Sell | 8 January 2018

M&A exit: how does it work?

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For most startups and emerging companies, being acquired is the most common form of exit. There are many ways for founders to exit their businesses (if you’d like to know more, please see our article What are my exit options?) but a sale process is more likely than taking the company public through an IPO.

If you’ve been following our suggestions, your business will be well-prepared internally for an exit (if you need a reminder, please see our article How do I prepare for an exit?). This article will give you an overview of the steps involved in a sale process. Most sales processes follow the same pattern, whether they be a share sale, asset sale, acquihire or merger, but there are different activities depending on your exact circumstances. Familiarise yourself with the path to completion before you approach potential buyers.

Step 1: First contact

Like most first dates, a sales process begins with informal discussions which focus on fit, feasibility and tentative exploration of value rather than detailed discussions on structure or terms. Some larger emerging companies may engage business brokers or investment bankers to seek out potential buyers and guide you in your initial meetings with them. Buyers may also come to inspect your premises and want to see your financial statements.

Step 2: Confidentiality Agreement and Non-Solicitation

If you are sharing sensitive information with potential buyers and their advisors, you should enter into confidentiality agreements for protection, particularly if the sale does not complete. You don’t want potential buyers to walk away from the deal and use your confidential information for their benefit, particularly if they are a competitor. If you’d like to know more, Confidentiality agreements: what you need to know provides an overview of these agreements and contains links to the two forms of ScaleUp Confidentiality Agreements. Consider whether a non-solicitation arrangement is needed: this is designed to prevent a potential buyer from poaching key members of your team.

Step 3: Due Diligence

This is where things start to get serious. A potential buyer will learn everything it can about your business by sending a due diligence questionnaire requesting various documents and details about your business including company records, financial statements, key agreements, intellectual property information and details of any disputes or litigation. Buyers are looking for anything they can point to which may influence the purchase price, conditions to completion and any warranty or indemnity protection they require.

If you’d like to know more, What is a due diligence questionnaire? has more information on what a potential buyer may ask to see.

Step 4: Term Sheet

Putting pen to paper. You have probably already survived this phase during an earlier investment round (if you’d like a refresher, Equity financing: how does it work? has information on term sheets). The term sheet will summarise the key commercial terms of the sale transaction and the negotiation of it is where the deal value will be determined. A buyer may impose an exclusivity provision in the term sheet so that you cannot engage in discussions with other potential buyers for a prescribed period. Once signed, a term sheet with an exclusivity provision moves a significant amount of bargaining power to the buyer. Your lawyer will help you ensure that the term sheet accurately reflects the agreed position on the commercial terms: it can be difficult to reopen these points later.

Step 5: Sale Documentation

The formal sale documentation is negotiated and drawn up, based on the term sheet. To protect your interests, minimise risks and ensure you comply with your obligations, you should hire a lawyer experienced in the sale of businesses. Once the sale documentation is signed and exchanged between the parties, the lawyers can begin preparing for completion.

Step 6: Deposit

At last, some money starts to flow! Sort of. A well-drafted sale document will require the buyer to pay a deposit for the purchase. However, most experienced buyers are likely to insist on the use of a third party to hold the funds before completion. This may be in the lawyers’ trust account or a third party who holds the funds “in escrow” prior to settlement of the transaction. Under an escrow arrangement, the funds will only be released to the seller once certain obligations are fulfilled.

Step 7: Pre-Completion

The length of this pre-completion period will vary, depending on the number and nature of conditions that must be satisfied for completion to occur. These conditions may include obtaining the necessary government or third party approvals, consents and licences; key employees entering into employment agreements with the buyer; and board/shareholder approvals of the buyer and seller. The buyer may complete any outstanding due diligence (for example, if particularly sensitive information has been withheld by the seller until after the sale documentation has been signed).

Step 8: Completion

Finally, the moment has arrived! Once the conditions have been satisfied, or waived, the transaction is ready to complete and money changes hands. For a share sale, the shares are transferred to the buyer and the buyer’s name is entered into the share register. For an asset sale, the business assets are transferred into the buyer’s name. The buyer pays the outstanding balance of the purchase price, and any funds held in escrow are released, to the seller.

Step 9: Post-Completion

You may not be able to sail off into the sunset immediately after completion. A sale usually involves a transition period where the buyer must integrate its business with yours to realise the synergies they sought. The sale documentation may set out transitional arrangements requiring you to provide ongoing services and your expertise to the business to help smooth this transition. These services may be provided for a fee or you may be subject to an earn-out or other mechanism to incentivise you to continue assisting the business. As a seller, it is critical that you inform your lawyers of your future plans so that any earn-out and/or transitional arrangements you are agreeing to in the sale transaction do not unnecessarily restrict your actions after completion.