Question: I’ve been reading your articles on buying and selling businesses in Rental Management Magazine. I’ve done pretty much everything you’ve suggested. I had a valuation done, hired a broker, and he has actually found me a potential buyer. We’ve agreed on a price, and the buyer has signed a Confidentiality Agreement, but now what do I do? This business is effectively my retirement plan, and I don’t want to mess it up. What is the next step?
James Waite’s Answer: This is the stage were most buyers and sellers proceed with the following, broadly outlined, steps:
Term Sheet: The parties typically negotiate and execute a “Term Sheet” (also referred to as a Letter of Intent [“LOI”] or Memorandum of Understanding [“MOU”]), which is almost always non-binding other than with respect to a few provisions, such as, for example, an earnest money requirement, a lockup (non-marketing) provision, an additional confidentiality requirement and/or perhaps a breakup provision.
Due Diligence: The buyer’s investigation of your business (discussed in detail in the June, 2018 issue of Legally Speaking);
Negotiation and Documentation: Negotiation and documentation of the transaction specifics;
Resolution of Pre-Closing Issues: These usually consist of closing contingencies, such as making sure all titles are provided and reflect the proper owner(s), liens have been cleared, disputes have been resolved, litigation has been settled, facilities have been repaired, fees, fines and taxes have been paid, key employees have been retained, regulatory approvals have been obtained, and environmental issues have been remediated;
Closing: Consummation of the transaction and payment of the amounts owing thus far to the seller(s); and
Resolution of Post-Closing Issues: Addressing post-closing failures of representations and warranties. This process might include investigating, negotiating and/or making claims with respect to indemnity obligations, holdback deductions, employment/consulting obligations, real estate lease issues, etc.
If only it were as simple as the above outline makes it seem. The reality is that business acquisitions and sales are some of the most difficult deals in the world to get right. In fact, although both sides tend to view such transactions as “win-win” propositions initially, in fact, according to a study by consulting firm LEK, 60% of such transactions actually destroy value.
Why? Although the reasons can be as numerous as the companies and people involved, the heart of the issue usually revolves around the views of the people at the tops of the participating organizations and/or their acquisition teams. Those who scrutinize the documents as well as the available data, make sure they understand both, ask questions if they don’t, and adjust their strategies to conform to the results generally do far better than those who “rely on their guts” (curiously popular though that may be). Those who may be tempted to say things like “I don’t care about all this legal mumbo-jumbo; it’s the relationship that counts” are the ones who tend to lose big and often. If you hear this from anyone on your side of the negotiating table, dismiss him/her; if you hear it from the other side, remember it; it could be valuable.
Your Next Step; the Term Sheet: As mentioned briefly above, the Term Sheet is a short, mostly non-binding agreement, the primary purpose of which is to set forth the key terms of the transaction, including price, payment(s), timing, terms, and structure. It serves as a guideline for the attorneys, who will then be responsible for negotiating and documenting the transaction alongside the buyer(s), the seller(s), their accountants, their financial advisors, and in some cases, their brokers.
Despite their ostensibly “non-binding” nature, Term Sheets can have substantial legal and business consequences for both buyers and sellers. In particular, sellers risk compromising their negotiating positions with respect to strategic deal points and/or surrendering considerable value, particularly if they haven’t obtained a proper business valuation and/or aren’t prepared to negotiate substantive legal, financial, business and/or payment terms. They may also expose themselves to liability for “breakup” or “termination” fees if they later walk away from a deal. Buyers on the other hand, can find themselves locked into positions and/or committed to strategies that must be walked back later, if possible, and may expose them to other types of walkaway-related liabilities.
For example, a buyer may demand that a seller “take the business off the market and refuse to accept competing offers” during the due diligence period. If the seller agrees, the seller will be surrendering an important leverage item. Consequently, the seller might then rightfully demand a(n) additional and/or non-refundable earnest money deposit or a breakup fee in exchange for doing so.
Note: In some cases, parties elect to either exclude their attorneys and advisors from Term Sheet negotiations, or forego the Term Sheet altogether and move straight to documenting the transaction in hopes of saving a little money. This rarely has the desired effect. In fact, in both cases, it usually proves more costly, as attorneys are generally forced to spend more time inquiring about deal specifics, attempting to add or clarify unspecified or unspecific deal terms and disentangle their clients from undesirable agreements – not to mention the additional costs incurred to have attorneys prepare inaccurate initial drafts of documents that must later be revised. This lack of clarity can result in confusion, mistakes and misunderstandings, which can generate mistrust and in some cases derail otherwise viable transactions. The bottom line is, it’s a little like convenience store sushi; it might sound like a good idea at the time, but it can really cost you.
