Although there are all kinds of different types of businesses, the process of selling a business ends up somehow proceeding through largely the same stages, because the inherent nature of the task is universal (a task that is fundamentally about managing the process of flowing lots of information to a buyer, generally in stages as the seller becomes more confident of the seriousness of the potential buyer’s interest and commitment). Typically, the process of selling a business breaks down into these stages:
This article is part of our multi-part series - A Basic Primer on Selling a Business. See the other parts of this series here.
Pre-sale planning preparation
Often largely overlooked, there is a huge amount of time and effort involved in simply identifying and assembling the documents and information that a buyer will want to review.
This process inevitably ends up being much more than one of just document assembly:
- Businesses are fluid and typically there may be key commercial relationships that are in flux, perhaps without a current contract yet in place. Smart sellers typically get these key relationships pinned down before starting sales processes.
- There are often gaps between types of information a buyer would want to see versus what the day-to-day operations of the business allow the seller to achieve “in the real world”. This is particularly true for certain types of internal budgeting and financial reporting. A seller will have to make a pragmatic judgement about what it can reasonably produce to satisfy potential key buyer enquiries. (An example in a product business is the state of inventory information: how recently does a comprehensive inventory need to be taken? How much detail needs to be provided on the aging and resulting value of products in inventory?)
- This preparation phase usually leads to insights about the best timing to try and take the business to market. If there are key upcoming supplier or customer contract renewals, for example, then it often makes sense to get them done before launching into a sale process.
Smart sellers spend a disproportionate amount of time on pre-sale preparation, before ever even contacting a potential buyer. Obtaining a fair or even generous valuation for a business from a buyer is an outcome built on the foundation of clear and efficient information communication…with no surprises or critical gaps.
This requires the seller to put him or herself in a buyer’s shoes, and think through all the reasonable business aspects and questions they may focus on…then think about do-able ways to provide the usually, very large number of contracts, documents and information that address them and explain how the business works. This first aspect of preparation is basically one of defining the scope of contracts, documents and information that have to be assembled. And it is usually huge!
In addition, for all of the primary contracts, documents and information being assembled, the seller has to also ask itself both “How will this look from a bidder’s perspective?” and then “What else can I provide that would address any predictable bidder concerns?”. This need for forethought, issue-spotting and advance preparation of answers and explanations applies across all the types of information to be provided, including business contracts. In relation to financial and operational data, there will be specific trends disclosed that may appear negative when seen in isolation, but for which there may be entirely reasonable explanations. Equally importantly, in business contracts, there may be terms in contracts that would worry a potential buyer, but which can be explained by providing further context and information (or which may even need to be fixed or changed before the sales process starts). A well prepared seller thinks through all these potential issues and concerns ahead of time, and typically acts pre-emptively to also include additional, secondary documents or information that will address predictable bidder concerns on key issues (often even creating new materials specifically for this purpose).
This preparation phase also involves thinking carefully about the best process and tactics to sell the business. Is it a business for which there are perhaps one or two obvious buyers, who could afford to pay more than others because of synergies with their existing business? Or is it perhaps going to yield the best outcome and the highest valuation to conduct a broader auction-style process, with many bidders? This thinking shapes the design of the sales process.
Initial discussions and an initial indication of value from the prospective buyer
This next step in selling a business is shaped by the inherent characteristics of the task: selling a business is time-consuming, requires a lot of effort, involves sharing often very confidential information to people outside the business, and can destabilise relationships with employees, customers, suppliers and other key stakeholders if it becomes rumoured…so sellers only want to proceed with all the work and risk involved in a sale process if they have confidence that they have a genuine potential buyer likely to offer an acceptable price.
So, processes typically start by a seller preparing a short summary document (sometimes called an “information memorandum”) with key business info and headline financial information about the business. This document then gets provided very selectively to one or more potential buyers, but only after the potential buyer signs a strict confidentiality agreement (agreeing to keep the discussions confidential and to return or destroy any information exchanged, to use the information communicated only for the purpose of evaluating the potential acquisition, and sometimes including other commitments, such as not to solicit the target business’ employees or key customers or suppliers). The important thing here is that the seller only provides a limited amount of business information to bidders at this stage, again, typically in the form of a short information document that includes summary financial information.
