What Are the Stages of a Deal?

January 1st, 2005

With few exceptions, the more one knows about a subject, the less daunting it is. As most owners have never sold a business, any apprehension is understandable. We believe it’s important to understand the typical components of a deal so that owners contemplating a sale can become comfortable enough to embark upon this journey when they are ready. And it is a journey. Each transaction is different and comes with it’s own special circumstance. To illustrate this process, we’ll include information about one of our firm’s recent transactions, and to maintain confidentiality, we’ll call the selling company "ABC Company".

Preparation of the Information Memorandum
Sometimes called "the book" or "the memorandum", this piece describes the company so buyers can gain an initial understanding of the opportunity. It can be 10 pages or 75 pages, or you and your advisor may choose to limit it to just 3 pages, with additional information to be provided at a later date to serious buyers only. For ABC Company, we prepared a traditional book that included key details about its History, Clients, Markets, Services, Systems and Financial Performance. Most of the client names were left anonymous to protect confidentiality, with only a few being listed by name because they could further a buyer’s interest by knowing their identity. An important part of describing the financial performance is illustrating what the true cash flow of the business would be under new ownership. This is necessary given the "perks" enjoyed by many owners of mid-markets businesses. Knowing which obvious and not-so-obvious items to look for is essential to this process. In the case of ABC Company, our client had favorable growth trends in terms of revenue and profit.

Determine Which Buyers To Approach and How To Approach Them
Simultaneous to preparing your information, you’ll need to determine who, from the "universe" of buyers, you will approach. Depending on the size of the company, it may only make sense to approach industry buyers, or perhaps financial buyers or buyers from related industries will be included in the process. At the risk of sounding self-serving, it is truly to the seller’s benefit to have an M&A advisor that specializes in your industry. For instance, a specialist will already know many of the potential buyers for your business, which means they won’t need to broadly market your business, thereby reducing any possible confidentiality issues. Additional buyer research should also be done.

You will also need to determine your approach to the buyers you select. Will you approach just one buyer? A limited pool of buyers? Or will you approach a wider group to ensure maximum value? Each of these has pro’s and con’s and each can be very effective under the right circumstances.

For ABC Company, we approached a moderate sized group of very qualified buyers to create competition. Because of our experience in the industry, we knew who would be interested and why, how they typically structure deals (ie. Cash and other components), how quickly they can close deals and the resources available to them.

Approach buyers
Once the information is prepared and the buyers are identified, a process that can take up to a month, the exciting part begins. The actual approach to buyers can be done via the telephone, by e-mail, mail or by fax. It’s typical for this to be done anonymously, with a brief description of the opportunity that’s interesting enough to gain their attention, but not so detailed as to divulge the identity of the seller. For ABC Company, we approached prospective buyers by e-mail primarily and asked them to reply or call us if interested.

Confidentiality Agreement
An extremely important aspect to any deal is keeping it under wraps. Interested parties who respond to the initial approach are immediately asked to execute a confidentiality agreement. This document is intended to give the seller assurance that the buyer will not divulge its confidential information to anyone outside of its acquisition team for a specific period of time, usually one to three years, and in case information is disclosed, it gives the seller legal recourse.

Once the confidentiality agreement is executed, both parties and their advisors are usually comfortable enough to speak freely about the details of opportunity. If the buyer appears to be qualified in terms of both their interest and their financial ability, the information memorandum is sent to them for review.

Q&A With Buyers
It’s a rare occasion when a buyer will submit an offer for a company based solely on the information memorandum. They often have additional questions about the company. During this period of Q&A, it’s essential for the seller to stay focused on their business and only divert their attention when necessary. Buyers will go about gaining further information in different ways:

  • Some buyers will submit their questions and base their interest level on the answers,
  • Some buyers will request a conference call with the shareholder and/or management, and
  • Some buyers will request a meeting or a site visit at the office(s).

During this stage, the goal is to determine which buyers are truly interested and will distinguish themselves from the pack, by expressing a higher level of interest and ultimately submitting an offer. If using an M&A advisor to assist in the sale, the use of deadlines throughout the process is typical in order to keep the process moving (ie. to execute confidentiality agreements, to receive buyer questions, to receive initial offers, etc.).

In the case of ABC Company, we received multiple lists of questions from interested buyers, some of which were answered via e-mail and others that were answered in conference calls with the shareholder. In that particular case, our client was willing to schedule conference calls with prospective buyers in the hope that it would speed up the process by not only providing answers to their questions but also allowing them to talk to the shareholder directly and ask any follow on questions that arose.

Offers / Letters of Intent
After receiving answers to their questions, interested buyers will be asked to submit an offer to acquire the company, indicating the price and terms that the buyer is willing to pay. To accomplish this, some submit a letter of intent (LOI), which often has a legal format to it, while others submit a less formal offer either verbally or in writing simply indicating the price and terms but omitting any "legalese". In either case, the offer is non-binding and is subject to confirmatory due diligence of the company information already received.

For ABC Company, we received a total of six offers, which is an impressive amount in any deal and particularly this one, given the limited group that we approached and the fact that increased competition among buyers always ensures that the seller will receive maximum value. Three of the offers we received were in LOI format and the other three were verbal

If multiple offers are received, buyers may be asked to submit a "best and final" offer and may be invited to visit the office in order to do this, or may be provided with updated financial or other information.

Ultimately the seller will select one buyer with which to move ahead and close the transaction.

Due Diligence
Once an LOI is signed with one buyer, the process of confirmatory due diligence begins. In this process, the buyer scrutinizes all the aspects of the company with the goal of confirming what has already been presented. They will want to review client and vendor contracts, licensing, systems, staff, benefits, visit the office(s)…Everything! They will also want to meet with your accountant to review financial statements.

The signing of the LOI is also when "the clock" starts ticking. In other words, the LOI will stipulate that the deal must close within a specified timeframe, during which due diligence will occur. If the deal doesn’t close within that timeframe, the LOI expires and everyone can go back to their business of either talking to other buyers or searching for other sellers, as the case may be.

We also recommend that sellers do a fair bit of due diligence of their own, prior to signing the LOI, to make sure they know the buyer and understand their intentions after the sale. This is particularly important if the seller will remain at the company post-sale for any period of time.

As ABC Company had multiple offices, site visits needed to be carefully coordinated. While those visits were taking place, the buyer’s financial team worked with the Company’s accountant to review the financial performance and understand all the details. All of these items needed to occur, including approval of the due diligence findings, within a timeframe specified in the LOI.

Definitive Purchase Agreement and Other Agreements
While due diligence occurs, the transaction attorneys for both buyer and seller will draft and negotiate a definitive purchase agreement. The word "definitive" is used because it is the governing document over the proposed transaction, and if an item is not stipulated in that agreement, it’s simply not part of the deal. In addition, other agreements that are often included in a sale and negotiated at this time include employment agreements and non-competition agreements.

Closing
Closing occurs after:

  • Due diligence is completed and approved
  • Financing is in place
  • Buyer and seller and their respective teams are fully satisfied
  • All agreements are executed

With an organized approach, a well-facilitated process and a little luck, the definitive purchase agreement is signed and the deal is closed. If cash (at closing) is part of the deal structure, it will be wired to the seller’s bank account at that time. As a final part of any deal, everyone shakes hands and moves on to the next phase in their lives.

This whole process often lasts four to six months, sometimes shorter, sometimes longer. With experienced advice to help you navigate the bumps in the road, you can significantly improve your chances for a successful deal and one that will bring you many years of lifestyle happiness and financial freedom. Knowing that, it’s not really scary at all, is it?

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