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Here are several of the most important tips to bear in mind when negotiating the letter of intent.

Remember the Balance of Power

The balance of power changes the moment you grant the buyer exclusivity. The advantage shifts to the buyer because you’ll have much more to lose if negotiations fall apart. If the buyer walks, the buyer has little to lose. But if you bow out, you must start negotiations all over again, which is often difficult since buyers may view your business as tarnished if a previous deal were to collapse.

Due to this dramatic shift in the balance of power, take your time to ensure the LOI is as specific as possible regarding the material terms. Failure to give proper attention to the terms in an LOI can be disastrous for you. The buyer prefers an LOI with as few specifics as possible so that it can be broadly interpreted. The less precise the LOI, the more opportunities the buyer will have to renegotiate the terms later in the transaction. To counteract this weakness, you’ll want to pin down as many specifics as possible in the LOI.

At the same time, an LOI that includes an attractive price for your business can be used as leverage in negotiations with other interested parties. A carefully managed LOI presents a prime opportunity to create a competitive auction that could ultimately result in placing a higher value on your business. 

The balance of power changes the moment you grant the buyer exclusivity. The advantage shifts to the buyer because you will have much more to lose if negotiations collapse.

Take Your Time Before Signing

Many LOIs seem too good to be true. But that seductive deal the buyer may be dangling may be nothing more than a ruse to lock you in for some time before coming back with a lower price after you’ve been out of the market for an extended period. Even if the buyer doesn’t have dishonest intentions, they may not be able to line up the financing to close the transaction.

So, take your time when negotiating the LOI. Most buyers will be in a rush to sign the LOI and get you to commit to exclusivity as soon as possible. Don’t fall into their trap – this is the last moment in the transaction when you have a strong negotiating position. Regardless of what the buyer says and how urgent they appear to be, move slowly when negotiating the LOI.

Move Fast After Signing

Take your time negotiating the LOI, but get hopping the moment it’s signed. Why? Time kills all deals. The longer it takes to close the transaction, the more things can go wrong. The buyer can discover additional problems with your business, or its value can be affected by adverse changes in the economy or industry.

Because the LOI – and most of its terms, such as the price – is non-binding, the terms can be subject to last-minute changes until the purchase agreement is signed. This is why time kills deals. The buyer’s perception of value could change as you near the closing table. The longer it takes between signing the LOI and closing, the more information about your business the buyer may discover, decreasing their perception of value. Buyers are on the lookout for any negative finding right up to the closing. Maintaining momentum is the best antidote – the faster you move, the less that can go wrong, and the higher the chance you’ll maximize the purchase price. How can you do this? Keep the buyer motivated and excited throughout the process. 

You should constantly introduce the buyer to new information regarding the attractiveness of your business. This can include new opportunities in your sales pipeline, new developments in your industry, new products you’re considering developing, or any other element of your business the buyer may find exciting or appealing. 

The ideal situation is one in which you can demonstrate to the buyer that your business is continuing to grow after you accept the LOI and that new developments in your business may make you ambivalent to the idea of selling in the first place. Project the attitude that if the buyer backs out now, it’s no big deal because you could spend a few more months capitalizing on these opportunities before putting your business back on the market at a much higher price.

Prevent Re-trading

The absolute biggest risk to you after accepting the LOI is the possibility that the buyer will want to renegotiate key terms after conducting due diligence. I’ve found this to be the case around 20% to 30% of the time.

Price and terms are always subject to some revision based on what the buyer discovers during due diligence. The price you accept in the LOI is the maximum you can hope to receive. Due diligence and purchase agreement negotiations only serve to scale back the terms as problems, and other issues, are discovered during due diligence. The questions are what’s going to change and by how much. The answers depend on what the buyer uncovers during due diligence and the negotiating postures of you and the buyer. The more the buyer wants your business, the less likely the terms will change.

What causes re-trading, and why is it effective? Re-trading is always due to one of two reasons:

  1. Undisclosed Issues: During due diligence, the buyer discovers your financial statements weren’t prepared in accordance with generally accepted accounting principles (GAAP). Or perhaps they discover that some of your key employees won’t stay after the sale, or you forgot to mention that you don’t have non-competition or non-solicitation agreements with your key employees. Regardless, if the buyer discovers issues during due diligence that you didn’t disclose, expect to renegotiate the terms of the transaction.
  2. Change in Leverage: Some buyers may have planned to renegotiate all along. Others might attempt to re-trade because they believe you’re desperate, or they think your negotiating position has significantly weakened during the process, and they believe they can renegotiate as a result.

Re-trading is effective because the buyer knows that if you walk away from the deal, you’ll have to go back to the market or to other buyers with whom you’re negotiating. Those buyers will view your business as inherently flawed. Other potential buyers are likely to consider your business as stigmatized and may offer a lower purchase price due to the increased perception of risk. Why did the other buyer back out? Regardless of what you tell them, the new buyer will be suspicious.

Re-trading isn’t always targeted at the sales price. Sometimes other terms may be renegotiated. For example, the buyer may propose an earnout to reduce their risk or change other terms, such as the amount of the down payment or the terms of an escrow or promissory note.

How do you prevent re-trading? Do the following:

Focus On Running Your Business

A signed LOI is just the start of the process. Once you’ve signed the LOI, continue to focus on running your business as if you weren’t going to sell it. Your top priorities should be maintaining profitability and keeping your sales pipeline full.

If the revenue or profitability of your business declines after you’ve accepted the LOI, expect the buyer to attempt to renegotiate the price or terms. To prevent this, do everything in your power to maintain the revenue and profitability of your business after you accept the LOI. By preparing for due diligence well in advance of the sale, you’ll help ensure the due diligence process doesn’t derail your focus on your business and affect the revenue.

Read the Buyer

There’s no “standard” LOI. If you suspect the buyer will be particularly picky about certain issues, such as the reps and warranties or access to employees during due diligence, be sure to address those matters in the LOI. It’s much better for the deal to blow up at this point than for you to take your company off the market for three months and then spend tens of thousands of dollars conducting due diligence, only for the deal to derail later because you failed to address sensitive issues upfront. This is where experience is vital. An experienced M&A intermediary or investment banker can be instrumental in anticipating which areas a buyer is likely to be most concerned about and can ensure these issues are addressed in the LOI.

Prepare for Due Diligence

Preparing for due diligence can dramatically speed up the process. Some buyers submit a due diligence list to you that contains a request for hundreds of documents. It takes some sellers over a month simply to compile all the documents necessary for the buyer to conduct due diligence. This is why due diligence can sometimes take two months or longer. Delays caused by the seller are common. The main documents most buyers will request should be ready and available to pass along to them the moment you’ve accepted the LOI. They should be highly organized and uploaded to a virtual data room or other location that can be easily accessed by third parties. Because this takes significant time to do, you should begin this procedure three to six months before you begin the sales process. If you don’t prepare, you can expect due diligence to negatively impact your focus on the business, and your revenue may decline as a result.

Maintain Confidentiality

Confidentiality agreements aren’t bulletproof. Avoid sharing some sensitive information during the due diligence process, even if you have a signed confidentiality agreement in place, especially if the buyer is a direct competitor. If you must disclose sensitive information, wait until the tail end of the due diligence process to do so. If the information is highly sensitive, all remaining contingencies should be resolved before you disclose the information. The buyer should sign off on the successful completion of the due diligence process, except for the last bit of remaining information.

