Purchase and Sale of a Business: Preliminary Agreements
For the purpose of this series, we’ll refer to the party selling the company as the owner, and the party acquiring the company as the purchaser. If you read about these transactions in other blogs or articles you might find the selling party referred to as the target company and the acquiring party as the acquirer.
In the preliminary stages of the purchase and sale of a business there are a few primary concerns: (1) the owner wants to make sure that the potential purchaser is serious, (2) the owner wants to make sure the secrets of his or her business are not compromised, (3) the purchaser wants to make sure the owner is serious about selling the business, and (4) the purchaser wants to make sure he or she is able to obtain enough information about the owner’s company to fairly evaluate the opportunity.
To address these concerns, parties often enter into the following preliminary agreements.
Non Disclosure Agreement
A non disclosure agreement, also sometimes called a confidentiality agreement or an NDA, is an agreement between the owner and the purchaser to not disclose information learned during the course of the purchase and sale transaction. The protection offered by an NDA allows each side to provide information necessary for the other to determine whether they are interested in proceeding with the transaction while minimizing the risk that the information will be used against them if the transaction falls through. NDAs can be one-sided, protecting only the owner’s business, or they can be mutual, in which case the owner would also agree not to disclose information related to the purchaser.
NDA’s are especially important when public companies are involved, or when the purchaser and owner are in the same line of business. When the transaction involves a public company, a mutual NDA is necessary as leaked information could affect stock prices for both parties, or potentially subject the parties to securities violations. When the purchaser and the owner are in the same line of business, the owner may be at a competitive disadvantage if he or she discloses trade secrets to the purchaser before the purchase is finalized.
A carefully drafted NDA should identify (a) what information is protected by the NDA, (b) how the disclosed information may be used, and (c) the circumstances under which the party receiving the confidential information may disclose that information to third parties.
Term sheets summarize the key terms of a potential agreement. Term sheets are not binding and are a relatively low-risk and convenient way of communicating preliminary deal terms. Term sheets are typically prepared by the purchaser and not signed by either party. The level of detail covered by a term sheet varies–it can cover many terms, or just the most basic terms. At a bare minimum the term sheet will address: (a) what is being acquired–stock or assets, and (b) the value and form of consideration–how much cash or stock owner will receive from purchaser.
Letters of Intent
Letters of intent can be used in conjunction with term sheets, but are often used as an alternative to a term sheet. Letters of intent are generally non-binding, but may include a few binding provisions. The letter is usually from the purchaser to the owner and signed by both parties. The purchaser will often want to include an exclusivity provision (sometimes called a “no shop” provision) which prohibits the owner from seeking other sellers for a limited time. Occasionally the exclusivity provision will be mutual, and the purchaser will also agree not to pursue an alternative acquisition.
Both the owner and the purchaser may decide to obtain the services of a financial advisor to help with the valuation issues surrounding the purchase and sale of a business. The engagement letter is an agreement between the owner or purchaser and the financial advisor. The agreement between the advisor and the owner or purchaser can be structured a number of ways (incentives for completion, price, accelerated purchase), but will generally cover the scope of the engagement–what, exactly, is expected of the financial advisor, the financial advisor’s compensation, and dispute resolution procedures.