Coming to terms with the term sheet in selling your business
You’ve done everything right to build a successful business and, in addition to making money, find that you have made your company an attractive acquisition target.
Initially, when someone wants to buy your business, the first contact from the acquirer may be a telephone call expressing interest and seeking additional information about your company. Your attorney assists you with confidentiality and non-solicitation agreements to protect your company’s proprietary information and employees during the acquirer’s initial investigation stage. Then, the potential buyer makes the offer.
The offer may be in the form of a term sheet (also called a letter of intent, or LOI, if it is in the form of a letter). The term sheet is typically the document by which the prospective buyer proposes (or offers) the basic economic terms and material conditions and provisions of an acquisition to the potential seller.
The term sheet can be one page, or it may be as long as five to 10 pages. Although there is no single “form” in writing one, you should expect any term sheet to include the same basic anatomy. The term sheet should, at a minimum, describe what is being purchased, the offered price and how the price is to be paid.
You can sell your business by either selling all of the stock (or limited liability company or limited partnership interests) of the company or by selling all or substantially all of the company’s assets. There are other ways to accomplish a sale — such as through a merger or share exchange — but stock or asset sales are the most common and are likely to be the alternatives you see if you are ever presented with a term sheet.
Generally, buyers want to buy assets because they can buy assets clear of the selling company’s known or unknown liabilities. The seller wants to sell stock because all of the corporate liabilities follow the ownership of the stock. There are important state and federal tax considerations that also can play a role in determining whether assets or stock is sold. You should seek the advice of your tax advisors to assist you with this analysis.
Whether the business has government and other licenses also should be considered. Such licenses (like environmental permits) are typically held by the company. If stock is sold, the business continues under the same corporate identity, and there may be no requirement to seek approval of the sale from the permitting agencies. If the purchaser buys assets, there will be a change in corporate identity and the buyer will need to apply for its own permits or seek a transfer of the seller’s permits. You should note, though, that even in a stock sale many licenses and permits (like liquor licenses) require the purchaser to obtain its own licenses or formally request that the licensing agency transfer the license from seller to buyer.
A potential seller needs to consider many factors when evaluating the price offered for a business in a term sheet. Some of those factors include any business appraisals that the seller may have received (that are not too stale), the appraised value of any real estate that may be part of the sale, buildings, equipment, fixtures, inventory, customer contracts, leasehold rights, the ongoing potential of the company to make money, its earnings for the last few years, projected earnings, the terms of payment and, in an asset transaction, the allocation of the purchase price among the various assets. The company’s accountant can be helpful in evaluating the proposed price and the purchase price allocation.
After the purchase price, the section of the term sheet of greatest interest to the seller is how the purchase price is to be paid. To the seller, a short payment section is best — it only takes one line to say “in cash at closing.”
Unfortunately, most payment sections are longer and include a mix of cash at closing and other forms of payment. Part of the purchase price may be paid with a loan from the seller. This might happen if the buyer does not have enough cash to pay the whole purchase price or cannot or does not want to seek bank financing. To document the seller loan, the buyer delivers a promissory note to the seller at the sale closing. To protect itself against nonpayment of the loan, the seller should take a security interest in the assets of the business and/or personal guaranties. The seller should note, though, that its security interest would be subordinated (or behind) any bank financing that the buyer may have.
Part of the purchase price also may be paid as an “earn-out,” which is a payment or series of payments made to the seller over time that is typically based on the company’s post-closing performance. Earn-out payments are conditional. If the business does not hit the designated performance targets, the payments are not made. Therefore, sellers should be happy (or almost happy) with their financial deal assuming that little to no earn-out payments are made.
The payment section of the term sheet also may propose a “holdback,” which is a portion of the purchase price either not paid or paid into escrow at the closing that would be paid back to the buyer if certain bad events described in the purchase agreement happen to the business after the closing for a stated period of time. The bad events might include the buyer finding out that the seller did not have good title to all of the assets that were sold or that the business underpaid its taxes in prior years. If the time passes — often 12 to 24 months — without any of the bad events occurring, then the buyer or escrow agent delivers the holdback amount to the seller.
There are numerous other provisions of a term sheet – including seller non-competition covenants, protections for seller’s employees, closing conditions and the obligation of the parties to keep the term sheet confidential. The buyer also may describe its rights to conduct due diligence and have access to information about the company and company officers. The buyer may also seek to have an exclusivity or “no-shop” provision, which means that if the seller accepts the term sheet it cannot have discussions with other potential buyers while the term sheet is effective.
The term sheet also includes provisions some have described as the “legal stuff,” which may include descriptions of the basic representations and warranties the seller is asked to make and the parties’ indemnification obligations. Although tough to read, the legal stuff is important, and should be carefully considered.
The term sheet also may include a sunset date. A sunset date says that if the closing does not take place by a particular date, then the parties will not go through with the transactions and have no further obligations to each other, except for confidentiality and other obligations that should appropriately survive the termination of a term sheet. nhbr
Dan Norris is an attorney in the Corporate Law Practice of the McLane law firm, which has offices in Manchester, Concord, and Portsmouth.