If the buyer requests confidential information before they’ve made an offer, prompt them to submit one. Every time they request additional information, consider it an opportunity to request an offer. For example, if the buyer asks for confidential information, you can say, “I’ve compiled all information required for due diligence in a virtual data room, and you’ll have immediate access to this information the moment we agree to a letter of intent.”

Disclose Beforehand

Disclose all problems about your business before the buyer makes an offer. If you disclose new, negative information after you accept the LOI, the terms of your deal will change. The sooner you fess up, the better. Disclose this information early in the negotiations on your terms, so you can control the narrative and position the problem how you want, ideally in a positive light. Failing to disclose key problems will enable the buyer to exploit these issues when they discover them later in the process. Every company has problems, and most problems can be framed in a positive light if they’re disclosed early in the process.

Be Thorough

Ideally, the LOI should encapsulate all the major terms of the transaction and not leave any significant provisions to be negotiated further along in the process. As I’ve already mentioned, negotiations later in the process will always result in unfavorable terms for you. Remember that the purchase agreement flows from the LOI. In the smoothest negotiations, all key terms are negotiated in the LOI, and the purchase agreement simply explains these terms in greater detail, but it doesn’t introduce new particulars to the transaction. While every purchase agreement involves some negotiations between the parties, they should be as few as possible and primarily restricted to legal issues. 

The worst LOI to accept is one that offers a range for the purchase price or one that leaves out other major terms of the transaction, such as the amount of the escrow, key provisions of earnouts, or the terms of a promissory note. Some LOIs specifically include a clause that the purchase price is subject to change based on what the buyer discovers during due diligence.

While buyers strongly prefer LOIs that are as vague as possible, you should do everything you can to nail down every key term of the transaction before you accept it. For example, buyers may include a clause that states, “Seller’s ongoing role and compensation will be established during due diligence.” I shouldn’t have to tell you at this point that agreeing to this is a terrible idea. We see many buyers of businesses with EBITDA of $2 million to $3 million propose to pay the seller only $100,000 per year to continue operating the business. 

The worst-case scenario is that you should include language in the LOI stating that certain terms will be agreed to no later than xx days (e.g., 20 days) from the execution of the LOI. Every substantive term needs to be covered in the LOI before it’s executed. Not only should all terms be covered, but the LOI should be as thorough and precise as possible – the clearer and more direct, the better. Eliminate all terms that are vague or confusing – for example, if working capital is included in the price, how is working capital defined, and what does it include?

The LOI should ideally encapsulate all the major terms of the transaction and not leave any significant provisions to be negotiated later in the process.

Define Working Capital

The biggest pitfall for most sellers is what is known as a working capital adjustment. Most transactions in the middle market include working capital in the purchase price. The difficulty here is defining exactly how working capital is to be calculated. Typically, the parties prepare a preliminary calculation of the value of working capital at closing. Then the buyer does a final count 60 to 120 days after the closing, and an adjustment to the purchase price is made based on the difference between the estimate before the closing and the final calculation.

If you want to avoid the working capital adjustment time bomb, the language in the LOI regarding how working capital is to be calculated should be as specific as possible. Working capital is normally calculated as the difference between current assets (inventory, accounts receivable, and prepaid expenses), and current liabilities (accounts payable, accrued expenses, and short-term debt). 

Exactly how each component of working capital is calculated is subject to interpretation. For example, is all inventory included in the calculation, or only salable inventory? How is salable inventory determined – after 30 days, 90 days, or 180 days? And what about accounts receivables? Is the buyer paying for 100% of your accounts receivables? How does a reserve for bad debt affect the calculation of the accounts receivables? How is short-term debt calculated? Is a line of credit included in this calculation? How do seasonal changes in the business affect the calculation? The actual closing working capital amount will not be known until the closing audit of your balance sheet is completed, usually 60 to 90 days after the change in ownership. Clearly defining the elements of working capital will keep this final calculation from becoming contentious.

Conclusion

This bears repeating – the letter of intent is the most significant document in an M&A transaction. With that in mind, the following are the major terms and characteristics of an LOI and the impact they have on the negotiations:

So, if the agreement itself is non-binding, why bother? Here’s why:

Now that you’re well-versed in the whys and wherefores of an LOI, I’ll explain the structure of the deal next. 

Here’s a description of the variety of processes and styles of negotiating the LOI:

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The key terms of an LOI include the following:

Less common terms include the following:

Here are details and considerations to keep in mind for each section of the letter of intent.

Introductory Paragraph

Most LOIs begin with a few standard niceties, such as a salutation and preamble, similar to any business letter. After a short introduction, many buyers attempt to differentiate themselves from other potential suitors by including some commentary about their level of excitement to acquire your company or perhaps comments regarding the strategic fit or long-term plans for your business. 

Some LOIs then transition into a basic description of the acquisition, such as the purchase price, form of the proposed transaction, or other high-level terms. While the introductory section is commonly cosmetic, some important terms can be buried within it. While sellers prefer clarity, buyers often prefer ambiguity, which can be used to their advantage later in the negotiations.

Here’s a straightforward introduction to an LOI:

This Term Sheet summarizes the principal terms of a proposed transaction for the purchase of Acme Incorporated (the “Transaction”). This Term Sheet is for discussion purposes only, and there is no obligation on the part of any negotiating party until a definitive written agreement is signed by all parties. Neither party will be obligated to proceed with, or successfully conclude, negotiations regarding a transaction or to conduct negotiations in any prescribed manner.

Binding vs. Non-Binding Provisions

Any well-drafted LOI should clearly state the parties’ intentions regarding the extent to which they desire the LOI to be binding. Some LOIs clarify the objective in the introduction or title of the LOI, such as “Non-Binding Letter of Intent.” 

Other LOIs separate the binding provisions, such as confidentiality and exclusivity, from the non-binding provisions like the purchase price, and then clearly label each section as binding or non-binding. Other LOIs wrap up with a paragraph listing the binding and non-binding sections with a sentence such as, “This agreement is non-binding with the exception of clauses 5, 7, and 10, which are intended to be binding.” Either approach is acceptable as long as the binding and non-binding provisions are clearly identified and separated.

A common mistake in many LOIs is to indicate that the entire LOI is non-binding. This can be problematic if clauses are included in the LOI that should be binding, such as confidentiality, expenses, deposits, and exclusivity. Regardless, courts will look to the parties’ intentions if the LOI is silent regarding whether it’s binding. 

Purchase Price and Terms

While the purchase price is perhaps the most important clause in the LOI, you can’t always determine the “true” or “total” purchase price solely by looking at the purchase-price number. Why? Many LOIs include additions and subtractions from the purchase price that are listed in a separate section of the LOI. 

What’s Included in the Purchase Price

A key example of inclusions (as opposed to exclusions) to the purchase price is working capital. Working capital is defined as accounts receivable, plus inventory and prepaid expenses, minus accounts payable, short-term debt, and accrued expenses. Does the amount the buyer intends to pay include working capital? Here’s an example illustrating the importance of defining whether working capital should be included in the purchase price: 

If the purchase price is $10 million, and the business requires $2 million in working capital to operate, the purchase price could be defined as either $10 million or $12 million, depending on whether working capital is included in the price.

