This post was jointly written by Trey H. Woodall and Casey W. Riggs.
Buying or selling a business can seem like a daunting task, but understanding the deal process can produce an overall more efficient and better experience and result in better terms. This overview will help you understand how a deal progresses through the following stages:
- Buyers and Sellers Finding Each Other
- Protecting Confidentiality
- Initial Due Diligence
- Offers and Letters of Intent
- Continuing Due Diligence
- Negotiating the Transaction Documents
- Closing the Deal
- Post-Closing
This is the first in a series of posts about buying or selling a business and is intended for those unfamiliar with the process. Future posts will provide more in-depth analysis and experience shares on relevant topics and issues that M&A professionals and more experienced business owners may find helpful.
Buyers and Sellers Finding Each Other
Buyers and sellers obviously have to find each other for a transaction to occur. This can happen in a number of ways, including the following:
- organically as business owners in the same or similar industries cross paths while doing business
- often, a seller may hire an investment banker or broker to help market the seller’s business
- some buyers conduct targeted searches, looking for particular types of businesses to purchase
However it happens, there are typically informal conversations between key people on the buy-side and sell-side to see if there is mutual interest. If brokers or bankers are involved, they will be heavily involved at this stage. High-level terms such as potential purchase price, rollover equity, and the sellers’ involvement after the sale are discussed. If there is mutual interest, the potential buyer and seller will want to move to the next step and start exchanging information. Future posts will discuss considerations in engaging a banker or broker to help market or find a business for purchase or sale.
Protecting Confidentiality
In most cases, the potential buyer and seller will enter into a Non-Disclosure Agreement (an “NDA”) very early in the process. The NDA is a contract where the parties agree to keep certain information confidential, like trade secrets and customer lists. The NDA may also include restrictive covenants, such as restrictions on hiring employees of the other party. The NDA often only restricts the buyer (a one-sided NDA); however, it may also impose confidentiality obligations or restrictive covenants on the seller as well (a mutual NDA). A mutual NDA is important if the buyer expects to share sensitive information with the seller (for example, if the buyer’s stock will be part of the consideration delivered to the seller) or has significant exposure to the seller’s employees. Future posts will analyze some of the important points to consider in negotiating an NDA.
Initial Due Diligence
After an NDA is signed, the parties typically begin sharing information so that the buyer can determine if it wants to make an offer for the business. At this stage, high-level information is shared, such as financial statements and other key information about the business. The depth and breadth of due diligence at this stage can vary widely from deal to deal. However, at this point, very sensitive information (e.g., customer names) may be withheld by the seller. But, the buyer needs enough information to determine if it wants to make an offer for the business, how much it’s willing to pay, and to assess material issues and risks. The amount of diligence shared at this stage can vary widely from deal to deal.
Offers and Letters of Intent
If, after preliminary diligence, the buyer wants to make an offer to purchase the business, it often does so in the form of a letter of intent (an “LOI”). The LOI typically includes the business terms (deal structure, purchase price, how the purchase price will be paid, rollover equity, if applicable, and other important financial terms). The LOI may also include an exclusivity period and very basic legal terms. The NDA is typically non-binding in terms of the commitment of either party to go forward with the transaction, but it does usually contain some legally binding provisions (such as confidentiality and exclusivity). Although the LOI is mostly non-binding, after it is signed, the parties are expected to negotiate consistently with its terms (unless the facts change). Future posts will analyze some of the important points to consider in negotiating an LOI.
Continuing Due Diligence
The due diligence process typically continues after the LOI is signed all the way up to the closing of the transaction. In the initial due diligence phase, the buyer may have reviewed financial statements and other key business information but may or may not have done a deep dive into all aspects of the business. After the LOI is signed, the buyer’s legal team often sends a comprehensive request list to the seller for more information and documentation about the seller’s business than was shared during the initial state of diligence. The breadth and depth of the diligence requests may vary depending on the type of buyer (for example, private equity buyers often take a very comprehensive approach to due diligence). The buyer may also have a quality of earnings study done at this point. The lawyers for the buyer and seller, and if applicable, brokers or investment bankers, will be involved in coordinating and guiding the due diligence process. CPAs and other financial advisors may also be involved.
Negotiating the Transaction Documents
The main transaction document setting forth the terms and conditions of the deal and the obligations of the parties is the purchase agreement. Depending on the structure of the transaction, this may be referred to as an asset purchase agreement, equity purchase agreement, merger agreement, or another type of purchase agreement. Outside of an auction process (where the seller is fielding bids from multiple potential buyers), the buyer typically prepares the first draft of the purchase agreement after the buyer is far enough along in its due diligence process to believe it will, in fact, go through with the acquisition. Typical purchase agreements, even for lower middle market companies, can often be in the fifty-to-seventy-five-page range and are typically extremely comprehensive in terms of the representations, warranties, and indemnities required from the seller and the seller’s owners. Most purchase agreements also require substantial disclosures from the seller as part of the diligence process and in connection with representations and warranties, which disclosures are incorporated into the purchase agreement as schedules.
In addition to the purchase agreement, there are a number of ancillary documents that may be required for a particular deal, such as escrow agreements, promissory notes (if a portion of the purchase price is being financed by the seller), loan subordination agreements, employment or consulting agreements for the seller’s owners, managers or employees, transition services agreements, restrictive covenant agreements, security agreements, guarantees, and potentially many others depending on the specifics of the deal. In future posts, we’ll explore the details and key considerations in all of these types of agreements.
Closing the Deal
Most lower middle-market deals, which are the ones we typically work on, have a simultaneous signing of the purchase agreement and closing. The closing occurs when the diligence is complete, all open issues are resolved, and the deal documents are in final form and ready to be signed. Typically, at this point, signatures have been exchanged but are held in escrow, and there is a closing call to release signatures or an email release of signatures. After the closing call or email release of signatures, the buyer wires the purchase price, and the deal is “closed.”
Post-Closing
After the deal closes, there may be some post-closing matters to address. Often, there are financial matters to address, such as working capital adjustments, escrows, earn-outs, and promissory notes. In addition, frequently, other post-closing work is required. For example, the sellers may go to work for the buyer or provide some form of consulting or transition services. And, of course, disputes can arise, requiring attention to representations, warranties, and indemnities. Future posts will explore many of these topics.
We see that clients who understand the deal process are more confident, less overwhelmed, and get better terms. Having skilled advisors on your team can help you run a successful deal. The mergers and acquisitions practice group at Riggs Davie PLC counsels clients through deals on the buy-side and sell-side in a wide range of industries, including technology, health care, health tech, fintech, professional services, financial services, real estate, business services, manufacturing, and distribution. For more information about our services, please visit www.riggsdavie.com or contact our practice group by email at dealteam@riggsdavie.com.
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.
