By Jeanette Wade, Noseworthy Chapman
The actual decision to sell is one of the most important and fundamental steps in the sale process. Before exposing the business to the market, the vendor must clearly understand the sale process and the information they need to provide. All buyers and financers require accurate and timely financial information when considering an acquisition.
This chapter will highlight the essential documents business owners need to have when preparing for a sale.
Non-Disclosure Agreement (NDA)
When in the process of selling your business, do not forget the risks of sharing confidential information with other parties.
To protect your confidential documents, ideas, and data during the sale process, it is standard course to ask the other party to sign an NDA. Be careful of certain provisions that may be restrictive in terms of conducting business and/or approaching other buyers.
A potential buyer should sign this document, which usually includes a provision that applies the same responsibilities to the buyers’ employees and advisors.
The NDA will cover these basic elements:
- Identification of the parties
- What is defined as confidential information
- The obligations of the receiving party in terms of confidentiality
- Any exclusions from confidentiality
- The obligations in terms of destroying or returning confidential information
- Once both parties have signed the NDA, you can convey information to the potential buyer.
Conveying Information to Buyers
Information can be conveyed to buyers through:
- A teaser
- A confidential information memorandum (CIM)
- Due diligence through:
- A data room/portal
- In-person interviews
- Facilities tours
Detailed due diligence is generally conducted after entering into a Letter of Intent (LOI).
Companies selling their business may wish to use a teaser as a marketing tool.
A teaser is a one- to two-page summary of a business being offered for sale, without mentioning the name of the selling company to maintain its confidentiality. It should include the business’ unique selling points to attract interest. This document should be kept short, professional, and factual.
A teaser should include the following information:
- Industry overview
- Business description
- Financial summary
- Customer overview
- Transaction structure
The financial summary is one of the most important parts of the teaser, as many potential purchasers will only invest in businesses that fit a certain financial profile. The financial summary will generally provide forecasts of the business’ EBITDA and other financial metrics.
Confidential Information Memorandum (CIM)
A CIM is a marketing document that provides potential buyers with more detailed information than a teaser. This document is used to market the business and help to sell it for maximum value.
A CIM should include the following information:
- Executive summary
- Overview of the market
- Overview of the business
- Products and services
- Revenue sources
- Customer profile
- Employee profile
- Financials – historical and projections
- Management structure
- Transaction structure (e.g., sale of assets versus shares)
Once a potential buyer reviews the CIM and shows interest in purchasing, they would have an opportunity to request additional information and potentially meet the seller’s representatives.
Letter of Intent (LOI)
The LOI acts as a catalyst to advance the acquisition process after a potential purchaser has completed their review of the CIM and other information gathered while considering interest in the business.
The document is of a legal nature; however, it is not usually intended to be fully binding, unless otherwise expressly stipulated. The LOI will create certain binding obligations on one party or the other, particularly regarding confidentiality and exclusivity. It is often used to clarify which key points of the deal must be negotiated and to protect all parties involved in the deal.
An LOI should include the following information:
- Purchase price (subject to the completion of due diligence)
- Commitment from the seller to provide all necessary due diligence information
- Terms of confidentiality and communication
- Amount on closing, holdbacks, and payment terms for a vendor takeback
- Structure of deal (e.g., shares, assets, combination)
- Non-compete terms
- Salient terms of any management contracts
- Conditions of the offer
- Timing of closing
- Duration of the exclusivity period of the negotiations (i.e., the period in which the seller agrees not to solicit or consider other offers for purchase without first speaking to the buyer)
- Due diligence period
- Adjustments to the purchase price based on the value of assets and amount of liabilities being assumed on closing
- Standard and non-standard representations and warranties of the purchaser and the seller
Once this document is completed, the detailed due diligence process will begin in earnest.
Due Diligence Process
During the due diligence phase of a business sale, buyers and advisors (e.g., accountants, financers, lawyers) request a significant amount of financial information about the company.
Due diligence is conducted to:
- Confirm and verify information that was provided prior to entering into an LOI, such as the quality of earnings
- Identify potential defects in the acquisition opportunity to avoid a bad business transaction
- Obtain information that would be useful in valuing the deal
- Ensure that the acquisition opportunity complies with the buyer’s acquisition criteria
Information gathered during the due diligence process includes:
- Corporate governance, organizational, and capital structure
- Management and employee details
- Financial and tax information
- Regulatory and environmental matters
- Legal issues
Corporate Governance, Organizational, and Capital Structure
This involves a review of the business’ organizational documents and corporate records where the transaction structure is a share purchase and sale. Examined information can include:
- Minute books
- Existing shareholder agreements
- Policy and procedures manuals, administrative policies, and other manuals
Management and Employee Details
This involves a review of the documents relating to the company’s management and employee base. Examined information can include:
- A list of the company’s current employees and independent contractors together with their start dates, position description, and base compensation
- Documents representing any material bonus, retirement, profit sharing, incentive compensation, pension, and other employee benefit plans, policies or agreements
- Any plans or arrangements providing insurance coverage, benefits, supplemental unemployment benefits, managers’ insurance, severance pay, vacation pay, deferred compensation or post-retirement insurance, or educational fund
Financial and Tax Information
This review includes the examination of historical financial statements and related financial metrics, as well as future projections, where available. Examined information can include:
- Business history and current economic environment
- Documentation detailing internal controls and workflow processes
- Projections and/or budgets as prepared by management
- Three years of historical financial statements
- Three years of tax returns
- Detailed asset lists and appraisals
- List of material contingent liabilities of the business
- Customer and market analysis
- Competitive analysis
- Trend analysis
- Business website and advertising programs
- List and description of all material insurance policies relating to or entered into by the business
The information examined during due diligence would include, where applicable:
- Banking agreements
- Equipment financing agreements
- Related security
Regulatory and Environmental Matters
This involves a review of environmental issues facing the business and how they may affect the business. Examined information can include:
- Hazardous substances/materials used in the business operations
- Environmental permits
- Environmental claims or investigations related to the business
- Contractual obligations relating to environmental issues
A potential buyer will want the following information with regard to pending, threatened or settled litigation:
- The nature of any pending or threatened litigation
- Claims, if any, against the business
- Settled litigations and the terms of settlements
- Governmental proceedings against the business
Challenges in the due diligence process may include:
- Not knowing what questions and/or information to ask for
- Slowness of execution
- Lack of communication
- Lack of expertise
To efficiently conduct due diligence, follow these useful tips:
- Use due diligence management software (e.g., iDeals, DealRoom, Sharevault)
- Start as early as possible
- Follow due diligence checklists
- Address potential risks throughout the process
- Employ a well-rounded group of professionals, including accountants, lawyers, and financers
The key to a successful due diligence process is to control the flow of information and timing of responses required. Selling a business has many complexities – every deal is unique.