Example A: Purchase price is $10 million, which includes $2 million in working capital. Seller will realize $10 million at closing.

Example B: Purchase price is $10 million but does not include working capital. Seller will realize $12 million at closing, assuming buyer separately purchases working capital at closing.

A common mistake sellers make is to focus solely on the purchase price while ignoring what assets and liabilities are included in the price. Most buyers structure their offers to include working capital in the price, which I’ll discuss in detail in a later section. When receiving an offer, you should analyze it in a spreadsheet, along with current balances for each of the assets and liabilities that comprise working capital, specifically cash, accounts receivable, inventory, accounts payable, short-term debt, and accrued expenses. Doing so will give you a more accurate assessment of their offer. It will also allow you to compare multiple offers on an apples-to-apples basis. Many LOIs fail to define working capital, leaving the definition and calculation to be determined later. That ambiguity will almost never be in your favor due to your diminishing negotiation position as the seller.

The following assets are usually included in the purchase price:

The following assets and liabilities are not normally included in the purchase price:

The LOI should clearly indicate which assets and liabilities are included in the purchase price, and specifically list any assets or liabilities that are excluded.

You can’t always determine the “true” or “total” purchase price solely from looking at the purchase-price number.

How the Purchase Price Is Paid

The LOI should also clearly lay out how the price is to be paid. Here are the most common forms of consideration for the purchase price:

A seemingly appealing offer with an apparently strong valuation may not be attractive once you dig deeper. For example, is any portion of the price contingent, such as a seller note, earnout, or escrow? If so, what are the terms and conditions of the contingent payment? And what is the financial strength of the buyer?

Here are ranges for how the purchase price is commonly paid. Please note that these percentages do not represent the maximum range, but the most common range for transactions in the middle market from $2 million to $100 million in purchase price:

Fixed Purchase Price vs. a Range or Formula

The purchase price in an LOI should ideally be a fixed number as opposed to a range such as $8 million to $12 million. Ranges are commonly used in indications of interest (IOI) for larger transactions of more than $100 million, but I don’t recommend them for transactions less than $100 million. If the buyer proposes a range, I suggest giving the buyer access to more detailed financial information, so they can firm up the price they propose in their LOI before moving forward to confirmatory due diligence. 

Valuations based on a formula – such as 5.5 times the trailing twelve months’ EBITDA – should be avoided, if possible. These formulas are subjective, such as how EBITDA is calculated, and any subjective terms are likely to slant in the buyer’s favor as the transaction progresses. Some formulas include a cap on the purchase price, which can only hurt you. Unless you like gambling on a coin toss with a double-sided coin, avoid a cap. 

With a formula, the buyer can adjust the purchase price based on a change in revenue, EBITDA, or some other financial metric. If you agree to such a provision, the adjustment should go both ways – both up and down – based on the value of the metric. In other words, if EBITDA increases or is found to be higher than your initial claim, the purchase price should also increase. For example, if the buyer agrees to pay a 5.0 multiple of EBITDA and you initially claimed EBITDA was $2.5 million, but due diligence uncovered that you understated EBITDA by $500,000 so that the total is $3.0 million, the buyer should pay you $15 million for the purchase price.

Here’s a sample purchase price clause:

Buyer will acquire 100% of the common stock of Seller for total consideration equal to $15,000,000, plus adjustments for Cash, Indebtedness, and Net Working Capital.

Here’s a more detailed purchase price clause:

In summary, make sure the purchase price, what’s included in the price, and details on how the purchase price is to be paid are all clearly defined in the letter of intent.

Working Capital

Buyers almost always include working capital in their offer price. Why? 

Buyers characterize working capital as any other asset that’s required to operate the business, such as a piece of machinery, vehicle, or any other piece of equipment. Working capital is an asset that must remain in the business for it to operate and is, therefore, no different than any other resource. I reluctantly agree with this point. You’ll rarely be able to negotiate to exclude working capital. However, there are methods you can employ to protect yourself from this clause turning around and biting you later in the transaction. In this section, I’ll cover them in more detail.

Working capital is an asset that must remain in the business for it to operate, so it is no different than any other resource. 

Working capital is defined as current assets minus current liabilities as follows:

The amount of working capital fluctuates on a daily basis in all businesses. For most businesses, the two largest components of working capital are accounts receivable and inventory. Most LOIs make an assumption regarding the current level of working capital required to operate the business, and then make an adjustment after the closing based on the actual amount of working capital (called a “true-up”). This is the fun part for buyers. If the definition of working capital is less than comprehensive, most buyers will work the definition in their favor. The result? Less money in your pocket and more money for the buyer. This is why buyers love unclear definitions in the letter of intent – because they can work them to their favor later in the negotiations after you’ve become emotionally and financially committed to the transaction.

If there’s a difference between the pre-closing and post-closing amount of working capital, the purchase price will be adjusted accordingly after the closing, typically calculated three to four months after the closing. For example, if the working capital target – also called the working capital peg – is $3 million, but working capital is calculated as $2.5 million after the closing, there will be a post-closing purchase price adjustment of $500,000 to make up for the difference. This adjustment isn’t usually made until several months after the closing.

Since working capital is a changing target, such a clause commonly results in post-closing disputes. In fact, I recently spoke with one intermediary who just wrapped up a working capital dispute that left the seller with $1 million less in their pockets. To avoid such a dispute, include a strong definition of working capital like the one below.

Here’s a sample clause that includes working capital:

The Purchase Price would be determined by adding or subtracting, as applicable, the Adjustment Amount to or from the Base Purchase Price. The Adjustment Amount would be defined as (a) the amount of cash and cash equivalents on the balance sheet on the Closing Date (“Cash”), minus (b) indebtedness of the Company at Closing (which, for the avoidance of doubt would be paid at Closing as a reduction of Closing proceeds to the Sellers) (“Indebtedness”), plus (c) Net Working Capital (as defined below) on the balance sheet at Closing. Prior to Closing, the Sellers, on behalf of the Company, would provide the Buyer with an estimate of the Cash, Indebtedness, and Net Working Capital of the Company as of the Closing Date (“Estimated Adjustment Amount”) for review and acceptance.

“Net Working Capital” would be defined as current assets (other than Cash) minus current liabilities and would be calculated in accordance with the Company’s historical accounting practices. There would be a customary post-Closing true-up of Cash, Indebtedness, and Net Working Capital to reconcile differences from the estimate, with the Buyer preparing the initial calculation.

Most LOIs aren’t specific regarding how working capital should be calculated. Here are some important questions that often go undefined:

In the face of the above problems, let’s examine some ways to avoid conflicts related to calculating working capital:

While the LOI may not include specific language regarding a post-closing working capital adjustment, nearly every purchase agreement will do so if the buyer is well-advised, and most are. So don’t overlook this section early on. A post-closing working capital adjustment isn’t boilerplate accounting language – this is a hidden weapon any buyer can use against you, especially if it’s not defined. Be assured that if a clear definition for calculating working capital isn’t laid out in the LOI, the buyer will use it against you when it comes time to negotiate the purchase agreement. If that idea makes you uncomfortable – and it should – nail this definition down before you move on.

