Building a strong business to provide for, or pass on to, successive generations is the dream that motivates many successful entrepreneurs. Along this journey, however, you may encounter opportunities to sell all or a portion of your business or to expand your business through a joint venture relationship. These events are sometimes collectively referred to as “strategic transactions,” and this article will outline some of the steps in the strategic transaction process. Understanding how the strategic transaction process works will help you be prepared to reach the best outcome for you and your stakeholders. We will explore these topics by looking at the people and the process involved in a typical strategic transaction, as well as the unique terminology often used in discussing these events. This article will provide an overview of the steps in a strategic transaction process.
A strategic transaction process generally involves engaging and working with your legal, accounting, and, if applicable, financial (investment banking) advisors to undertake some combination of the following steps:
1. Build a Transaction Team. Develop a team of key employees or third-party professionals that can help you evaluate strategic opportunities in light of your current situation.
2. Confidentiality Agreements. Prepare and execute confidentiality (non-disclosure) agreements appropriate for discussions that you may have with potential financial advisors and, ultimately, prospective strategic partners or buyers.
3. Evaluation of Current Situation. Start with a solid and realistic assessment of your company’s current situation and an understanding of market and industry risks as well as risks unique to your company and operating environment. This may include the exploration of opportunities available, obtaining a valuation of the business, and reviewing the types and identities of prospective partners or buyers.
4. Marketing Strategy. Work with your advisors in order to develop a list of prospective partners or buyers and a strategy as to what potential acquirers will be approached and in what order. This normally includes a combination of strategic buyers (i.e., companies in the same or similar industry) as well as financial buyers (i.e., private equity firms and family offices). Strategic and financial buyers often approach a transaction with different objectives and a different view on management retention, investment return expectations, and investment time horizons (e.g., buy and hold indefinitely vs. buy and hold for five years or less), and these considerations may impact the offered valuation. Your advisors will also help decide who is best positioned to reach out to each potential acquirer.
5. Preparatory Diligence. Your professional advisors will review current financial reporting and legal exposures to determine if there are specific actions you should take to improve your situation (e.g., convert from cash-based financials to accrual-based financials prepared in accordance with GAAP) or reduce risks (e.g., plug holes in key contracts or settle pending legal disputes) that may impact the outcome of the process. This is also the time to plan and start to populate an online (electronic) data room that will be used in the preliminary and confirmatory diligence phases of a strategic transaction.
6. Company Information. Your legal and/or financial advisors will help prepare a package of information that provides an overview of your company, management team, markets, customer profile (usually without names) and summary-level financial performance to share with interested parties. This may include a preliminary summary document (e.g., a teaser) for distribution to parties prior to execution of a confidentiality agreement as well as a more substantive presentation (e.g., a confidential information memorandum or “CIM”) to be provided to process participants who have executed a confidentiality agreement and indicated a serious interest in exploring a transaction.
7. Preliminary Due Diligence. Interested parties will expect a basic level of information regarding the financial and business results and prospects of your company. As a general rule, the acquiring party will ask for as much information as you are willing to provide. Your advisors will help you navigate these requests and gauge the level of information that is appropriate to share during each phase of the process while protecting your trade secrets and other competitive information.
8. Indications of Interest / Letters of Intent. Depending upon the nature of your strategic transaction process, you may ask prospective buyers or partners to provide preliminary indications of transaction value and structure (i.e., Indications of Interest) or proceed directly to a more complete expression of the proposed price and terms upon which they would be prepared to move forward with a strategic transaction (i.e., Letter of Intent). This is the time to address material business issues that could impact the ability to close a transaction, but not necessarily the time to push for a complete transaction package. In a competitive auction process, however, it may be possible to negotiate a substantial portion of the material transaction and risk allocation terms at the letter of intent stage if sufficient information has been made available and you have provided an adequate data room in the preliminary diligence process. (In certain “auction” processes involving the sale of your business, your legal counsel may draft a definitive transaction agreement that would be provided to prospective buyers to edit and return as a part of their proposals for a transaction.)
9. Exclusivity. In most cases, the acquirer will require the seller to agree (often as part of the letter of intent) to cease acquisition discussions with any other parties for a reasonable period of time (e.g., 60 to 90 days) to afford the acquirer a reasonable period of time to complete the transaction without fear of a competitor topping their bid after the acquirer expends significant time and resources pursuing the transaction. In all public company transactions (and some private company transactions), a “fiduciary-out” or similar mechanism will be negotiated as an exception to the exclusivity provisions to ensure that the seller’s board of directors can carry out any fiduciary obligations that it is subject to under applicable law and accept unsolicited offers at better valuations.
10. Integration Planning. Sophisticated acquirers will start developing (or refining) an integration plan for the acquired business as soon as the letter of intent is signed, or it otherwise becomes clear that they have been selected as the preferred acquirer. While this process will be largely driven by the acquirer, sellers should ensure that they are part of these discussions to ensure that promises made in the early stages of negotiations are memorialized in the formal post-closing business plan.
11. Confirmatory Diligence. Once a letter of intent is signed, the parties will normally push to complete the final diligence process as quickly as possible. This may include a “quality of earnings” or “QofE” report to be prepared by the acquirer’s accountants as well as more substantive legal, tax, labor, benefits, insurance, environmental, and regulatory diligence by specialists in these areas. Sellers prefer the use of the term “confirmatory diligence” to reflect the view that this phase of diligence is aimed at simply confirming the information regarding the company as reflected in the marketing and preliminary diligence materials previously provided.
12. Transaction Documents. After a period of confirmatory diligence, counsel for the acquirer will often deliver the initial draft of the definitive purchase agreement and any material ancillary agreements (e.g., employment agreements, joint venture or partnership agreements, etc.) for review and discussion by the parties (in certain auction processes, the seller may provide potential buyers with a draft of the definitive agreement and ask the buyers to prepare comments as a part of their transaction proposal). Counsel for the seller will commence preparation of “disclosure schedules” to reflect exceptions to the representations and warranties included as part of the definitive purchase agreement and certain related matters. Disciplined tracking of information and documents exchanged in the preliminary and confirmatory diligence stages is critical to ensure that the information included in the disclosure schedules is appropriate and reflects all material information that was shared with the acquirer.
13. Closing. Once the acquirer completes its confirmatory diligence, the parties complete the negotiation of the transaction documents, and signature pages are exchanged, then the parties will close and fund the transaction. In many cases, the agreement will be structured as a “sign and close” transaction, where the parties sign the documents and fund the transaction the same day. Where this is not possible for legal or regulatory reasons (e.g., where regulatory approval under the Hart-Scott-Rodino Antitrust Improvements Act is required due to the size of the transaction and its parties), the agreement will provide for the closing to occur in the future after certain conditions are satisfied as well as provide guidelines for how the business may be operated during the interim period between signing the purchase agreement and closing of the transaction. The parties will pay careful attention to the mechanics around the satisfaction of any obligations (e.g., loans, transaction expenses) and the mechanics of transferring funds in compliance with applicable banking and privacy laws and related considerations.
14. Integration. Following closing, the acquirer will implement the formal integration plan developed during the preceding months, generally with the assistance of the seller and its personnel.
15. Post-Closing Matters. In many cases, the agreement will provide for certain financial matters to be addressed after the closing, including true-up of any working capital requirements and resolution of any indemnification escrows established with respect to the seller’s representations and warranties in the agreement. There may also be certain post-closing covenants to be performed by the parties.