What goes in an “information memorandum”? That is a matter of tactics and choice. Often the short document given to bidders as a basis for an initial offer is just a few pages of key financials, combined with some summary text on what the business does. In larger auction-style processes for big businesses (especially for example if the seller is choosing to involve a larger number of bidders), the so-called information memorandum can end up being an 80 or 100 page document reviewing all aspects of the business, together with several years of financial information and introductory sections providing industry overview information. (Tactically, providing more information at this stage means the offers from bidders are more informed, and should be more reliable, than if very limited information is given. But the trade-off is that it also disseminates that business information to a wider audience.)
Potential buyers are given a deadline to provide a written indication of what they might pay for the business, usually also asking them to provide some information on their financing sources; their key information needs in order to be able to provide a firmer offer in the next stage of the process; and any internal or regulatory approvals they would need to obtain in order to sign and complete the purchase of the business.
So the result is that the seller gives a limited amount of information and then gets some indicative bids from a select number of potential buyers.
These stages in a sale process also get replicated in situations in which there is simply a bilateral dialogue with one potential buyer. The same logic applies: a seller does not want to go through the time and expense (and potential rumour or leak risk) of moving into a due diligence (information-sharing) process with a potential buyer until it has confidence that the buyer is serious and will potentially offer an acceptable price.
“Due diligence” and a “binding” offer
The initial offer from a bidder is only as solid as the amount of information provided. Since that initial information is pretty summary in nature, sellers know that initial bids from potential buyers have to be treated with a large grain of salt. The next step in the process is thus to evaluate the initial bids and bidders, select those that seem financially credible and in the desired valuation range, and then provide significantly more business information…in order to then ask for a second and “firmer” offer.
This is the stage that involves providing large amounts of business information to bidders. It typically also involves management giving some pre-prepared presentations on business performance and key ongoing projects. The overall objective is to explain all the key aspects of business operations to bidders, so that they can use that understanding to forecast future business performance and use that forecast to develop a valuation of the business.
This information used to be shared by organising a physical “data room”, in which all kinds of business contracts and documents were provided in indexed files (somewhere allowing anonymity, away from the target business’ premises) for review by a potential buyer and its advisers (eg lawyers, accountants, bankers, consultants). Now, such documents are typically provided online, via a secure access “virtual data room”, which is essentially a shared set of document folders accessible only by permitted users. There are various commercial providers that offer this service, usually on a pricing model linked to the volume of documents to be hosted online.
Buyers are usually given a period of weeks to review these materials, and typically can submit written questions to the seller each day (typically for short written responses provided on a rolling basis as the buyer’s review proceeds). This communication channel is primarily intended to address simple factual questions about document contents, including reconciling any seemingly contradictory information on the same topic found in multiple documents.
In addition, during this stage of a business sale process sellers typically provide management presentations on key aspects of business operations. These are typically rehearsed but unscripted presentations explaining key aspects of operations in areas like Finance, Legal, HR, Technology, Sales, Sourcing and Facilities, and they typically involve some time for Q&A and discussion. These are a very important part of the education and information-communication process, because they allow the target business’ management team to explain operations and strategy…building on the raw facts and information contained in contracts and business documents.
A really important thing that happens during this stage is that a bidder refines its valuation of the business. A bidder is given access to information about almost all aspects of business operations and, at the same time, it is able to work through the financial statements and accounting policies of the target business (and develop its own views about them). If there are hitherto unknown or inestimable liabilities or key risks in the business that come out through the due diligence process, then the bidder can now factor them into their valuation. More importantly, they can develop a picture of future business operations and use that to develop a financial projection of future business performance.
Buyers are expected to synthesize all of the information and undertake a more comprehensive valuation of the business, then provide a second “firm” offer. Often the seller also provides the buyer with a draft acquisition agreement at this stage, and asks the buyer to provide a mark-up showing any key modifications desired to the proposed purchase contract. And typically the bidder is asked to summarise any conditions to its offer (including possible regulatory or internal approvals and any financing conditions) as well as its timeline to progress to signature of a final contract (and subsequently, to completion of the legal transactions involved). (Some business acquisitions can be signed and “closed” or completed on the same day, but it is common for there to be various practicalities (such as regulatory approvals or multi-step corporate transactions) that require that a transaction is completed during a defined period after the purchase agreement is signed. In these situations, the agreement will contain specific provisions about how the business can be managed during this interim period, and about the conditions that have to be met in order for the acquisition to close.)
You often hear people talking about “binding offers”, when in fact, all offers are carefully written not to be binding and to have a variety of outs for the bidder. The importance of the second bid from a potential buyer is not whether it is legally binding or not (it generally isn’t), rather it is that it represents a much more credible offer because the bidder has been provided with more extensive business information and been asked to re-do its business valuation based on that more extensive information and insight. And it’s asked to communicate that offer in writing, together with any key terms and conditions it proposes.
