What to look for in a term sheet in a merger or acquisition? Holdbacks and subject-to’s are important factors. But to negotiate a winning deal, here are four more key components both buyers and sellers should consider:
- Representations and warranties. In defining the terms of this language, of course the buyer and their legal counsel will want to make this section of the term sheet as expansive as possible. In my opinion, the seller should be willing to represent the business as represented, but not have to go too far beyond that. This means they should not agree to “the sky is falling” or other doomsday scenarios that are clearly out of their control (e.g., Acts of God). They should just be willing to represent the business as is and as represented. For example, a buyer may be concerned about the real estate (e.g., facilities) they might be purchasing as part of the transaction, and the seller can have a “Phase I” environmental study performed.
- Indemnification of the business by the seller for the buyer. Again, the seller should be willing to indemnify the business for what they think it is worth (i.e., purchase price). They should not go beyond that amount unless there is something mutually agreed upon with the buyer (e.g., pending litigation), which would be a part of a disclosure schedule. If this becomes an issue down the road, the buyer should negotiate a mechanism to reduce the purchase through the promissory note or the earn-out. It’s difficult to go back and ask for money back, so again I emphasize the importance of the promissory note.
- Covenants not to compete. I suggest working with legal counsel and your advisor to agree on something fair and reasonable. The buyer and seller should not take this for granted. They should not assume it won’t be an issue down the road as things can go awry. Buyers must protect their customers and territories and sellers shouldn’t be “banned from the industry.” Usually the term of the non-compete mirrors the length of the employment agreement and the earn-out, plus one to two years, which is negotiated of course.
- Employment agreements. Finally, I suggest both sides work with legal counsel and their advisors to get comfortable with termination provisions for “with and without cause,” confidentiality, and non-competes. Do not assume anything here, and resist the temptation to let the provision be a deal breaker. Again, it’s important to just make sure you have sufficient protection on both sides. The buyer needs protection of the new investment here so that the seller can’t go down the street and open up a new competing business. And the seller cannot be precluded to ever be employed in the industry again or for too long of time.
A good advisor can assist you through these important deal points. This qualified advisor can work with legal counsel to ensure that every attempt is made to prevent deal breakers and find the win-win for all parties.
Steve Pomeroy is the founder of Big Change Advisors, an M&A consulting firm in Los Angeles focusing on middle market companies in the IT services space. Since 1992, Big Change leaders have completed over 38 transactions including M&A, Capital Sourcing, and Public Offerings representing over $800 million in total transaction value. Big Change Advisors donates a percentage of all fees to help serve the homeless through the Los Angeles Mission. To request a free consultant, contact us.