3 Initial Steps in Responding to an Unsolicited Offer for Your Business
The transaction data for 2016 indicated record numbers for multipliers to EBITDA (Earnings Before Interest Taxes Depreciation and Amortization - a key cash flow metric for mergers and acquisitions) in the middle market. How should you respond to strategic buyers or private equity sponsors?
Step 1 - Is a Non-Disclosure Agreement (Before You Provide Financial Information)If you express an interest in considering a sale or merger, the prospective purchaser will begin to ask for financial information and operational data to formulate the transaction structure and purchase price. Before you begin to provide this type of confidential and proprietary financial information to the prospective purchaser, a good non-disclosure agreement is important (particularly if the prospective purchaser is a strategic buyer and competitor in the industry). As a practical matter, protective language and appropriate remedies are important, but you don't want to have to file suit to protect certain critical information from an industry competitor. It is equally important that you engage experienced legal counsel who will be able to advise you regarding the appropriate point during the transaction process to disclose specific customer and operational information. Recently, a strategic suitor requested detailed employee information early in the due diligence process, and we suggested that a summary of job description, years of service and other information would be more appropriate until the terms of the transaction were thoroughly negotiated. These companies openly competed for talented professionals, and it was too early in the process to share detailed employee information to an aggressive competitor. Get your Non-Disclosure Agreement signed and protect your competitively-sensitive and critical information.
Step 2 - Understand the Proposed Deal StructureTypically the prospective purchaser will prefer to purchase the assets of the business, because it limits the purchaser's exposure to undisclosed liabilities and the tax treatment can be more favorable for the purchaser (an opportunity to depreciate assets). On the other hand, the seller may prefer to sell the stock/equity of the business for the tax advantages of capital gains treatment. Regardless of whether the transaction is structured as an asset deal, stock deal or recapitalization, a clear understanding of the deal structure is critical to maximizing value, including whether the purchase consideration contains equity in the purchaser. Exchanging equity requires additional due diligence on the purchaser, and a determination of relative values of the combining entities.
Step 3 - Negotiate the Letter of IntentThe Letter of Intent is the third step to kicking off full transaction due diligence (financial and legal due diligence) and the negotiation of transaction documents and closing deliverables. It is critical that the seller understand the binding and non-binding terms of the Letter of Intent. It is also important, from a psychological perspective, that the terms of the Letter of Intent accurately reflect the material terms of the proposed transaction. Even though the terms may be non-binding, it is difficult for good people of conscience to overcome a later argument over disputed terms when the prospective purchaser points out that the purchaser signed a Letter of Intent outlining the disputed terms. For this reason, it is important that experienced legal counsel is involved early in this process. If there are legitimate reasons for a structural change in the transaction, it is simpler to make the changes before any documents are signed.