Are you ready for an exit transaction? (Probably not.)
For many businesses, including startups, the ultimate end goal is a seven or eight figure exit transaction where the company is purchased by a larger corporation or private equity company, resulting in a handsome payout to all stakeholders, including the founders, investors, and employees. In the legal industry, we call this a merger or acquisition transaction. But with exit deals potentially around every corner, most founders are not asking themselves (and probably should be), if the Company is ready for an exit transaction and the scrutiny that comes with it. This article explains the basic steps of a merger or acquisition transaction, so that you can better understand what to expect at exit.
An exit transaction, whether that be a stock purchase, asset purchase, merger, IPO, or otherwise, has several stages. Please keep in mind that these are the most common stages, and not necessarily how every transaction will proceed.
Stage 1: Initial Discussions and Letter of Intent
During Stage 1, the company and potential buyer/acquirer will have initial discussions around price, key deal terms, and timeline. After an NDA is signed, the Company and Buyer generally exchange some initial confidential financial or tax related information to foster further discussions. At the end of Stage 1, the company and potential buyer/acquirer will usually negotiate a letter of intent (“LOI”), setting forth the initial deal terms that they have agreed upon, the general timeline for the transaction, and general terms and conditions to allow further negotiation of final agreements to take place. For the Company being sold, the LOI often will include an “exclusivity” or “lock-up period,” where the seller agrees to negotiate exclusively with the one potential buyer/acquirer toward final agreements for a particular period of time, usually 60-90 days.
Stage 2: Due Diligence
Once the LOI is signed, the buyer/acquirer typically sends over a long list of data/document requests to the Company. These usually include most of the following (and much more):
- Financial statements and tax statements for the last 3-5 years, with supporting materials
- Lists of all customers (or sometimes just the largest customers if the list is long)
- All customer agreements
- Vendors/independent contractors
- Lists of all vendors/independent contractors
- All vendor/independent contractor agreements
- Copies of employee agreements
- Copies of employee policies
- List of all employees, including locations, salary data, etc.…
- Corporate Governance:
- All company formation documents, including bylaws/operating agreements, amendments, and joinders since its formation.
- Copies of annual/special meeting minutes for the company since its formation
- Copies of all employee/company policies (including data security)
- List of all investors
- Copies of fully signed investor documentation for all investors, including those that have been repurchased or transferred
- Clean cap table
- Records of all valuations and share/membership unit transactions completed
Depending on the buyer/acquirer, some of the due diligence may be conducted by an outside CPA, an investment bank, an IT security diligence company, or other professionals. In our experience, many selling companies are prepared to be asked questions about the above information, but actually producing the documentation is another matter. Due diligence is like a point-by-point comprehensive inspection on a vehicle: it is extremely thorough, invasive, and time-consuming. The process is usually very stressful for the company and it officers going through it.
Some of that stress is avoidable, however, if the company has engaged with its attorneys, accountants, IT, and other professionals in advance of the transaction to talk about documentation and items that will come up in due diligence. An experienced mergers and acquisitions attorney, like the VW team, can help guide a pre-exit audit, helping the company identify documentation needed and potential deal problems (bad carburetor anyone?) before they are uncovered by a potential buyer/acquirer. Even if the company does not proceed immediately to an exit transaction, having this documentation in order also pays dividends for future investor rounds, government/regulatory scrutiny, and future business management as the company grows.
Stage 3: Final (Definitive) Agreements
After several weeks to several months of due diligence, the buyer/acquirer, if it wishes to move forward, will present the company with final agreements for discussion to complete the proposed transaction. These may include purchase/merger agreements, employment/consulting agreements, and other documents needed to close the particular transaction. The company, the buyer/acquirer, and their respective attorneys will often go through multiple rounds of redlines and negotiations, discussing key financial and legal points before a final set of agreements is reached.
In most purchase transactions, the purchase agreement also requires the company (seller) to prepare “Disclosure Schedules.” The Disclosure Schedules are, very simply, lists of assets, lists of agreements, lists of employees/contractors, disclosures regarding litigation and liens, and other disclosures called for by the purchase agreement. Sellers many times underestimate how long these schedules (and the information they contain) take to track down. But frequently these disclosures mimic (or incorporate) materials already requested by the buyer/acquirer during Stage 2: Due Diligence prior. This again is why having the company’s internal documentation in order is so critical. It can save the company selling headaches at multiple stages of the transaction.
Stage 4: Regulatory Approvals (if applicable)
If the acquirer or Company is publicly traded, very large in size, or in a heavily regulated industry, the transaction may require government/regulator approval prior to closing. This stage may take several weeks to several months depending on the approvals needed.
Stage 5: Closing
Once the company and buyer/acquirer have agreed on all the transaction terms, have finalized the Definitive Agreements, and any regulatory approvals have been received, the parties will schedule a closing for the transaction. At the closing, which may take place in person or electronically, the company (seller) and buyer/acquirer will sign any Definitive Agreements (if not signed prior to closing), wire funds to the company/seller for the purchase price, and then ultimately close the successful transaction.
Stage 6: Post-Closing Integration
Once the transaction is closed, the real work begins with post-closing integration of the company into the buyer/acquirer organization. This process may be very formal/regimented with some private equity firms, or more informal, depending on the acquirer. Many founders will work in the integrated business for 6 months to 2 years (or more) post-closing to help integrate the business. After departure, the founder(s) may be subject to a 2-5 year non-compete/non-solicit agreement, preventing them from competing with the business they just sold to the buyer/acquirer. Then it’s onwards to the founder’s next big project.
A company exit is one of (if not the) largest and most complex transactions that a company and its owners/founders will ever go through. This is why it’s critical to have a corporate attorney who is comfortable with these types of transactions and the corporate preparation that comes with them, to make sure the company is prepared for an exit. But hopefully this post will help you better understand the mechanics of a merger and acquisition transaction and help you better plan for the company’s future exit.