I recently read a paper by John Carvalho, the principal behind Stone Oak Capital, an M&A advisory firm for middle market businesses based in Edmonton. The paper was entitled a “A Comprehensive Guide to the M&A Process” and I thought it was a good read. Among several other topics addressed in the guide, John explains what he sees, from his perspective as an M&A financial advisor to sellers, as the 5 phases of an M&A transaction. This article borrows many of the concepts from John’s article but summarizes what I see, from my perspective as a legal advisor in M&A transactions to both buyers and sellers, as the 7 phases of an M&A transaction.
The 7 phases in a typical M&A transaction are as follows:
- The seller’s preparation phase;
- The seller’s marketing phase;
- The buyer’s due diligence phase;
- The binding agreement negotiation phase;
- The condition precedent satisfaction and closing phase;
- The transition phase; and
- The buyer’s integration phase.
These are described in more detail below.
1. The Seller’s Preparation Phase
During this phase the seller prepares the business to be sold at maximum value by (i) making the business look as attractive as possible to potential buyers and (ii) compiling information in a manner that allows the buyer to see that value with a minimal amount of effort. Steps in this phase include the following:
- Fixing “flaws” in the business.
- Preparing reliable financial statements (preferably 3 years of audited annual statements).
- Formalizing key customer and supplier relationships.
- Collecting critical documentation and placing them in a virtual data room for review by prospective buyers.
- Obtaining preliminary assessments of value (to gain reasonable expectations).
- Identifying potential buyers.
- Developing a sales strategy (i.e. targeted sales efforts vs controlled auction vs open auction).
- Preparing a standard form of confidentiality agreement for prospective buyers to sign.
- Preparing an investment teaser that provides an overview of the acquisition opportunity.
- Preparing a confidential information memorandum highlighting the key information relevant to valuing the business for review by prospective purchasers.
Depending on the preparedness of the business, this phase can take anywhere from 1 month to 1 year.
2. The Seller’s Marketing Phase
The seller’s marketing phase typically unfolds as follows:
- Seller contacts potential buyers to gauge interest.
- Interested parties are presented with the investment teaser.
- Potential buyers consider the acquisition opportunity.
- Parties with continuing interest sign the confidentiality agreement and receive the confidential information memorandum.
- Parties with continuing interest present either an indication of interest or a letter of intent that indicates a purchase price they are willing to pay and other high level terms (i.e. methods of payment, exclusivity during due diligence, break fees, etc.).
Depending on the number of potential buyers and the competitive tension felt by those buyers, this period typically lasts 1-2 months.
3. The Buyer’s Due Diligence Phase
After receiving offers from potential buyers, the seller then chooses those parties that it wants to continue discussions with. However, given the time and cost of conducting due diligence, note that some potential buyers may insist on the seller first agreeing to an “exclusivity period” for the potential buyer to conduct its due diligence and further negotiations. If this is accepted, the seller may not have contact with any other potential buyers during this period.
In any event, during this phase potential buyer(s) complete a thorough due diligence review of the operational, financial and legal history of the business, as well as it projected future results. Potential buyers often use lawyers, accountants and bankers to assist with this due diligence process and expect that the seller and its comparable advisors will be available to answer questions as they arise. This also typically includes meetings with management and site visits.
Note that, in most circumstances, buyer due diligence will not be a substitute for the provision of customary representations and warranties from the seller in the final purchase and sale agreement and the buyer will still expect to receive them from the seller. Rather, the goal of the potential buyer(s) during this phase is confirm or refute their assumptions regarding the value of the business and to find any hidden flaws in the business that might negatively affect value before entering into the binding purchase and sale agreement.
At the conclusion of this due diligence phase, the potential buyer(s) either confirm their initial offer or suggest revised terms that the seller may or may not agree to. Depending on the preparedness and responsiveness of the seller, this phase typically lasts from 1-3 months.
