Exclusivity/documentation is the final phase of the sales process. This phase occurs when a seller goes exclusive with a single buyer. We generally have received several bids and determined the winner of an auction. Both parties sign a letter of intent (“LOI”) at this phase, and the seller agrees not to provide information or engage with any other potential buyers. The seller is essentially going off the market, which can be a bit scary because, if the deal does not move forward with the exclusive buyer, we will have to go back to the other bidders. We keep the other bidders warm and engaged in a limited fashion to ensure that we have backups.
TASKS COMPLETED DURING THIS PHASE
We work through confirmatory due diligence during the exclusivity and documentation phase, which often involves a buy-side quality of earnings report. Other components of confirmatory diligence include HR, accounting, tax, compliance, regulatory, legal, and IT. Running these workstreams in parallel is critical to minimize time to close. Also, confirmatory diligence is a big undertaking, and sometimes the knowledge level about the company needs to go beyond the deal team that has been involved to date. At this stage, other people in the company may need to be made aware of the transaction (e.g., sales management, IT, HR, etc.), which can be tricky.
During this period, we also negotiate, finalize and execute the definitive purchase agreements and work through any related regulatory tasks to close.
The time from signing the LOI to closing varies depending on the industry. For example, some deals may need regulatory approval or use complex accounting methodologies, which would require more time. We generally put 30 to 45 days in the LOI with a provision that both parties can extend the period of exclusivity by mutual consent based on putting forth best efforts.
The time from signing the legal documents to closing can be 30 days or longer, depending on the different types of approvals. For financial services deals where there is generally regulatory approval, it is often 30 or 60 days. During this period, the seller and buyer essentially both own the company, which creates challenges in the documentation phase.
The seller can expect to pay for tax counsel or tax accountants if there is tax work to be done, an attorney to assist with negotiating terms, a tax lawyer, and other types of professionals. Buyers can expect to encounter fees from legal, accounting, consulting, IT, technology consulting, and HR consulting.
The ballpark cost for these services for a seller is anywhere from $75,000 to a couple hundred thousand. A buyer can spend a couple hundred thousand easily on diligence for a middle market transaction that is valued at $75 to $125 million. Generally, the seller pays for the seller’s costs, and the buyer pays for the buyer’s cost. In a rollover deal, where the company is getting bought by a sponsor, the surviving entity ends up absorbing costs from both sides.
Pitfalls that we have seen during the exclusivity/documentation phase include:
- Indemnification, which reps and warranties insurance can mitigate. For more information on rep and warranties, listen to Colonnade’s podcast episode 010: Escaping escrow: Reps & Warranty Insurance.
- Determining who owns the intellectual property. To mitigate this risk, we address this issue early in diligence
- When the buyers want to speak with the seller company’s top clients; we try to delay that conversation until as late as possible. We want to get to the point where we feel comfortable that we have covered all the major issues, and we’re likely to close
- When two parties have different views on tax regulations
Exclusivity/documentation is the final phase of the sales process, but as you can see, there’s a lot of work yet to be done. In fact, there are still many challenges of this phase of the sales process that must be simultaneously and actively managed. Our job at Colonnade is to manage this complex set of workstreams and successfully close the deal. Then, it’s time to celebrate.
For more on the exclusivity/documentation phase, listen to the Middle Market Mergers & Acquisitions podcast episode 017 here: https://www.coladv.com/podcasts/017-pick-your-partner-the-exclusivity-phase/