5 Documents You Must Know Before Selling Your Business
When selling a business the owner will be inundated with multiple tasks. Working through due diligence, managing employee questions, and still running the business are only but a few balls the owner will be juggling. It is critical that an owner prepare for a sale well in advance of entering the market. Part of the preparation should be to develop an understanding of some of the documents they are sure to encounter. Below we look at five documents that every seller should know before selling a business.
1. Investment Banking Engagement Letter
If you enlist the services of an investment banker as your sell side advisor then you need to understand what the engagement letter will encompass. Think of the engagement letter as a statement of work between the business owner and the banker. The letter should outline the scope of the relationship and, if done correctly, should align the interests of the seller and the banker.
The following are some key components of the engagement letter that deserve extra attention.
- The fee agreement describes how the investment banker will be compensated. A typical fee structure would include a non-refundable deposit or retainer and a success fee. While some sellers may baulk at the idea of a monthly retainer it is important to remember that the banker will be putting in significant work to help prepare the business for sale and then actually getting its sold. The fee also shows that the seller is committed to the transaction. We have a detailed article on M&A advisory fees that includes an introduction to the Lehman Scale for interested readers.
- The term will describe how long the engagement will last. During this term the banker will be preparing the offering memorandum, contacting potential buyers, reviewing offers, and closing the deal. Sellers should be comfortable with a longer-term agreement since the time for M&A transactions is measured in months and not days. For highly niche or regulated industries it may even be years.
- While the term may be long, sellers should carefully consider exclusivity clauses. Any investment banker worth their salt will likely ask for exclusivity. This may make some sellers nervous, but it is important to remember the banker is on your side and will be putting in a lot of work. Carefully interviewing different firms and seeking feedback from prior clients can help calm the nerves. At the end of the day the seller has the final say to grant exclusivity. If they decide not to, however, it may limit the universe of bankers that are willing to work with them.
- Engagement letters contain a section for termination and the tail. The termination clause will be familiar for many business owners. It states how the agreement can be terminated and typically requires written notice from one party to the other. The “tail” is a period after the engagement ends in which the banker will still be paid a fee if a transaction takes place. Tails may last as long as two years. They are put in place to ensure that the investment banker is properly compensated if a deal is struck with a party introduced by the banker.
2. The Teaser
Arguably one of the most important documents in the sale process is one of the first created. Once the engagement letter is in place the investment banker will begin drafting a teaser. This document will be sent to potential buyers and does not contain any company identifiable information (it is “blind”). This document is critical because it will sum up the investment opportunity in one page and may be the only piece of information a potential buyer will see. The objective is to get the prospect interested enough to move forward in the process.
Besides enticing buyers, the teaser also serves as a filter. A well-constructed teaser will attract the right buyers and filter out those parties that wouldn’t be a match. This saves both the prospect and the seller valuable time.
A professionally drafted teaser will:
– Provide prospects with a clear understanding of the business (the industry, how revenues are generated, the management team, high-level financial overview)
– State the goals of the transaction (100% sale, partial sale, owner transition)
– Be blind and not disclose any information that could be used to identify the company
– be honest, concise, and professional. Honesty is always the best policy in business and buyers will sooner or later discover false statements
3. The NDA
Many business owners will be familiar with the Non-Disclosure Agreement (“NDA”). The purpose of an NDA is put in place to require confidentiality among the parties. During due diligence many confidential documents will be shared. As the seller, you want to be comfortable that the potential buyer won’t take a look at your secret sauce and go try to copy it elsewhere.
As with any legal agreement you want to include language describing the term, termination, defining what constitutes confidential information, and what happens with information once the agreement ends.
Once the NDA is signed the seller will be sharing the confidential information memorandum (“CIM”) with the buyer. The CIM will contain detailed information on the company and will serve as a jumping off point for buyers to get more familiar with the company. After reviewing the CIM buyers will make one of many go/no-go decisions.
4. Letter of Intent (LOI)
After reviewing the CIM and having calls or even visits with management the buyer will present the seller with a Letter of Intent (“LOI”). Some LOI’s may be preceded by an Indication of Interest (“IOI”) which would be less formal. Depending on the situation the IOI may or may not be issued to the seller.
The LOI will contain the prospective buyer’s deal structure and terms. Once the LOI stage is reached the seller can be fairly confident that the buyer is serious, though nothing is ever guaranteed. The details contained in the LOI can vary by deal and by the parties involved. At a minimum the deal structure, consideration, desired close date, conditions to close, and due diligence requirements should be included. It is wise to get any hard requirements on the table before signing the LOI. Both parties should know what the other expects and no major surprises should come up as the purchase agreement is being drafted.
Once the LOI is executed it is time for the seller to bring their attorney and tax consultant into the mix.
5. Purchase Agreement
While the LOI may not be binding the purchase agreement is and should be drafted with the help of an experienced M&A attorney. The agreement will contain the details of the LOI and any other terms that have been mutually agreed upon. The following are some of the common sections found in purchase agreements. Depending on your deal these may change.
- Definitions should be clearly and concisely defined. This section will define any term that is in capitalized throughout the document (i.e. Indemnification) and should be taken very seriously.
- The economic terms section will define the purchase price, earn-outs, and purchase price adjustments that will apply to the transaction.
- Representations & Warranties are promises and statements that the seller and buyer guarantee as true. Working closely with an M&A advisor and attorney is critical when drafting the reps & warranties section as statements included here could open the seller up to post-deal liability.
- The indemnification section typically follows the representations & warranties section. Here actions that can damage one party, typically the buyer, are defined.
- Closing covenants limit the seller’s actions prior to and after the transaction. The buyer has already valued the business and doesn’t want the seller making any decisions that would cause the valuation to be incorrect. For example, the seller may not be able to hire new employees or make large purchases.
- Finally, the conditions to close describe what must take place for the transaction to close. These conditions may include regulatory approval or written consent of landlords and suppliers if it is required to change ownership of contracts.
The sell-side process can be long and tedious. Prior to entering what is typically a marathon and not a sprint, sellers need to be sure they are well versed in the documents they will encounter. An M&A advisor can provide a great deal of value but being educated and knowing what to expect is always a good decision.
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