Second in the Series
How Does It Really Work? Understanding a Term Sheet for Acquisition or Investment
The focus here is on middle market businesses (under $100 million in revenue) owned by the founder, family and management.
Why should business owners focus on how deal term sheets and letters of intent work?
- Transactions involving your company begin to take shape at this stage and everyone will refer back to the term sheet or LOI.
- Whether you are the issuer or recipient, what you negotiate at this point determines how your best interests are protected.
- Increasing sophistication and market efficiency trends make this a basic requirement for knowing what you are getting into.
What is the real purpose of these documents?
- It has become routine for prospective buyers-lenders-investors to provide written outlines for proposed deals in order to move forward.
- Being selected or making that choice is increasingly dependent upon detailed clarification of price and terms to gain control of process.
- The discipline of advance scrutiny of intent and boundaries ultimately benefits the party most at risk for completion.
Why all the fuss if these outlines are non-binding for the parties?
- The substance of a term sheet or LOI reflects the seriousness of both parties to proceed with intent to complete the transaction.
- To put competitive bidders and other attractive proposals at bay is not taken lightly and reputation on performance is significant.
- Most non-binding documents do have some binding provisions which matter to responsible principals.
What are the most important items to make clear in a term sheet for any type of deal?
- Valuation and structure play into every situation because the equity value and its allocation is always relevant.
- Clarity for the current value of an acquisition target or equity issuer or the basis for a credit facility is core to everything in negotiations.
- The conditions to completion of confirmatory due diligence and actual closing must be realistically understood to avoid disappointment.
Why is deal structure for any proposed Acquisition or Investment transaction so important?
- How the deal is defined for tax purposes and who-gets-what in the end is what really matters so you should know from the earliest stage what that is.
- The party doing the drafting usually knows more about the relevant market and “playing the deal-game” than the seller-issuer-borrower.
- Structure often reveals financial motivation and deal strategy.
Why does it seem that there is always something that causes big problems in getting to the finish line to close deals?
- Most non-sponsor controlled owners either knowingly or unconsciously downplay business risks and stubbornly refuse to be realistic in the early stage of the transaction process.
- Professional owners (private equity funds) get better results because they anticipate issues and take action to resolve roadblocks.
- Some issues simply can’t be anticipated and do not have straight forward solutions so you have to adjust to developments.
What can be done to avoid costly delays and broken deals in this highly competitive market?
- Be tougher on yourself more than you think is needed; even that will only be the first step to actually being ready to complete any deal.
- Demand that your advisors be realistic rather than provide lip-service to your preconceived opinions.
- Be curious, learn more; understand the other party better and work through the inevitable problems to prevail for what you believe.
What other topics will MidMarket address in this Q&A series?
- Details and nuances on company valuation and deal structuring for sale, buying another business, issuing equity or borrowing capital.
- Negotiation considerations to protect your interests in any type of corporate finance deal.
- Tips for avoiding mistakes and disappointment in competitive deal contests.
First in the Series
“How It Really Works: Sale of Founder-Owned Private Company”
The focus here is on middle market businesses (under $100 million in revenue) owned by the founder, family and management, rather than a sale by a corporate parent or a private equity investor.
What do business owners wish they knew before starting the sale process?
- No matter what, the deal won’t go the way you think it will.
- Allowing specifics to be worked out later (after letter of intent/term sheet) is a bad idea.
- Management distraction leads to missed forecasts and then the buyer drops the price.
How does the sale process start?
- You are approached by a large strategic buyer which should pay more than equity players.
- A private equity firm entices you to get cash now and a lot more later.
If it is your idea to sell, your board or CFO or lawyer begin to suggest how to proceed.
Why are there so many surprises?
- You probably won’t be realistic about potential problems until it is unavoidable.
- Only real nitty gritty due diligence by the buyer uncovers the unexpected.
- Even if you have sold a business before, values, processes and taxes have changed.
Why do some people seem to do so much better than others?
- They know exactly what they want and clearly lay that out to bidders.
- They disclose potential deal killers up front to buyers and offer realistic solutions.
- They understand deal dynamics and then all the stars become aligned for their deal.
What determines price?
- Your company’s strategic contribution to the buyer’s business.
- Deal structure and buyer’s profile govern financing limitations for the prospect.
- The buyer knows that you have another prospect ready to take its place.
How do buyers decide what to offer?
- They ask what you expect and gauge how much competing buyers will offer.
- If you don’t tell them what you want, they will rely on conservative analysis.
- If you allow them to confirm your earnings growth or cost savings, they will stretch.
What should the founder-owner know about the agreement of sale?
- It will be much more detailed and complex than you think is needed.
- The term sheet is the roadmap, so make it comprehensive.
- It is best to thoroughly read the contract and exhibits of a relevant deal before you start.
Why can’t the Founder-Owner get a clean break at closing (or take the money and run)?
- Because the post-closing price adjustments have serious consequences.
- Representations and warranties insurance has limitations and exceptions.
- Private equity buyers nearly always have a roll-over investment requirement.
How does a Founder-Owner know whether a deal is fair?
- Your deal can be compared to others that are most relevant.
- A well-orchestrated process produces an accurate reflection of the market.
- Experienced advisors will have informed opinions that you can rely upon.
What other topics will the MidMarket Q&A Series include?
- Details and nuances on company valuation and deal structuring.
- Negotiation of acquisition agreements and debt and equity agreements.
MidMarket represented Thompson
May/June 2018 Tobacco Business Magazine with Thompson and STG
Read more from the May/June 2018 issue here.
March 2018 : Patrick Hurley collaborates with the CFO Alliance task force to discuss M&A in 2018 and the corporate development transactions of buying or selling a company from the view of the Middle Market CFO. Click to read the Special Task Force Report.
November 9, 2017 – Familiar faces and new friends from far and wide gathered in London this week for intensive review of M&A and strategic investment deal market activity for middle market companies across Europe, the Americas and Asia. While the number of deals has waned again in 2017, the value of the transactions and capital put to work has held strong at 2015 peak levels. Traditional lenders in the UK and on the Continent have remained active in spite of creeping regulation which has mainly left the U.S. market to Business Development Companies and Specialty Finance lenders as U.S. commercial banks nearly fully retreated. While Britain’s M&A activity is stronger than ever in spite of Brexit jitters; the business plans of many London-centric private equity firms is America. A particular highlight for me was chatting with David Wolfe (left in picture) about Eastern European market activity. Cheers!