The Term Sheet – Preliminary Negotiation for a Sale
This Part of the Selling Your Small Business series discusses The Term Sheet, an extremely important agreement created early in the negotiation process between a potential buyer and a business owner. The Term Sheet is a list of key terms the buyer and seller agree upon on a non-binding basis, although, as discussed below, certain provisions are expressly made binding.
The negotiation of the Term Sheet determines whether it is worth the parties going forward and spending the time and incurring the cost of the purchaser’s full investigation of the company (referred to as “due diligence”) and the complex negotiation involved in reaching a definitive deal and agreeing upon a merger agreement. At this point, the buyer and seller assume all aspects of the business are as represented by the seller and no issues or impediments will emerge; if the parties can agree to a price and other fundamental terms on that basis, then they can conclude it is worth going forward. The key terms set out in the Term Sheet include, among others:
- a tentative price,
- an anticipated closing date (e.g., within some number of days from the execution of the Term Sheet),
- a description of what will be transferred by the seller (i.e., specific assets or stock),
- the manner of paying the purchase price (e.g., the number and timing of installments, basic terms of an earnout, any amount held back for contingencies, etc.),
- conditions to closing (e.g., what must occur before the deal can close, such as the buyer obtaining financing or the receipt by the seller of certain opinions of counsel, etc.), and
- how the expenses of the buyer’s due diligence and the negotiations will be allocated (e.g., each party pays their own or some allocated disproportionately to one party or the other).
Binding Terms of the Term Sheet
The Term Sheet expressly states that it is non-binding, save for certain terms that are expressly made binding. To the extent they are included, the binding terms generally include confidentiality and exclusivity, each of which is discussed briefly below:
- The seller will be providing substantial information to the buyer about its business, strategies, trade secrets, products, customers and suppliers, as well as confidential financial information. As a result, the buyer should require the seller to agree to confidentiality, either in the Term Sheet or in a separate agreement incorporated in the Term Sheet as an attachment. Further, in some instances both the buyer and seller may wish to keep confidential the fact that the owner is considering a sale or that the parties are in negotiation, and may make this confidential as well.
- Confidentiality provisions must be carefully drafted given the importance of the information they protect to the business. Without going into great depth, the confidentiality agreement from the seller’s perspective should:
- include a broad definition of confidential information conveyed in writing or orally,
- protect confidential information disclosed before or after the date of the agreement,
- allow disclosure on a need-to-know basis to the buyer’s agents (attorneys, accountants, etc.), provided the buyer is liable for disclosure by those agents (as well as the buyer’s and its agents’ employees), and
- preclude the buyer and its agents from not only disclosing confidential information, but also from using such information in its own business and commercial endeavors.
- The buyer will seek to include a provision that prohibits the owner from seeking other buyers or from discussing terms with unsolicited buyers that come forward. The buyer wants exclusivity in recognition of the time and expense of its evaluation of the business leading up to a final deal, and seeks to prevent another buyer from coming in at the last minute and undermining the negotiations with the seller.
- Buyers will want a longer exclusivity period, but in a small business acquisition an owner will want a short period, potentially as short as seven to fourteen days. If the buyer is obstinate and demands a longer period, the seller may seek an exclusivity fee. This fee is paid to the seller but is taken off the ultimate purchaser price if a final deal is reached; thus, the seller is being compensated for the inability to seek other deals for a period of time.
- The seller will also want to negotiate circumstances in which it can break exclusivity and consider or seek other offers (e.g., if the offer price is changed below a certain level, if fiduciary duties require that the seller consider other deals, etc.). Conversely, a buyer will often seek a financial penalty if the seller breaks exclusivity, an amount referred to as a “termination fee” or a “break-up fee”.
- In summary, exclusivity is common, but a seller must weigh the attractiveness of the buyer’s offer, the perceived ability of the buyer to obtain financing and otherwise complete the purchase, and the likelihood of better offers should the seller continue seeking a buyer.
Although it may be tempting to hammer out key deal terms without counsel, legal representation at this stage is highly recommended. At this point in a deal, a lawyer can help an owner understand what terms are common and within an accepted “market” standard.
Also, decisions made at the Term Sheet stage can implicate the owner’s fiduciary duties to other shareholders or can trigger statutory or contractual rights of non-selling shareholders. Legal counsel can help the owner navigate these duties and rights, as a failure to satisfy fiduciary duties or account for other shareholders’ rights can have significant adverse consequences even after a deal goes through.
In addition, the sale of a business may require additional actions, including regulatory filings or other steps depending on the size of the company, the number of shareholders, the industry in which the company operates, and other factors. An experienced attorney can assist an owner in meeting all of its obligations.
As noted in Part I of this series, the sale of a business represents the owner’s last and best opportunity to recognize the value of the business, and careful planning and competent counsel can make the difference between the owner’s successful exit and the owner spending his retirement in a legal and financial morass.
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