Highly Variable but With Predictable Steps
Each sale process is unique and the idea of a “typical” sale process is a bit of a misnomer. Depending on the type of buyer, the performance of the company, the industry performance, the economic backdrop, the availability of financing, the findings during diligence and other factors, a seller will face a dynamic journey. But unknowns aside, each deal process has a common series of steps, documents and milestones. We’ll review these steps here so sellers can become familiar with the terminology and stages of the sale process.
Preparation is Key Prior to Starting The Sale Process
Based on topics covered in previous articles, this post assumes that an owner has contemplated whether the timing is right to sell, has clean financials, has an opinion on a fair valuation range for the business, feels confident about management depth, has a clear vision for growth and an understanding of the types of buyers the owner wants to engage with. We also assume that the owner has prepared an overview of the business in the form of a confidential information memorandum, or has available a summary of historical financials and key performance indicators, along with a clear articulation of growth strategy. Once a seller has made the decision to go to market with a business and is prepared to do so, the following steps will be relevant.
Steps in The Business Sale Process
Step 1: Non-Disclosure Agreement (NDA)
Protect your confidential information by having interested parties execute a non-disclosure agreement. This is a standard request in the deal process and experienced buyers should not take issue with agreeing to confidentiality. Your attorney will have a template NDA that can be distributed to buyers. Should a buyer request edits to the NDA, your attorney can work with you to review proposed edits. As mentioned in the post on buyer types, strategic acquirers may benefit from gaining access to your financials, operating history and strategic positioning, even if these groups sign an NDA. So proceed with caution as you agree to share information with prospective acquirers, and protect yourself to the best of your ability with an attorney prepared non-disclosure agreement.
Step 2: Initial Discussions and Preliminary Information Sharing
Sellers should have a high level overview of the business that can be shared with potential buyers. This overview can be shared following the execution of a non-disclosure agreement and will set the stage for continued discussions, or for a prospective buyer to have enough information to know that the deal is not a fit. Keep specific customer information confidential at this stage, and be prepared for buyers to either request more detail, or to share reasoning for walking away from the deal. The time that elapses during this stage of the deal process varies significantly and can range from a couple of weeks, up to many months.
Step 3: Indications of Interest
After interested parties have received preliminary information and had a chance to form an opinion on the proposed acquisition, if a prospective acquirer decides to move forward an indication of interest may be submitted to the selling company. The indication of interest, or IOI, is a non-binding offer that may detail valuation range, proposed deal structure, timeline for diligence and post acquisition integration comments. If there are certain elements of an offer that are important to a seller, the seller may request feedback on these topics in the IOI.
A First Look at Valuation
Valuation reads are an important component of the indication of interest, and a seller will get a third party buyer’s estimate of valuation for the company. Ideally the seller’s expectations for valuation will overlap with the range provided in the IOI. Remember, this valuation is based on limited information provided during the preliminary information sharing phase. The language in the IOI is likely to reference a range of EBITDA multiples that are applied to the EBITDA figure provided by the seller. As the buyer analyzes the business in more detail, the valuation will be refined and the multiple may be applied to a revised EBITDA figure.
Post-Acquisition Plans and Alignment With Seller Goals
Sellers will want to understand the buyer’s thoughts on post acquisition integration, including how the buyer intends to work with the existing management team. IOIs may include details on management compensation or retention packages. Sellers should reflect on whether their desired post-acquisition involvement is aligned with the proposed structure provided by the buyer in the IOI.
If a seller desires feedback on certain components of the IOI, questions can be submitted to the buyer to gain clarity on key topics. Sellers should use the IOI stage as an opportunity to explore the buyer’s goals in completing the acquisition and to determine whether those goals fit with the seller’s goals. If so, further exploration of partnership makes sense. Otherwise, sellers should be disciplined about communicating to buyers if the terms of the IOI don’t accomplish the seller’s desired outcomes.
Step 4: Management Presentations and Site Visits
After determining that the terms of the buyer’s IOI present a compelling enough picture for the seller to continue the discussion, the deal process will move to management presentations. Up to this point, the buyers may have had limited interaction with the broad management team, or in some cases no interaction. The early part of the deal process is designed to weed out those buyers that are a poor fit for the seller’s desired transaction outcome. Because management teams are busy operating the company, the goal is to avoid pulling key personnel away from the operations and into conversations with low fit buyers. It’s better to know early if a buyer isn’t a fit than to spend hours and days exploring a partnership only to find out the buyer has expectations that would have precluded the transaction from being a fit for the seller.
Options if The Sale Process is Confidential
Management presentations are a chance for buyers to visit the company and to sit down with the executives for a detailed discussion of the business. If a seller is running an internally confidential process (i.e. the management team is not aware of the transaction) and has concerns about investors visiting the company’s location, a neutral location can be selected for the meeting. Accounting firm offices or law firm offices are two options for hosting management presentations, assuming the seller does not want to host prospective buyers at the company’s headquarters.
