Selling a private company is much more than a business transaction. After all, the owners have invested time, treasure, and in some cases blood and tears into building their business. Many owners have the first dollar their company ever earned encased in glass. They have developed deep relationships with employees, customers, and suppliers. For many business owners, their very identity is tied up in their company. Selling the business is emotionally and psychologically draining.
The sale process can also seem unduly complicated and ritualized to business owners used to making their own decisions and implementing those decisions with little or no oversight. The sale process includes the preparation and review of unfamiliar documents, seemingly endless requests for documents and financial records (known as “due diligence”), and long discussions over legal points and contingencies. There may also be difficult tax issues to work through. For many clients, the sale process is mysterious and takes much longer than they think it should take.
In this three-part series, I intend to de-mystify the process and explain the different phases of the sale of a company. In this first installment, I will discuss the process of identifying a buyer for the company, the importance of a non-disclosure agreement, and the preparation of a terms sheet and a letter of intent outlining the business points of the deal. I will conclude this first part with a discussion of how and when the business owner should disclose the transaction to minority owners, employees and other stakeholders.
In Part II, I will discuss the basic forms a business sale may take – an asset sale, stock or LLC interest sale, redemption or merger. I will conclude Part II with a description of the “Due Diligence” process, which applies to all forms of transactions.
Part III will contain a detailed look at the main provisions of an Asset Purchase Agreement and a Stock/LLC Interest Purchase Agreement. I will include a clear (hopefully!) explanation of the warranties and representations commonly made by sellers, the indemnities commonly included in such agreements, common pre-closing and post-closing covenants and the closing process itself.
Without further preliminaries, here is Part I of Anatomy of a Business Sale.
Identifying a buyer
Business owners can identify buyers in a number of ways. A long-time employee, a competitor or a customer may express an interest in acquiring the company. Sometimes an investment banker or business broker may approach the business owner on behalf of a potential buyer.
Business owners who have concluded that now is the time to exit their company may reach out to their lawyer or accountant. These professionals may know people who would have an interest in the business. More likely, they will put the business owner in contact with an investment banker or a business broker. These professionals usually have wide networks of contacts and know how to get the maximum exposure and the highest price for the business. There are also business transition experts who specialize in planning and assisting the business owner with developing and executing a transition plan, using accountants and lawyers with whom they have established relationships.
The investment banker or business broker will usually spend time with the business owner, interviewing him or her and reviewing financial records and business policies and procedures. They will usually prepare a set of comprehensive materials describing the general nature of the company, its industry, and its approximate location, without divulging its precise identity. The broker or investment banker will compile a list of possible contacts, using his or her own database and perhaps soliciting suggestions from the business owner and the business’ lawyer and CPA. That list will then be approved by the business owner, who of course has the final say on who he or she will contact. The broker or investment banker will then contact the people on the list, inquiring whether they have any interest in a possible transaction.
In some cases, the business owner is not concerned about pre-sale publicity and the broker or investment banker will embark on a very public marketing campaign to sell the business.
THE Non-Disclosure agreement or “NDA”
If a prospect responds to the overtures of the broker or investment banker, the next step is to ask the prospective buyer to sign a non-disclosure agreement with the seller. This agreement requires the prospective buyer to keep confidential any information it may receive concerning the company, its finances or its business. In most cases it will also require the buyer not to disclose the very fact that the company is for sale or that any transaction is being discussed. The NDA should also contain provisions prohibiting the prospective buyer from trying to hire away the selling company’s employees, trying to contact the company’s customers or vendors or otherwise using any of the information they receive about the selling company in any way other than the consideration of the transaction.
The non-disclosure agreement should also require the prospective buyer to return any and all documents it receives if the deal does not proceed. Nowadays, most of this information is shared electronically, and if the deal does not proceed it is important to obtain a certification from the prospective buyer that it has permanently deleted all confidential material from its computer system.
In some cases, the prospective buyer may be providing information to the selling company as well. This would certainly be the case where the buyer wants to pay part of the price over time, or with shares of its stock. In these cases, the NDA works in both directions and the selling company will be required to respect the confidentiality of the information provided by the prospective buyer or merger partner. Likewise, if the deal does not progress, the selling company will be required to return or permanently delete any confidential information it received from the prospective buyer.