4. The Binding Agreement Negotiation Phase
Prior to this point, the parties have typically only agreed to the primary purchase terms (i.e. purchase price, methods of payment, asset or share purchase, etc.). Once due diligence is completed and those terms are confirmed (or revised), the buyer and the seller negotiate and settle the terms of the binding agreements that will dictate ALL of the terms under which the business will be sold from the seller to the buyer.
The Purchase and Sale Agreement is the primary document that the buyer and seller will negotiate and it will sent out in detail:
- The form of the transaction (asset or share purchase).
- The subject matter of the transaction (inclusions and exclusions).
- Purchase price details including methods and timing of payments.
- Purchase price adjustments, holdbacks and escrow.
- Representations and warranties or each of the seller and the buyer.
- Conditions precedent to closing in favour of each of the seller and the buyer.
- Termination provisions and penalties for failure to close.
- Indemnification provisions in favour of each of the seller and the buyer (including limits, baskets, exclusions and inclusions).
- Dispute resolution procedures.
- Etc.
Other agreements that may be required might include the following:
- Transitional Service Agreement — A transitional service agreement is used when the seller is required provide transitional support to the buyer after closing such as maintaining certain licenses or registrations for the benefit of the buyer, or providing accounting, human resources and other management services. The scope, duration and cost of these services will need to negotiated.
- Employment Contracts – The buyer may want the selling shareholder or other key management personnel to agree to on-going employment terms before agreeing to complete the transaction.
- Non-Competition Agreement — An agreement to not compete with the buyer post-closing is pretty standard. However, the scope, duration and geographic boundaries of the restriction will need to be negotiated.
- Seller Financing Agreements (if any) — Seller financing generally occurs when there is a gap between the purchase price and the financeable asset base of the seller. These agreements set out the security arrangements that will protect the seller against the risk of default as well as the amount, timing and interest rate associated with the financing..
This phase can take 1-2 months although it is often initiated during the due diligence phase once the parties become confident that there will be able to finalize the primary terms of a purchase and sale.
5. The Condition Precedent Satisfaction and Closing Phase
Once the binding purchase and sale agreement is signed, closing often remains subject to the satisfaction of condition precedents in favour of each of the seller and the buyer. These conditions may include:
- Lender approval.
- Shareholder approval.
- Customer or supplier approval (i.e. to the transfer of contracts).
- Competition Bureau and/or Investment Canada approval.
- Stock exchange approval.
- Other applicable regulatory approvals.
- Etc.
Closing can only take place upon the satisfaction or waiver of the agreed upon conditions precedent and satisfaction of applicable conditions may take anywhere from 1 week to 3 or more months.
6. The Transition Phase
If necessary to ensure uninterrupted operation of the business following closing, and often during an asset sale, there may be a transitional phase whereby the seller provides transitional support to the buyer after closing such as maintaining certain licenses or registrations for the benefit of the buyer, or providing accounting, human resources and other management services. This phase can last anywhere from 1-6 months.
7. The Integration Phase
During this post-closing phase, the buyer attempts to smoothly integrate the acquired business into it existing operations in the most prudent fashion. This may mean substantially leaving the acquired business as a stand-alone business and only integrating it for financial reporting purposes. Or the acquired business may be partially or fully integrated into the buyer’s existing operations depending on the perceived value of the acquired brand or systems and the value of any synergies that may exist.
Given the limitation period for the seller’s representations and warranties in the binding purchase and sale agreement, it is also prudent for the buyer to complete any follow-up investigations as early as possible during this phase to confirm that the sellers representations and warranties are accurate and, if not, determine if any damages to the buyer that may have resulted from those inaccurate representations and warranties.
Invitation for Discussion:
I encourage you to read John’s article for further information on the M&A process and how a financial M&A advisor (which we are not) can help with the process. However, we do have a wealth of experience as legal advisors on M&A transactions, both large and small, and understand the process from beginning to end.
If you are contemplating buying or selling a business, please do not hesitate to contact one of the lawyers in the business law group at Linmac LLP. We would be happy to assist you on this exciting journey.
Disclaimer:
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.