Contents
“The worst financial transaction you will ever make is to sell yourself short.”
Greg Gilbert
The Components
From the first thoughts about selling your business through to the final documentation is quite a journey. The exit process culminates with the signing of lots of documents, transfer of funds and handing over the keys. Here’s what to expect.
Getting exit ready might feel like a hard job but it’s just the “getting started” stage of the whole exit process. Let’s call it phase 1. Phase 2 is the decision to sell or transfer ownership, which includes getting your Information Memorandum together and finding some eager buyers who are willing and able to acquire your business for terms that are acceptable to you.
These 2 phases are infinitely easier than the final phase, though it won’t feel like it at the time. The real hard work is in getting the deal across the line and completed.
There are lots of free resources to guide you through a typical deal structure if you know what to Go“google”. One of the best resources I found in plain language is the Midexo Guide to Due Diligence, which clearly outlines their approach, illustrated below:
- Strategy
- Target Identification
- Confidentiality Agreement (NDA)
- Valuation
- Letter of Intent / Heads of Terms
- Due Diligence
- Deal Structure
- Negotiation
- Contracts and Share Purchase Agreement
- Deal Close
Heads of Terms
Ideally you want to have several indicative offers to choose from. These need to be carefully qualified and filtered. Having a choice is a great position to be in because you can start with the one that offers you the best terms for you and potentially put any others that are attractive on ice for a short period.
Heads of Terms (HoT) sets out the commercial terms on which the deal proceeds. Though not legally binding (in most cases), it outlines terms not just the price. It includes some expected conditions that the buyer has identified as critical to a successful acquisition for them. The document usually crystalizes after a bit of to and fro between buyer and seller. It isn’t just a declaration from the buyer, it’s the culmination of initial negotiations.
The main purpose of the HoT is:
- Written confirmation, in principle, of the main terms agreed
- An outline of the timetable
- Clarity of the obligations of both parties during the negotiations
- A guiding framework for the final legally binding contract
Before settling on the HoT, it’s the opportunity to ask lots of questions and not make any assumptions. As always if in doubt, clarify. It’s a lot harder, though not impossible, to clear up misunderstandings later in the process. It’s always more expensive later in the process.
The HoT typically include:
- Purchase price, timing and methods of payment
- Performance criteria for final payment / price
- What’s included and what’s excluded in the deal
- Who is responsible for costs, including any legal requirements such as lease transfers and contract assignments?
- Post completion restrictions on the seller
- Timetable for the transaction (you don’t want a DD to be endless)
- Period of exclusivity
- Confidentiality, during the process and if the deal isn’t completed
Once a HoT is agreed, there is a period of exclusivity where other offers are held at bay while the due diligence period starts. Whilst, on the whole, not legally binding, certain clauses have legal force, such as confidentiality and relating to who pays costs of the subsequent elements of the transaction. The HoT is the agreed principles and intentions of both parties.
Due Diligence
The exit planning path is fraught with twists and turns and becomes extremely perilous when the due diligence (DD) process starts.
Due diligence is a forensic analysis of your business that starts with a number of checklists consisting of over 2+200 questions (sometimes extending into thousands). The questions look at the intricate details of every facet of your business. At some point in the process, you are guaranteed to get to the point where you ask, “How much more do they want to know?” and “When’s this going to stop?” It’s excruciating and stressful.
Being in good shape makes due diligence easier
Value is attributed to more than just the numbers in your business and the DD process identifies any weaknesses or risks that the buyer finds unpalatable. Knowing what the buyer is going to find BEFORE starting the process gives you a head start. It allows you to either fix things or be open about them rather than appearing defensive. Finding inherent weaknesses in your business allows the buyer to reconsider the offer price or build post-acquisition claw backs into the Sale and Purchase (SPA) Agreement.
One of the biggest success factors in the completion of an acquisition deal is seller preparation for a robust due diligence process. The more challenging the DD process is for the buyer; the more risk they apply to the investment and the lower value they place on it. It’s the reason they walk away before wasting more money on the process.
Due diligence is costly in terms of time, energy and money for both parties. Being unprepared as a seller leads to very high levels of anxiety and stress. Preparation and understanding of your business gives you a return on the investment of time and effort you have put in.
DD questions start off structured in the form of checklists. The checklists separate into a number of categories, depending on the needs of the buyer and the industry sector including:
- Financial
- Legal and contracts
- IT
- People / HR
- Tax / compliance
- Operations
- Environmental compliance
DD leaves nowhere to hide; it allows a buyer to pick apart the business, so they understand exactly what it is they are acquiring and how much effort they are going to have to put in to integrate it with their existing portfolio of investments and businesses.
What they uncover exposes elements of risk that they are unhappy with, and which are then used as an opportunity to reduce the offer price, request withholding amounts or even withdraw their offer.
Every due diligence process demands production of a comprehensive package of documentary evidence. All of the documents are gathered into a data room which is accessed by the buyer under the supervision of the sellers’ lawyers and corporate brokers.
Tracking all the documents, questions and answers becomes complicated very quickly. In pre-technology days the data room was a physical library of documents and paperwork, in hundreds of files. These days there are tracking tools and electronic repositories to make life easier. It still needs methodical and diligent management.
Getting through due diligence without a professional and experienced team is, at best, a challenge if not virtually impossible. Your preparation is essential to a speedy conclusion. The longer the DD takes the more stressful it is for both sides and the more likely the sale fails to complete. Preparation for a sale reduces the stress and frustration of the DD experience.
DD is where many deals collapse for any number of reasons. Sellers get tired of the endless questions that seem to add more questions with every answer. Buyers get frustrated with the lack of accurate information or changes in the answers. Buyers discover criteria or characteristics that don’t fit their acquisition profile etc.
The aim of DD is to evaluate the risks in the business. Accuracy and consistency of information about the target company gives a buyer comfort and reduces their perception of risks. It’s not just a paperwork and document gathering exercise. At some point the buyer is going to want to see the business and its people in real life. They want to experience the intangible aspects of the business such as its culture.
Increases in the perception of risk can require longer earn-outs or ties-in or a financial retention as part of the final contract.
If you, as the business owner, are conducting the DD process without the support of your staff then be prepared to scan, copy, and search for what feels like a million documents. I’ve personally felt more attached to the photocopier and scanner during the DD process than any other item, including my bed. Being prepared really pays dividends.
In the most prepared companies, keeping an up-to-date document library saves thousands during the sale process and costs 10-15 minutes a week in normal operations.
Any worries or concerns the buyer has in DD are translated into warranties and indemnities in the SPA. It is critical for the buyer to make sure that they understand the business and basis on which the purchase is being made. Any misunderstanding can have a disastrous impact after completion. Similarly, the seller wants to reduce any post-acquisition penalties. Lawyers earn their fees at this point, on both sides.
At the risk of repeating myself, preparation is king.
Specific interest is usually taken over:
- Property and leases
- Contracts
- Employees, especially terms and conditions
- Intellectual property
- Governance and compliance
- Outstanding litigation (or potential exposure to future litigation)
Are you stuck in the day-to-day of your business with no time to plan for the future? A Professional Business Mentor is just the leverage you need to get out of the rut and flying. Discover how you can make your business worth more AND avoid leaving money on the table when you finally leave your business. Click here to contact Christine by email alternatively you can book a call with the Business Mentor of the Year 2020, author and speaker. Who helps business founders get their businesses exit ready so they can enjoy a happier, richer future. She saves them THOUSANDS and increases the value of their businesses by MILLIONS.