Startups + Formation

Each month, Eric Duffee looks at a different piece of The Anatomy of a Deal – a series of easy-to-digest articles that break down complicated aspects of business transactions – helping you better understand terms + processes that can shape the direction of your business.

Every deal takes on a life of its own, which is part of the satisfaction – and sometimes the challenge – of doing a deal. This month, we take a look at a typical life cycle of a deal. Successful deals take months of preparation and execution, and involve a number of different players.

This article looks at deals where the seller has engaged an investment banker to run a full “auction process.” When there’s no investment banker involved, some of these steps won’t apply, as noted below. In addition, sometimes there may be additional – or fewer – steps in any given case, and sometimes your advisors may decide to change the order of operations somewhat. Just as every deal is different, the specific strategy used in any case may also be different.

1. Getting Ready

We’ve covered this before in prior installments of this series, so I’ll spare you from reading it all again. Suffice to say here, it’s critically important to get yourself and your business ready to do a deal before engaging in any sale process.

2. Engagement of Investment Banker

Then, the seller finds and engages the right investment banker. The role of the investment banker is to provide financial and valuation analysis, to market the business through an auction process, and to facilitate due diligence and closing.

In selecting the right investment banker, it’s important to understand what value they bring to the table, including their experience in completing similar deals and their understanding of the industry. Investment bankers aren’t cheap, but good bankers should generate great value that warrants their fees. For that reason, however, it’s very important to be sure you’re engaging the right banker. Oftentimes, it’s worth interviewing more than one banker.

After selecting the right investment banker, the seller and the banker negotiate the banker’s engagement agreement. This agreement is critically important to both the banker and the seller and should be negotiated with the assistance of counsel who is familiar with these engagements.

3. Banker Due Diligence + Initial Marketing

Once the investment banker is engaged, the banker completes a deep dive into the seller’s business and financials. The preliminary goals are to gain a strong understanding of the business and to develop valuation expectations. Then, using this information, the banker develops a teaser and a confidential information memorandum (CIM), which will ultimately be shared with interested bidders.

The teaser – as the name implies – provides a very high-level overview of the business and is shared with a relatively large number of potentially interested parties (as determined by the investment banker). The teaser often does not identify the seller by name, but it gives some high-level background about industry, location, and financials. However, if the business is very unique, it may be hard to maintain confidentiality even in the best of circumstances.

After receiving the teaser, there (hopefully!) will be some interested potential buyers who want to know more. The investment banker will have a number of high-level conversations with potential bidders to test their level of interest and ferret out those who are serious enough to receive a copy of the CIM.

The CIM is a much more detailed document that generally does disclose the seller company and its financial information. For that reason, before sharing the CIM with anyone, the investment banker will first enter into the…

4. Confidentiality Agreement

The CIM is full of very sensitive information, so a strong confidentiality agreement should be in place before sharing it. If you’re not using an investment banker, the confidentiality agreement is generally the first real step in the sale process.

It’s important to make sure that you have a robust and enforceable confidentiality agreement. Even if the potential buyer is offering up its own form of confidentiality agreement, you’ll want to make sure to have that agreement looked at by counsel experienced with these deals. There are some unique issues in sale transactions that make a one-size-fits-all confidentiality agreement insufficient.

5. Preliminary Due Diligence

Once the confidentiality agreement is signed, preliminary due diligence begins in earnest. However, due diligence should generally be viewed as a phased process, whether or not you’re engaging in an auction process.

Particularly in an auction process where you have multiple bidders, you don’t want to be sharing your most sensitive information with a large number of people, some of whom will certainly not acquire the business. Some of the interested bidders may also be competitors. While confidentiality agreements are important, remember that they have to be enforced. The best strategy is not to share sensitive information until absolutely necessary, and when there’s greater confidence that a deal will get done.

Using this data, the interested bidders are ready to submit their…

6. Preliminary Indications of Interest

The next step in an auction process is for the interested potential acquirers to submit the preliminary indications of interest (IOI). Think of this as a “lite” version of the letter of intent (LOI). It will include a preliminary value (or oftentimes, a range of values) the potential buyer has assigned to the business based on its limited due diligence. For that reason, it’s even less certain than a LOI. The purpose of the IOI is to further narrow down the number of potential bidders that will continue to the next stage of the process...

7. Management Presentations/Further Due Diligence

After the IOIs have been evaluated, a relatively small number of bidders will be invited to participate in management presentations. These are face-to-face meetings between each bidder (separately) and the seller’s executive management team to give further details regarding the business and its prospects. In addition, those same bidders are generally given additional due diligence information to help them formulate their offer.

From this, bidders should be able to make a determination regarding a potential deal and be ready to submit their…

8. Letters of Intent

We’ve covered LOIs in prior installments, so I’ll spare you the details here. The LOI is much more detailed than the IOI and becomes a critically important point in the process where the seller must pick one potential buyer with which to go exclusive.

For the reasons we’ve discussed previously, you need a good letter of intent even if you’re not going through the auction process.

Once you’ve picked the buyer to go into LOI with, we begin…

9. Confirmatory Due Diligence

At this point, the buyer gets mostly unrestricted access to all of the seller company’s material information, including the sensitive stuff. That said, you still want to manage this process to make sure that it’s efficient and appropriately staged. For example, you may still want to withhold certain super sensitive information until just before closing. You’ll also want to limit who they can talk with and when. While there’s more hope that the deal is going to get done at this stage, deals can fall apart at any time.

While this stage is ongoing, it’s typical that a parallel process is also ongoing…

10. Negotiation of Definitive Agreements

During this stage, the lawyers work on turning the parties’ intentions into binding deal documents. It usually takes a few weeks to fully-negotiate and complete the documents, and there can be some tension here. We’ve talked about deal terms elsewhere, but it’s important to remember that you want experienced deal advisors involved and working together to make sure you get your money…and keep it!

In many cases, it’s advisable to include drafts of the key deal documents in the final bid package and ask each bidder to provide a proposed mark-up of the documents. This data point will help differentiate between bids that are relatively close and give you a better sense of how likely you’ll be able to get to closing with each bidder. We’ve seen many cases where a seller chooses a buyer that actually had a lower bid price because their proposed transaction terms – as reflected in their response to the draft deal documents – are much better than the higher bidders.

11. Closing

Closings usually aren’t as dramatic as you might think – though there are always some exceptions. Drama at closing usually isn’t a good thing.

There may be a lot of last second scrambling to get everything done. But at the end of the closing day, the buyer owns the business and the seller gets paid. Time to celebrate!

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All in all, you can expect a sale process to take several months to complete, though good pre-planning and execution will help to make things go as quickly and efficiently as possible.

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Next Month: Representation + Warranty Insurance

Read last month’s piece: Transaction Structures – Part 2: Mergers