Your negotiating leverage disappears the moment you sign the letter of intent.

Key Dates and Milestones

Most LOIs submitted by buyers contain few, if any, deadlines. And, from the buyer’s point of view, why should they?

The antidote is simple – include deadlines and milestones in your counteroffer. As a seller, do not under any circumstances overlook the importance of adding deadlines and milestones to the LOI. Your negotiating leverage disappears the moment you sign the LOI. Why? Most LOIs contain an exclusivity clause that requires you to cease negotiations with all third parties after you accept the LOI. The result is that you must take your business off the market once you sign the LOI, and you end up susceptible to the pressures of “sunk costs” with this buyer. Buyers know this, and some intentionally use it to their advantage. Don’t let it happen to you.

Ideally, the LOI should contain a list of the following key dates and milestones:

Tip: If you have significant negotiating leverage over the buyer, include a clause in the LOI in which the buyer will lose exclusivity if they fail to meet the deadlines. Such a clause will keep the buyer on their toes and helps ensure you maintain as much negotiating leverage as possible as the transaction progresses. 

Confidentiality

Any buyer who’s negotiating with a seller who’s represented by an M&A intermediary will execute a confidentiality agreement prior to submitting an LOI. Some LOIs will reaffirm the confidential nature of the negotiations. Others will expand upon the original confidentiality agreement that was signed, either in the form of an additional clause in the LOI or in a separate supplemental agreement. 

I strongly recommend a supplemental confidentiality agreement if you’re negotiating with a direct competitor. The agreement can contain specific language regarding the non-solicitation of your customers, employees, and suppliers. It can also address any other particular concerns you have regarding confidentiality, such as trade secrets, non-public pricing information, names of employees, or names of customers.

Why isn’t a comprehensive NDA signed earlier in the transaction? A highly restrictive NDA is likely to be met with resistance in the preliminary stages of a transaction, especially when the buyer hasn’t yet decided if they’re interested in digging deeper into your company. Once the buyer has taken a closer look and is sufficiently motivated to make an offer, they may be willing to spend more time negotiating such language, especially given that they will now be privy to much more sensitive information than in earlier stages of the transaction, such as information contained in your confidential information memorandum (CIM).

Due Diligence

Most LOIs presented by buyers include one or two sentences regarding due diligence, usually addressing the length of time requested for the process and access to the necessary information to conduct due diligence. Most buyers request 30 to 60 days, and many request an indefinite term. I recommend countering with 30 to 45 days. The process can always be mutually extended if necessary. If you’ve invested time into preparing your business for due diligence, the due diligence period can be at the shorter end of the range.

Ideally, the LOI should describe the due diligence process in more detail, including the procedure and scope. You should resist providing access to your customers and employees unless absolutely necessary. In most cases, I feel it’s best to remain silent regarding these issues in the LOI. If the buyer insists on meeting with key customers and employees, put off doing so until the tail end of due diligence or, ideally, after the purchase agreement is ready to be signed and all contingencies have been resolved.

A common tactic some buyers use is to gradually wear you down over time with numerous requests for information during the due diligence period. In their view, the more time and money you invest in conducting due diligence, the more likely you are to concede in negotiations later in the process. This strategy plays on the sunk cost fallacy, in which people tend to follow through on an endeavor if they’ve already invested time, effort, or money into it. This wearing-down tactic is highly effective, especially against first-time sellers or any seller with a strong emotional attachment to their business. 

The buyer will also likely engage third parties to assist in conducting due diligence, such as their accountant, attorney, and third-party consultants, such as environmental advisors. Note that CPAs and attorneys can usually be excluded from an obligation to sign an NDA as their license may carry an implied duty of confidentiality. Still, the LOI should either require that these third parties sign an NDA, or the buyer should remain liable for breaches caused by any third parties the buyer employs.

Here’s a sample clause addressing the due diligence period:

The entry into the Definitive Agreement and Closing would be subject to Purchaser completing financial and legal due diligence. It is the parties’ expectation that due diligence would be completed within 30 days after the date of this Term Sheet.

The more effort you have invested in preparing for due diligence, the shorter the due diligence period can be.

Exclusivity 

Most exclusivity clauses prohibit you from soliciting, discussing, negotiating, or accepting other offers for 30 to 90 days after you accept the LOI. This clause is also commonly called a “stop-shop” or “no-shop” clause. The precise length and activities that are prohibited vary based on the exact language contained in the clause. As the seller, you’re usually prohibited from contacting both current and future buyers. This clause effectively allows the buyer to lock up your business for an extended period. Exclusivity is a critical concession you should make with great care. 

Corporate buyers normally demand an exclusivity provision because they’ll invest considerable time and money in performing due diligence, so they don’t want you shopping their offer with third parties in an attempt to get a better deal. Negotiating to remove a no-shop clause is rare because buyers aren’t willing to invest the necessary time to close a transaction if you’re simultaneously courting other buyers or shopping their offer.

It’s reasonable for buyers to want to lock up the transaction to have the assurance you won’t shop their offer as they invest significant time and money conducting due diligence, negotiating the purchase agreement, and preparing for the closing. The exclusivity period gives the buyer the necessary time to work on the details of the transaction without worrying about losing the deal to another buyer.

I rarely make absolute statements, but here’s an exception – far too many sellers overlook their commitment to exclusivity. They fail to realize the impact that a far-reaching exclusivity period can have on their negotiating leverage. You should grant exclusivity carefully and do everything possible to limit the time you’re prevented from speaking or negotiating with other buyers.

Far too many sellers overlook their commitment to exclusivity. They fail to realize the impact that a far-reaching exclusivity period can have on their negotiating leverage. 

Length

Once the exclusivity period is signed, time is on the buyer’s side. The more the buyer draws out the process, the weaker your negotiating leverage becomes. This isn’t hypothetical – every seller should be aware of the implications of agreeing to an exclusivity clause. The deal will never get better for you once you sign the LOI – it can only get worse. Therefore, the longer the time period between signing the LOI and closing, the more likely the terms of the transaction will change. For you, the shorter the exclusivity period, the better.

Most buyers request stop-shop clauses ranging from 45 to 90 days, though I have seen stop shops as long as 120 days. As a rule, you should negotiate exclusivity periods for 30 to 45 days – or 60 days maximum. While most transactions take at least three to four months to close, the exclusivity period can be mutually extended once the key milestones have been met, which are outlined below. 

Shorter exclusivity periods encourage the buyer to move quickly and penalize them for dragging their feet. Longer exclusivity periods encourage both parties to endlessly haggle over the legal points in final negotiations. The LOI should clearly cite the exact duration of the exclusivity period and, ideally, list the precise date the exclusivity period expires.

As a seller, you should be wary of buyers who strongly negotiate for longer exclusivity periods. Exclusivity periods that go beyond 60 days are generally unnecessary and encourage the buyer to take their time. These buyers want to wear you down. The longer the transaction takes, the more negotiating leverage you’ll lose.