Following is an oversimplified example of a Term Sheet. This is included only as a means of providing a basis for understanding, and should not be used as a template (it is not complete).
______________________(“Purchaser”) is pleased to present for your consideration this Term Sheet outlining the proposed terms upon which Purchaser would purchase the of the Business as described below (the “Transaction”).
The proposed terms are as follows:
Business: ____________________________________________, located at ___________________ (the “Business”).
Equity or Assets: [Equity Deals]______ % of the issued and outstanding stock of the Business.
[Asset Deals] The assets of the Business listed on the attached Exhibit A.
Real Estate: The real estate located at _____________________________ which shall be _________________ by Purchaser at Closing.
Payments / Terms: The amounts payable by Purchaser in exchange for the Seller’s undertakings will be as follows:
(a) Cash and Cash Equivalents: A total of:
(i) $___________________________________USD, plus
(b) Assumed Liabilities: The obligations of the Business listed on the
attached Exhibit B will be assumed by the Purchaser as of the Closing Date; and
Earnest Money: $ USD, payable to the Seller(s) upon execution of this Term Sheet by both parties. Said Earnest
Money shall be non-refundable unless._________________________________________________________
Lockup: Seller(s) will not market the Business or the assets for sale to third parties for ________________________.
Breakup Fee: If ______________ elects to exit the Transaction in the absence of a breach by ____________________, then
_______________ will be liable to _______ for a breakup fee of $ .
Closing Date: ______________________ __________,_________ .
Due Diligence: Immediately upon the parties’ execution of this Term Sheet, Purchaser will commence its due diligence
investigation. Seller will make available to Purchaser all material information reasonably relevant to the Business.
Closing Contingencies: The parties’ obligations to close the Transaction shall be subject to and contingent upon:
1. negotiation and completion of the remaining Transaction documents on terms reasonably acceptable
to Seller and Purchaser incorporating the terms of this Term Sheet and the representations and
warranties ordinarily associated with a sale and purchase of the Business;
2. completion by Purchaser of its due diligence investigation with results reasonably satisfactory to Purchaser;
3. regulatory approval(s); and
4. no material adverse change shall have occurred with respect to the Business between the date of
this Term Sheet and the Closing Date.
Closing: At Closing, Seller will transfer the above referenced equity / assets to Purchaser.
Cooperation: The parties will cooperate in an effort to minimize the taxes payable in connection with the Transaction.
Costs: Except as otherwise expressly set forth herein, each party will bear its own costs and expenses.
Confidentiality: Each party agrees to maintain all negotiations and information regarding the Transaction, the other party
hereto and/or its business in strict confidence for a period of ____________.
This Term Sheet shall, if not sooner executed and delivered by each of the parties named below, expire automatically at 5:00pm local time on the ____________________ day of____________________ _________,_____-___ .
If and when the parties execute this Term Sheet prior to the aforesaid expiration date: (a) the terms of Sections ___________ hereof shall be fully enforceable and shall thereafter be binding upon and inure to the benefit of the undersigned parties and their respective heirs, administrators, representatives, successors and assigns, subject to their incorporation into the Transaction Documents; and (b) the parties will negotiate in good faith to prepare and finalize the Transaction Documents in an effort to close the Transaction referenced herein on the Closing Date, it being understood however, that, except only as expressly set forth above, this Letter of Intent will not be deemed binding on either party hereto, its purpose being merely to set forth the general terms upon which the Transaction and the Transaction Documents will be based. In the event either party shall commence any legal action seeking to enforce the terms hereof or of such remaining Transaction Documents (or redress for any breach hereof or thereof), the prevailing party(ies) shall be entitled to recover its/their costs and expenses (including without limitation, reasonable attorneys’ fees) from the non-prevailing party(ies).
Executed by the undersigned to be effective as of the ______ day of, 20___.
cc: James Waite
In the end, because the Term Sheet serves as the primary roadmap for the transaction, getting it right is imperative. It should never be taken lightly, and it should never be done without involving your attorney, your accountant and your financial advisor. As is so often the case, involving the right people as early as possible in the process is not only critically important to your success, it’s also usually the least expensive path forward. Feel free to contact us if we can help.