context of a non-disclosure agreement executed between the parties, a Letter of Intent, when signed, permits buyer and its designated team of advisors (attorneys, accountants, and members of buyer’s management) to begin their due diligence investigation of the target business. To ensure that the information seller shares about the business remains protected and is limited to use by buyer solely to evaluate if buyer should acquire the business, a confidentiality provision is an important element. Occasionally, the confidentiality provision also includes names of select individuals from seller’s team who are the only ones authorized to receive and respond to buyer’s inquiries to ensure a coordinated and efficient due diligence process.
Exclusivity and Termination. The last thing a potential buyer wants to do is to engage in the investigation of seller and the target business, incur costs and fees, and make the related time commitments – only to later learn there are other potential buyers invited to the party, triggering the need for an exclusivity provision seeking seller’s assurance that buyer is the only party engaged in negotiations. What frequently gets negotiated is the duration of the exclusivity period, which, depending on the size of proposed transaction, varies between 30 to 90 days. Naturally, seller prefers the shorter end of the spectrum to allow itself other options should the buyer have a change of heart, and buyer likes to maximize the duration. And, finally, there is seller’s need for certainty about the process, which is addressed through listing the conditions – satisfied or failed – that trigger the termination of the Letter of Intent, again with a select surviving the termination.
In Part One of this series, I shared thoughts on First Steps. In Part Three of this series, I plan to focus on What to Expect between Signing a Letter of Intent and Closing. Stay tuned for another conversation on ClarkTalk!!
Thank you for joining us on ClarkTalk! We look forward to seeing you again on this forum. Please note that the views expressed in the above blog post do not constitute legal advice and are not intended to substitute the need for an attorney to represent your interests relating to the subject matter covered by the blog. You should certainly consult legal counsel of your choice when considering the sale or purchase of a business. If you wish to consult with the author of this post or another attorney at Clark & Trevithick, please contact Raj Puri by email at firstname.lastname@example.org or telephonically by calling the author at (213) 341-1322.