Types of Exclusivity Periods

The exact language of the exclusivity clause varies from agreement to agreement, but most prohibit you from actively marketing your business and continuing any discussions or negotiations with any third parties. Here’s a typical exclusivity clause you may see in an LOI:

Seller agrees to deal exclusively with Buyer from the date of this letter through October 10, 20xx (the “Exclusivity Period”), and will not, directly or indirectly, solicit, entertain, or negotiate any inquiries or proposals from any other person or entity regarding the acquisition of the Company or the Company’s assets. As of the effective date of this letter, the Seller will (a) terminate any existing sale discussions, (b) not enter any new sale discussions, and (c) pause all marketing activities, including the removal of any online listings.

Some overreaching LOIs require you to share any offers you receive during the exclusivity period with the buyer. The buyer wants to know what others are willing to pay for your business and will use that number against you. Don’t agree to such a provision.

Other clauses are less restrictive and allow you to continue marketing your business but exclude you from accepting a competing offer. You should always be negotiating for less restrictive clauses if you can. 

The Impact of Negotiating Leverage

Other interested buyers usually move on to other deals or other corporate development projects once they learn you’ve accepted an offer. The result is that you’ll end up losing the best buyers after you sign an LOI that includes an exclusivity provision – and the current buyer you’re negotiating with likely knows this. 

Unfortunately, some buyers intentionally make a high offer, never intending to follow through on it. They then take three months to conduct due diligence and wear you down with a multitude of requests. They may also plant seeds of doubt in your mind regarding your business and do everything possible to poke holes in your business during due diligence. In their mind, the more time and money you spend on due diligence, the better. Then, at the last moment, they start nibbling away at the purchase price – or take a chainsaw to it. 

What’s the result? It’s usually not pretty for you. Your business has now been off the market for months, and discussions with other buyers have cooled to the point where they may be difficult to revive. If your business goes back on the market, other buyers may view it as tainted goods and expect a price concession at best or refuse to submit another offer at worst. Regardless of the time period, re-entering the marketplace puts you at a great disadvantage. 

Once the exclusivity period is signed, time is on the buyer’s side. The more the buyer draws out the process, the weaker your negotiating leverage becomes. 

Preventing Renegotiations

So, what’s the solution? 

To protect yourself from a buyer’s attempt to renegotiate the price during the due diligence period, you should do the following:

Earnest Deposit

Buyers in the middle market view their financial investment in performing due diligence as a demonstration of their earnest intent and consider it an equal substitute for an earnest-money deposit, so they don’t commonly offer or agree to provide an earnest money deposit. Correctly performing due diligence requires an enormous investment of both time and money. While I agree that due diligence requires a serious investment, you should nevertheless be careful if you’re negotiating with a direct competitor, and it may be wise to request an earnest money deposit.

How much is enough when it comes to a deposit? A good rule of thumb is 1% to 2% of the purchase price. For a $10 million transaction, this equates to a $100,000 to $200,000 deposit. Or, for a $50 million transaction, a $500,000 would be sufficient, in most cases. 

Another question to consider is the extent to which the deposit is refundable and under what conditions it may be refunded. Most buyers request that the deposit be refundable until a purchase agreement is signed, while sellers often prefer some portion of the deposit be non-refundable. I’ve encountered a few sellers who demanded a non-refundable security deposit before due diligence has been conducted, and as fast as you can say, “Abracadabra,” … poof! … the buyer is gone. Asking for a non-refundable deposit is seen as unreasonable by most buyers, and such a request will likely send them packing.

A compromise can be made in which the deposit is progressively non-refundable upon the occurrence of certain events, such as the completion of due diligence, preparing the purchase agreement, or receiving a financing commitment letter. In practice, this is difficult and time-consuming to negotiate and usually isn’t worth the time unless you’re dealing with a direct competitor.

Buyers in the middle market view their financial investment in performing due diligence as a demonstration of their earnest intent and an equal substitute for an earnest-money deposit.

Allocation

The purchase price may also be affected by the tax implications of the transaction, which is generally a key factor in determining whether the transaction is structured as an asset or stock purchase. Ideally, the LOI should specify how the purchase price will be allocated for tax purposes. Determining the allocation at this early stage can prevent this from becoming a serious problem later in the transaction. How the purchase price is allocated has major implications for both you and the buyer, and has the potential to kill a deal if both parties refuse to compromise. 

While negotiating the allocation is simple in theory, it’s common for both parties to propose widely different allocations. Reaching a middle ground may require you both to significantly alter your initial proposed allocations.

Here’s a sample allocation for a $12 million transaction:

Negotiating the allocation early is often met with much less resistance because both you and the buyer are far less entrenched in your positions and are often more willing to make quick compromises in the spirit of moving the deal forward. Alternatively, you could both agree to allocate the price based on the tax basis in the assets, which will usually work out in your favor, as in the following example:

For tax purposes, the Purchase Price will be allocated according to the Company’s tax basis in its assets.

You can find more information about the classes of assets and common allocations in Chapter 20, which addresses deal structures.

Legal Form of Transaction

Another important consideration is whether the transaction will be structured as an asset or stock sale. Sellers usually prefer a stock transaction because their net proceeds after taxes will often be far greater than an asset sale. Buyers usually prefer an asset sale because this limits the possibility of contingent liabilities. Also, the buyer can receive a stepped-up basis in the assets, which reduces the taxable income for the buyer post-closing by maximizing the amount of depreciation they can write off.

The reality is that most transactions in the middle market are structured as asset sales. If the sale is structured as an asset sale, the LOI should define what assets and liabilities are included in the price.

The form of the transaction, particularly whether it’s an asset or stock sale, can also impact the other terms of both the LOI and the purchase agreement, especially the reps and warranties.

Most transactions in the lower middle market are structured as an asset purchase. 

Escrow – Holdback

Most LOIs are silent regarding the amount of the purchase price that will be held back in an escrow account to satisfy any indemnification claims for breaches of reps and warranties in the purchase agreement. In most middle-market transactions, a portion of the purchase price – typically 10% – is held back for a fixed period, usually 6 to 18 months. This serves as a form of insurance in case you make any representations in the purchase agreement that later prove to be false or for other issues, such as a breach of a post-closing covenant.

Ideally, the LOI should address whether a percentage of the price will be escrowed or held back and if so, the amount of the holdback. Here’s a sample clause:

10% of the Purchase Price payable at Closing will be deposited in a third-party escrow account to be held for a period of 12 months after Closing as security for Buyer’s indemnity claims under the Purchase Agreement.

The major points to consider regarding escrow include:

Representations and Warranties

Regardless of how thoroughly the buyer conducts their due diligence, they’ll never be confident they’ve discovered every possible problem or defect with your business. Reps and warranties are designed to cover what the buyer may have missed during due diligence and can be one of the most contentious sections to negotiate in the purchase agreement. Unfortunately, most LOIs say little beyond the fact that the reps and warranties will be customary – with no mention of exclusions, knowledge qualifiers, caps (maximum liability), or the basket (minimum liability). 

In most cases, that’s the best the parties can do, and both you and the buyer must move forward based on good faith and confidence in each other. Your goal is to minimize your exposure while the buyer will seek the broadest exposure possible. Most LOIs state that the LOI is subject to the preparation of the purchase agreement, which will contain reps and warranties that are customary or appropriate for a transaction of its nature.

Here is a sample clause that commonly appears in LOIs:

The Purchase Agreement would include such representations and warranties as are appropriate [or customary] for a transaction of this nature, including representations and warranties covering capitalization, authority, environmental matters, taxes, employee benefits and labor matters, violations of law, and customary matters relating to the business, such as its financial statements.