Sellers should be prepared to walk through the company’s historical performance, vision, growth opportunities, financials, products/services, team, and forecast. Anything that would be material to the future performance of the business could be covered in this discussion. Management will want to clearly articulate why investors should be excited about the company and its prospects. Forward projections should be backed by logical assumptions that historical trends indicate are attainable.
This is the management team’s chance to shine. Preparation is important and management teams will want to spend time planning, practicing, and allocating topics to management team members who plan to participate in the management presentations.
Step 5: Letter of Intent
After management presentations are complete, buyers will have more information than they had at the Indication of Interest stage and can now refine their offers for the business in a Letter of Intent (LOI). The Letter of Intent, like the Indication of Interest, includes non-binding deal terms, such as valuation, diligence timeline, financing structure, and post-close management structure. Unlike the IOI stage, after which the seller invites multiple parties to participate in management presentations, the LOI stage will result in the seller moving forward with just one buyer. This is a key difference between the IOI and LOI stages. Although LOI deal terms are non-binding, the terms are intended to set the expectation for final terms that will be included in the binding agreement. If final terms stray materially from those in the LOI, the buyer should provide reasoning for the difference.
Moving Into Exclusivity With One Party
Upon selecting an LOI, the seller will move into an exclusive period with a buyer. During exclusivity, the seller cannot solicit offers from, or negotiate with, other potential buyers. Either the buyer or the seller can still walk away from the transaction at this point, but the exclusivity agreement is a good faith gesture from both parties about the seriousness of a proposed transaction. This is an important step for both sides of the transaction as it establishes an element of trust for both the buyer and seller before both parties incur sizable legal and accounting fees.
Once the LOI has been selected, accepted and signed, the parties will move into Due Diligence.
Step 6: Due Diligence
A Highly Detailed Review of the Business
The Due Diligence period is entered into with one buyer and entails a granular review of key information required to verify the accuracy and completeness of information provided by the seller in previous phases of the deal process. The seller should create a data room and upload documents for review by the buyer’s team. Buyers will commonly submit a diligence request list to the seller, detailing the information the buyer desires for review. The diligence process may include requests for documents such as legal documents, like incorporation documents and bylaws, board minutes, stockholder records, accounting records, tax information, financial records, vendor agreements, customer contracts, sales documents, marketing collateral, operational procedures, human resources records, employee handbooks, intellectual property documents, product information or other information required to validate claims made leading up to the diligence phase.
As buyers review information, it is not uncommon for ad-hoc information requests to surface. A member of the seller’s team should be available to review, approve and fulfill these requests. The diligence process is highly involved on both sides of the deal and requires a lot of back and forth communication. For a small business transaction, the diligence process is likely to take anywhere from 60 to 120 days, although parties can mutually agree to extend the diligence period if necessary.
Terms May Be Adjusted as a Result of Diligence
Depending on the buyer’s conclusions during the diligence phase, the buyer may attempt to renegotiate some terms included in the Letter of Intent. For instance, if the buyer’s review of accounting records results in a request for adjustment to revenue recognition or expense recognition, this could have an impact on the reported levels of cash flow. Because valuations are based on cash flow, this would result in an adjustment to the purchase price.
Working capital negotiations also typically take place towards the end of the diligence period. The buyer and seller will review the historical levels of working capital and form an agreed upon level of working capital to use as a post-close target. This level, called a peg, will result in a true up of cash depending on the performance of the business after the close.
Once the buyer and seller have collaborated to usher the deal through the diligence process, a purchase agreement will be drafted.
Step 7: Purchase Agreement
Nearing The Finish Line
The Purchase Agreement is a mutually binding agreement entered into between the seller and the buyer. The agreement includes all of the deal’s terms and conditions, including the description of the deal, representations and warranties, indemnification clauses, conditions of close and how either party can terminate if the deal isn’t moving towards close. In the case of most lower middle-market transactions, the Purchase Agreement will either be a share purchase or an asset purchase.
Sellers will rely on experienced M&A attorneys during this phase and should work with legal advisors to understand the implications of terms in the Purchase Agreement. Once the Purchase Agreement is signed, the buyer will move forward with pulling together the final details of the financing so that the deal can move to close.
Step 8: Close
Once the Purchase Agreement is complete and the buyer’s financing details are finalized, wires are exchanged and the deal moves to close. The seller can plan for internal and external communication, and can begin the post-close transition process.
Summarizing The Sale Process
Remember, there is no one-size-fits-all sale process. Each business sale is unique and varies slightly in cadence relative to the steps listed above. But in the spirit of education and preparation, which we believe is important for prospective sellers, the above steps will help familiarize owners with stages in the deal process, which will ideally give owners confidence as they approach a most important event in the entrepreneurial journey.