Most prospective buyers honor their commitments and it is rare to see litigation arise out of an NDA, but it happens. Consequently, it is important to have your lawyer draft the NDA or carefully review the NDA provided by the broker or investment banker.
THE “Agreement in principle,” the “Term Sheet” and the “Letter of Intent”
After the parties sign an NDA, the prospective buyer usually asks the selling company to disclose summary financial information and information about its facilities, product or service lines, customers and vendors. The buyer may also want to meet the owners and top executives and interview them about the business.
When the prospective buyer has a good picture of the company’s historical financial information and of the business in general, the owners will start to negotiate price, payment terms and other specific terms and conditions of the deal. These specifics may include the owner’s continued employment by the selling company after the closing (how long, what salary and benefits); the disposition of company-occupied real estate (is it part of the deal or will it be leased to the new owner); and whether the seller will retain any company assets. With advice from the lawyers and accountants, the owners should also determine the form of the deal: a sale of assets or a sale of the company’s stock or LLC interests. These business points will often be reduced to writing in a “Term Sheet,” a short (usually 1 or 2 pages) summary in bullet points that is signed by the seller and the buyer.
Sometimes the parties go straight from the Term Sheet to the actual transaction document — an Asset Purchase Agreement, a Stock/LLC Interest Purchase Agreement or a Merger Agreement. Depending upon the size and complexity of the deal, the parties often move from a Term Sheet to a Letter of Intent (“LOI”). The LOI sets out the agreed-on business terms but goes beyond the Term Sheet by including some or all of the following:
- (1) the seller’s commitment to give the buyer access to the business for ‘due diligence’ purposes (we’ll address due diligence in detail in Part II).
- (2) a “no-shop” provision, whereby the seller agrees not to discuss selling the company with anyone else for a fixed period of time.
- (3) a provision that allows the buyer to terminate the LOI if at any time it concludes that the details of the business are unsatisfactory.
- (4) a termination date or a date by which the deal must close.
- (5) provisions for a deposit, to be held by the investment banker, broker or, more commonly, the seller’s attorney.
- (6) any financing contingency or other contingencies.
The LOI usually not a comprehensive legal document, but it can be legally binding. Legal counsel should absolutely be involved in the preparation of the LOI to ensure that it is perfectly clear which parts are legally binding (e.g., the “no shop” clause and confidentiality provisions) and which are not.
INFORMING EMPLOYEES AND OTHER STAKEHOLDERS
If there are minority owners in the company, it is often a touchy issue determining precisely when to inform them of the possible transaction. In larger companies, the majority owner is often the only one actively involved in the business and family members or early investors have only minor equity interests. Of course, these minority owners are certain to become involved eventually in any transaction, either because their approval is legally required for the company to sell assets, or because most buyers of stock or LLC interests will want to acquire 100% of the company’s equity.
When and how to break the news to minority owners, top company executives and other stakeholders is mostly a business decision for the majority owner, who must balance the risk of premature disclosure against the risk of angering other stakeholders by a perception that they were not sufficiently trustworthy to be told of the deal earlier.
There are certain key employees who simply must be told fairly early in the process because their cooperation is essential to getting the deal done. The CFO, for example, will need to handle much of the response to due diligence inquiries about the company’s financial position. Likewise, the head of Human Resources may be tasked with compiling information about employees, the structure of benefit plans and pending litigation that will be disclosed to the prospective buyer. These and other key employees are often offered a “deal bonus” to ensure that they remain with the company through the transition and the consummation of the deal.
There is no easy answer to the question of how much information a business owner should share with employees and other stakeholders before a company sale. Every situation is different. The business owner should consult with legal counsel, the broker or investment banker and others to determine whom to tell how much and when.
COMING UP NEXT
In Part II, I will discuss the two basic forms a business sale may take – an asset sale or a stock/ownership interest sale (including a merger). I will also provide a discussion of the due diligence process and the importance of full disclosure.