Some LOIs also require each party to represent that entering into the LOI or purchase agreement won’t conflict with or breach any other contract. This is normally a formality and rarely negotiated.

Reps and warranties are designed to cover what the buyer may have missed in due diligence and can be one of the most contentious sections to negotiate in the purchase agreement. 

Conditions – Contingencies

Most LOIs also include conditions for consummating the transaction, such as the following:

Because most LOIs are non-binding, conditions to the sale aren’t required for the parties to move forward. But conditions serve one important purpose – they set the expectations of the parties.

In effect, conditions allow the buyer, and sometimes you, to cancel the transaction if they can’t be met – notwithstanding the fact that most LOIs are non-binding anyway. Regardless, most state laws require the parties to act in good faith and use their best efforts to attempt to resolve the conditions. But most LOIs are silent regarding the extent to which action is required, such as best efforts and commercially reasonable efforts, and the parties must rely on state law to determine to what extent effort is required. 

In practice, proving that the buyer didn’t make a reasonable effort is difficult, and the transaction is normally canceled if the conditions aren’t met. The only scenario in which this is likely to come into play is if a competitor makes an offer on your business with the sole objective of obtaining competitive information, and they don’t make reasonable efforts to resolve the conditions outlined in the LOI.

Financing Contingencies

The most common condition is a financing contingency. The financing condition allows the buyer to cancel the sale if they can’t secure the funds to finance the transaction. You may argue that if the buyer is confident they can obtain financing, they should be willing to bear the risk if financing can’t be obtained. If you have multiple competing offers on the table, you may be able to negotiate to remove financing contingencies or require a commitment letter from lenders within a specified number of days after accepting the LOI. Alternatively, you could require the buyer to reimburse you for your out-of-pocket expenses if they can’t obtain financing.

Note that most banks require significant documentation on your business before they will provide a commitment letter. This documentation is normally only provided to the buyer during the due diligence period and, therefore, only after an LOI is accepted.

Another option is for you to agree to finance the transaction if the buyer can’t obtain financing, but the terms of the seller note you’re proposing should be unattractive enough that it motivates the buyer to aggressively seek third-party financing.

The degree to which a financing contingency is common depends on the type of buyer you’re negotiating with. Most well-capitalized companies have the funds on hand to complete smaller transactions. Private equity firms, on the other hand, nearly always seek third-party financing in addition to the committed capital they may already have access to.

The biggest downside to a financing contingency for you is that all the buyer must do if they don’t want to follow through on the deal is to claim that they can’t obtain financing. This effectively serves as a “blanket contingency” for a buyer. The degree to which this is important is debatable, given that most LOIs are non-binding anyway.

The biggest issue to watch out for are buyers who have little money on hand and seek to finance a large portion of the purchase price. These buyers may seldom have existing relationships with banks and may not have any contacts or experience in the industry. This means they may have a difficult time obtaining financing. The biggest warning sign is if the buyer is planning to shop for investors after signing the LOI.

Covenants

In law, a covenant is a promise to do or not do something. In an LOI, covenants primarily relate to how the business will be conducted prior to the closing, such as “between the date of this Letter of Intent and the closing, the seller agrees to operate in the ordinary course of business.”

The buyer essentially wants a guarantee that the business will continue to operate in the ordinary course of events until the closing occurs. This effectively requires that you avoid making any material changes to your business prior to the closing, such as terminating key employees, liquidating assets, or declaring large bonuses. Some LOIs prohibit such changes, while others require the buyer’s approval before making the changes.

The buyer’s goal is to prevent you from making radical changes that can affect the value of the business. Most buyers simply desire that you continue to operate the business as you normally would, but they often ask that you run key decisions by them before implementing them. I’ve encountered some sellers who have made drastic changes to their business prior to closing, such as terminating major advertising contracts, firing key employees, discontinuing lines of business, selling major pieces of equipment, and so on. As the seller, you should continue operating your business as usual and obtain the buyer’s approval before you make any major changes to your business.

Seller’s Role

Another key element of any LOI is the role you’ll play in your company after the closing. If you’ll continue to be involved, the key terms of your employment or consulting agreement – such as salary – should be worked out prior to accepting the LOI. 

In most cases, it isn’t worth it financially for you to continue working in your business. If a business generates $3 million in EBITDA per year, few sellers will be willing to continue working in the business at a salary of $300,000 per year. Why would they take a 90% pay cut? Most aren’t willing to do so. It’s best to find out now what the buyer’s expectations are regarding your continued role and potential salary. If you can’t agree on the terms of the employment agreement, it makes little sense to accept the LOI. The primary exception to this rule is if you sell your business to a private equity firm and retain the equity in your business post-closing.

There are three primary instances in which it may make sense for you to play a continued role in the business:

  1. As a Consultant: Many sellers must consult with the buyer for an extended period to assist with the transition. This is common in complex businesses where the seller is one of the few people in the business that has in-depth knowledge regarding how to operate the business or in businesses where the buyer requires your intensive assistance to help with the transition.
  2. As a Salesperson: It may make sense for you to remain as a commission salesperson post-closing. This is especially true if you enjoy sales, are proficient at it, and are seeking extra income during retirement. Sellers are usually quite open to this idea if they don’t enjoy managing the business but love sales. This can be a win-win situation for both parties, especially if the buyer is willing to offer you a flexible schedule.
  3. When a Buyer Offers You Equity: Finally, it may be worthwhile to stay if the buyer offers you a significant amount of equity in the business. For example, most private equity groups expect you to remain to operate the business post-closing. At a minimum, the private equity firm will want you to stay long enough for them to find a replacement. Otherwise, most PE firms prefer that you stay long-term. To make it worthwhile for you, most financial buyers will require you to roll over some of the sale proceeds into equity in the new entity – usually in the range of 10% to 30% of the purchase price. In this scenario, you sell a majority of the business now, then sell your minority interest in a second sale in three to seven years. This often makes sense for you because it allows you to diversify some of your risk by taking some chips off the table now while potentially having another bigger exit in the future.

If you don’t want to stay on with your business, you should seek out buyers who don’t require you to do so. Alternatively, you should focus on building up your management team and identifying a potential successor several years in advance that can continue to run the business after you’ve made your exit.

If you’ll continue to play a role in your business after the sale, the key terms of your employment or consulting agreement – such as salary – should be worked out prior to accepting the LOI. 

Management’s Role

There are two primary issues in a letter of intent that relate to your employees – disclosure and retention. 

Disclosure 

One of the most challenging issues faced by sellers is deciding which employees to tell about the sale and when to tell them. Most sellers prefer to keep the sale a secret until the day of closing. Perhaps they may disclose the sale to their CFO and professional advisors, but keep in mind the infamous WWII slogan – loose lips sink ships. The more people who are told, the more likely it is that word will end up in the wrong ears.

At the same time, buyers often want access to key employees before the closing occurs. Their objectives for wanting to speak with employees are usually two-fold:

  1. Due Diligence: To help with their assessment of due diligence. For example, the employees may be more frank regarding some aspects of the business than the seller, or they may be more frank regarding issues the seller may have failed to disclose regarding the business.
  2. Retention: To ensure key employees are retained.