Final contract negotiation and signature
Depending on tax or other aspects of legal mechanics, the acquisition of a business can happen through one or many related legal transactions. A buyer may simply buy the shares of the company that owns the business or it may buy all the assets of the business or it may even choose to conduct a merger (basically combining two companies into one company) with the target business company. Many business’ operations are conducted through one or more companies, so often a business acquisition involves multiple related transactions to transfer various legal pieces of a business to a buyer.
In this final phase, the seller and the buyer complete the negotiation of the final terms of a purchase agreement. Sometimes, in a successful auction situation, a seller may conduct parallel negotiations with two or more bidders simultaneously (giving the seller much more leverage in negotiations).
The purchase contract plays at least two key roles in a business acquisition. The obvious one is that it implements the mechanics for the legal transfer of ownership of the business (which, as mentioned, may involve multiple corporate transactions in several steps). But the equally important additional role of the purchase contract is that it allocates risks of unforeseen or unknown events regarding the business between the buyer and the seller, while delineating what risks the seller will bear and what risks the buyer will bear.
Given our starting point that selling a business is inherently complex (both because a business represents a package of assets, liabilities and operating relationships, and because all of those operations are fluid and dynamic), it won’t come as a surprise to hear that a typical business sale contract ends up being longer and more detailed than a typical product sale contract.
Of course, the contract for the sale of a business defines the key terms like the price (including any price adjustment mechanism, based on for example a final closing inventory adjustment), the legal steps to implement the transaction, who seeks any regulatory approvals required and the timing to close the acquisition (including what happens if for some reason a required regulatory approval can’t be obtained and the acquisition can’t be closed).
In addition, the purchase contract also ends up defining which party (buyer or seller) bears the risk of different categories of future events that might befall the business. Since a buyer in practice cannot enquire into every single detail of business’ operations, buyers typically ask sellers to make some promises about the state of the business in the purchase contract (which in legal language are called “representations and warranties”), to supplement the information made available in the due diligence process. And if any of these promises turn out not to be true in some respect, then that gives the buyer recourse against the seller for compensation (usually only during a pre-defined time period for any such claims after the acquisition closes). These promises can cover all kinds of things, but there is a core set of issues that get addressed in the seller representations and warranties in most business sale contracts: things like confirming ownership of key assets, including any intellectual property like patents, trademarks, copyright and trade-secrets; detailing the top suppliers and customers of the business and confirming that none of them have given notice to terminate their existing agreements; regarding labour relations matters, including that no key employees have given notice to resign; that there is no undisclosed important litigation against the business; that the business has been run in compliance with applicable laws; that there are no known environmental liabilities; and, perhaps most importantly, that an attached set of financial statements (which could be for 1 or more years) are true, complete and correct (and often also including a promise that there are no undisclosed liabilities).
The net effect of the representations and warranties given by the seller about the business is to define what types of future “surprises” about the business operations will enable the buyer to seek compensation from the seller. The seller’s representations and warranties are made in general terms, and any exceptions to them (for example, if there is one big legal litigation) get described (either by listing them in exhibits to the purchase agreement or by referring to them directly or indirectly among the due diligence materials disclosed to the buyer during the sale process). And obviously, the seller tries to give as few representations as possible and make them as narrow as possible in scope (while the buyer seeks exactly the opposite). The process of negotiating the scope of these representations ends up defining (ideally clearly) who bears the cost of any future events that violate the promises made about the state of the business on the day it is sold.
For this reason, the overall “price” of an acquisition can’t be thought of in isolation as simply an amount of money paid: the price is really both the payment made and the impact of any key risks or liabilities taken on in the terms of the purchase agreement.
DIAGRAM 3 Stages in the process of selling a business
Continue reading our multi-part series:
A Basic Primer on Selling A Business
- Part 1 - Why selling any business is a challenging information-sharing process
- Part 2 - Case studies in selling a business as an information-sharing process
- Part 3 - The role of financial statements and the misguided view that they are all that matters
- Part 4 - What are the key stages in the process of selling a business
- Part 5 - How do people value a business?
- Part 6 - What kinds of information will buyers of a business want to see?
- Part 7 - How to handle the “bad news” about a business being sold
- Part 8 - What legal issues will buyers usually be concerned about when reviewing contracts?
- Part 9 - Summary: An Overview of Business Sale Processes