Coming to terms with term sheets; How to proceed with mergers and acquisitions
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?
Answer: This is the stage where 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 an earnest money requirement, a lockup or non-marketing provision, an additional confidentiality requirement and/or perhaps a breakup provision.
Due diligence: The buyer’s investigation of your business, which was discussed in detail in the June 2018 Legally Speaking column.
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).
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 and more.
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, according to a study by consulting firm LEK, Boston, 60 percent 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 top 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 or her; if you hear it from the other side, remember it as this could be valuable.
The 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 as it is not complete.
The next step: As mentioned briefly, 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 then will 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 also may 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.
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 the hopes of saving a little money. This rarely has the desired effect. In fact, in both cases, it usually proves more costly, as attorneys generally are 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 that it’s a little like convenience store sushi. It might sound like a good idea at the time, but it can really cost you.
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.