As I have discussed in previous chapters, there are two key elements in deciding to inform your employees:

  1. When: When to tell employees depends on your business’s culture. If your culture is particularly healthy and your team is small, it may make sense to inform your employees in advance of the sale – if you believe they can all keep mum. Otherwise, the consensus is that you shouldn’t tell them too soon because they may leave or too late because they may feel betrayed.
  2. How: In most cases, it makes sense to inform your key managers first and then disclose the sale in a group setting to the remainder of your employees. Your key managers can set the proper tone when you make the disclosure in the group setting, assuming they’re well respected. If your team is large, your key managers can inform their subordinates in their own group settings.

You can couple this disclosure strategy with a retention agreement with your key employees. If you prepare a formal retention bonus agreement, you can also include a confidentiality and non-solicitation agreement that can be assigned to the buyer.

If you agree to allow the buyer to talk to your employees, you should only let this happen at the tail end of due diligence. Ideally, the purchase agreement should be fully negotiated and ready to be signed.

Retention

The second issue buyers are concerned about is retaining your employees. Some LOIs contain a contingency that states that the buyer won’t move forward unless they can obtain employment and non-compete agreements from your key employees. In some cases, this process unfolds uneventfully, especially if the buyer is well-capitalized and agrees to a salary increase with your key people.

But be careful about agreeing to such a clause. If employees catch wind of the fact they can hold up the sale, they often will. As a business owner, the last thing you want to happen is to be held hostage in your own business by your employees. 

For example, I worked on one transaction in which several of the key employees made excessive demands on the buyer. These employees knew the position they were in and decided to hold the buyer and seller hostage. What was the result? The buyer didn’t acquiesce to the employees’ demands and fired the employees the day after the closing. Sometimes the squeaky wheel gets the grease, as the saying goes, but other times the squeaky wheel gets replaced.

Non-Compete

While nearly all buyers expect you to agree not to compete with the buyer after the closing, such an agreement is usually implied and not explicitly stated in the LOI. Despite this fact, it doesn’t hurt to include one line in the LOI stating that the buyer expects you to sign a non-compete at closing for a specified number of years and within a certain geographic area. If you desire to engage in something related to the business after the closing, you should specifically carve out the desired activity to make sure it won’t conflict with the non-compete.

Termination

Termination of most LOIs is tricky if the LOI is non-binding. If the LOI is non-binding, it should be cancellable without effect. Some savvy buyers also include a clause that requires you to reimburse their expenses if you walk away from the deal. You may seek a reciprocal clause if the buyer walks. Such is the give and take of negotiating any LOI. In practice, momentum is as important for each party as nailing down all the specifics. Regardless, all LOIs should terminate if you and the buyer fail to reach an agreement by a specified date.

Miscellaneous

Here are several miscellaneous clauses that most LOIs include:

Expenses

This provision addresses how fees and expenses will be allocated between the parties. Most specify that expenses will be paid by the party that incurs them. Some LOIs require you to reimburse the buyer for their expenses if the deal doesn’t happen. Most sellers consider this to be unreasonable and refuse to sign it.

Governing Law

Governing law isn’t an issue if the parties are both located in the same state. If the buyer and seller are in different states, the buyer usually proposes their home state as the governing entity. The seller often agrees if the state is Delaware or the buyer has significantly more negotiating leverage. Delaware is considered a favorable choice because of the extensive experience of its courts. Delaware has a more well-developed body of case law than other states, which serves to give corporations and their counsel greater guidance on matters of corporate governance and transaction liability issues. Otherwise, the parties compromise and choose a neutral state.

Legal Authority

Some LOIs also require that the parties confirm their legal ability to consummate the transaction. 

Negotiating is a soft science. What works for one deal won’t necessarily work for the next. That being said, understanding the intricacies of the LOI and who has leverage at what point in the negotiations will help you understand how to maximize your position and best maintain your leverage throughout the transaction. First, I’ll explain the strategy most buyers use when negotiating the LOI.

Buyer’s Strategies

A buyer will typically submit a letter of intent after spending some time assessing your business and determining if it’s a good fit. Among the items customarily included in the LOI are the price and terms, what assets and liabilities will be included, an obligation to negotiate exclusively, and conditions to close. 

For sellers, mistakes made negotiating the LOI are far more common than in negotiating the purchase agreement. Most sellers dramatically underestimate the importance of the LOI and are in a hurry to move on with the transaction and rush to sign the LOI. Experienced buyers have many strategies for taking advantage of this lack of patience. 

Here are a few of the most common strategies buyers use to maximize their leverage.

Rushing Into an LOI: Savvy buyers put pressure on you to quickly sign the LOI and move into due diligence. Why? Most LOIs contain an exclusivity clause in which you must agree to cease all negotiations with third-party buyers and take your business off the market. The moment you sign an LOI that contains such an exclusivity clause, your negotiating position evaporates. And that’s exactly what experienced buyers aim to do. 

Chipping Away at the Price: Another strategy buyers often use is to get you to invest as much time and money as possible in the deal before they begin to slowly chip away at the price and terms later in negotiations. At this point, many sellers have already spent tens of thousands of dollars with their attorneys to negotiate the purchase agreement, and they don’t have the energy to go back to square one with a new buyer. As a seller, you’re in sole negotiations with one buyer. Corporate buyers, on the other hand, may be in negotiations with multiple sellers simultaneously. The fact that you’re exclusively negotiating with one party while the buyer may be negotiating with multiple sellers has the potential to dramatically weaken your negotiating position and encourages the buyer to continue negotiating until the final minutes before the closing.

Potential Damage From Backing Out: Buyers may also take advantage of the potential downfalls of a seller backing out of a deal. Experienced buyers know that if you walk away from the transaction and put your business back on the market, other buyers might think you’re peddling damaged goods. If you put your business back on the market and restart negotiations with another buyer, that buyer might downgrade their valuation and conduct much more thorough due diligence if they are aware it didn’t work out with a previous buyer.

Buyers employ all these strategies to maximize their negotiating leverage and minimize the price they pay. A poorly drafted letter of intent will allow them to box you into a corner, which means you may eventually receive less for your business. Understanding how to properly negotiate the LOI is your best defense against these tactics. 

For sellers, mistakes made negotiating the LOI are far more common than with the purchase agreement. Most sellers dramatically underestimate the importance of the LOI and are in a hurry to move on with the transaction. 

Undefined Terms in the LOI

The tactics described above stem from weak or ambiguous LOIs. Failing to define certain terms in the letter of intent can be devastating for you. Because the buyer’s attorney usually prepares the purchase agreement, if a term isn’t defined in the LOI, it will be worded in the buyer’s favor in the first draft of the purchase agreement and it may take a significant number of rounds of negotiations to undo a term you failed to define in the LOI. With that in mind, here are some terms that could – but shouldn’t – go undefined in the LOI: 

These points are just a sample of what can go wrong if critical terms aren’t defined in the LOI. The bottom line is that you have all the leverage when you’re negotiating the LOI. Use it. Spend as much time as you like negotiating the LOI. Savvy buyers will use momentum and pressure to get you to sign the LOI as quickly as possible. Don’t do it. Take your time negotiating, which will maximize your price and terms and help you maintain your negotiating position. 

Failing to define terms in an LOI can be devastating for a seller. Because the buyer’s attorney usually prepares the purchase agreement, every definition will be worded in the buyer’s favor. 

Comparing Offers

Which offer would you accept?

It’s a trick question – you can’t decide. You don’t have enough information to make a decision. 

I would ask the following questions before I could evaluate either offer:

Unfortunately, I’ve seen countless buyers who propose deals with terms like the offers above. And they often get away with it because sellers commonly focus only on price. Yes, the LOI you received might look attractive enough to accept – but 90% of it may be boilerplate, and the terms may be vague enough that the buyer can rewrite them to their tastes later. When you receive an LOI, it’s critical to pin down the buyer on all the key terms of the transaction; otherwise, there’s a good chance the unwritten terms won’t be favorable for you when they’re finalized in the purchase agreement. I’ll provide details on all the terms that can be included in the LOI in this chapter.

The Major Characteristics of a Letter of Intent

This is a listing of the major terms and characteristics of an LOI, and the impact they can have on negotiations: 

The Term Sheet

A term sheet is sometimes used to start negotiations by allowing the parties to focus on the key terms of a transaction before preparing a more detailed letter of intent and, later, a purchase agreement. A term sheet isn’t usually necessary if the buyer is a private equity group or sophisticated corporate buyer. In these cases, the buyer or their attorney usually prepares the LOI. Note that “term sheet” is not used consistently across the industry and what some refer to as the term sheet may be called different names depending on the industry or size of the business. 

A term sheet can be as simple as a sheet of paper with your agreement regarding the basic terms of the transaction, such as the selling price, down payment, financing terms, length of time for due diligence, training agreement, non-compete agreement, and contingencies. This document allows you to focus on structuring the essential elements of the transaction without getting bogged down in the language required to document those terms. Once you agree to the term sheet, you can move straight to the LOI. I’ve seen many parties spend dozens of hours and thousands of dollars in attorney fees because they didn’t agree on the basic terms and structure of a transaction before they dove into drafting the letter of intent. A term sheet can prevent this problem by allowing the parties to focus on the critical terms of the transaction before they prepare a more detailed letter of intent.

If you decide to prepare a term sheet before a letter of intent, you’ll want to agree on the following basic terms:

Non-Binding

Most LOIs are drafted to be non-binding, except for a few key provisions. The non-binding provisions include those relating to price and terms, such as:

The binding provisions relate to how the process is to be governed, including:

Regardless, the parties should be sure to clearly express which provisions are intended to be binding.

Why are most LOIs intended to be non-binding? It’s because the terms of the transaction may change based on what the buyer discovers during due diligence. Prior to due diligence, you’re making representations the buyer must accept at face value. It’s not until you accept a buyer’s letter of intent that they will have the opportunity to confirm, or verify, your representations – hence, due diligence is often called “confirmatory” since your representations are “confirmed” during this period. Buyers don’t want to be bound to a document that’s based on assumptions they haven’t yet had a chance to confirm. With a non-binding LOI, the parties aren’t bound to the transaction until a purchase agreement is signed, which usually occurs sometime after the completion of due diligence, or in many cases, not until the closing.

A provision stating that the LOI is intended to be non-binding is usually concluded by the courts to be non-binding. But some courts have ruled that an LOI may be binding in certain circumstances. When determining the binding nature of an LOI, the courts typically look at the parties’ intent, the language used in the agreement, and the degree to which performance has already been completed. Although most LOIs aren’t usually intended to be binding, the courts have ruled that the parties have a duty to negotiate in good faith, even when the agreement doesn’t explicitly state such an obligation. This should give you comfort if you’re negotiating with a direct competitor and have concerns regarding their intentions, such as if their objective may be to appropriate your trade or other secrets. 

Reasons Why an LOI Is Necessary Even if It’s Non-Binding 

As stated above, an LOI is an integral document to any M&A transaction, even though it’s non-binding. Here’s a list of the value a well-drafted, non-binding letter of intent adds to the transaction despite its non-binding nature:

Why are nearly all LOIs non-binding? It’s because the terms of the transaction may change based on what the buyer discovers during due diligence. 

Problems and Solutions

Many problems can arise as a result of signing a letter of intent. Here’s a list of the most common ones and how to prevent or resolve each:

“The most difficult thing in any negotiation, almost, is making sure that you strip it of the emotion and deal with the facts.” – Howard Baker, US Senator

For my money, the letter of intent (LOI) is the most significant document in an M&A transaction, eclipsing the importance of even the purchase agreement. This is because, in most cases, the prices and terms you ultimately receive are more affected by negotiations over the LOI than the purchase agreement. 

Let that sink in. For most sellers, how you negotiate the LOI is more important than how you negotiate the purchase agreement. Signing a strong LOI that protects your interests puts you out in front of the pack as you head to the finish line. A weak LOI is more akin to heading to that finish line but in a three-legged race. In this chapter, I’ll discuss the characteristics of an LOI, how best to negotiate your letter of intent, and how to use leverage to ensure you get the best deal possible. 

It was the ancient Greek storyteller Aesop who said, “Honesty is the best policy.” Honesty can also become your #1 weapon when selling your business, if you know how to use it.

Does that mean you can’t conceal a few warts on your business from buyers during the sales process? And if you do hide a few material facts that you should have disclosed, does the buyer have recourse if they find out about these facts after the closing? Well, both Aesop and I think being honest about your business will be better in the long run than either of these misdirections. 

Honesty is an underused tool in M&A transactions. Trust is critical to successfully selling your business, and the easiest way for you to build trust is to be honest in all your dealings with buyers. Acquiring a business is a risky endeavor for any buyer. And the value of a business is directly related to risk. 

If the buyer doesn’t trust you, they may seek to reduce their risk by:

Being honest saves you time and can potentially increase the value of your business. It can also reduce the thoroughness of a buyer’s due diligence and make negotiations far less contentious. Any buyer who senses you’re dishonest will either head for the hills or triple their level of scrutiny during due diligence. They may also request holdbacks or other forms of protection. Honesty can pay off handsomely when selling your company. If the buyer believes you to be forthright, they’ll perceive your business to be less risky, and negotiations will likely go more smoothly as a result.

Why Honesty Is the Best Policy

Saves Time: Being authentic and forthright saves you time from having to remember any half-truths you may have told during the sales process. It gives you freedom because you have nothing to hide.

Eases Due Diligence: Building trust through honesty and proper disclosure can reduce the intensity of the buyer’s scrutiny during due diligence and can reduce the possibility of re-trading. Speaking the truth prevents you from having to recall what you may have said, which reduces the stress of due diligence.

Maintains Integrity: Selling a business is a protracted endeavor and concealing material facts is difficult. It’s nearly impossible to conceal material facts in perpetuity. Your odds are slim-to-none for concealing a material defect all the way to the closing table and even less after the closing. A sophisticated buyer will perform excruciating due diligence and is likely to discover any material facts that may exist in your business. If the buyer discovers a fact you failed to disclose during due diligence, you’re doomed. I guarantee you that the terms of your transaction will change. 

Limits Exposure: Buyers have recourse for issues they find via reps and warranties. As a seller, your exposure can last years due to reps and warranties and other safeguards buyers often include in the purchase agreement. If the buyer discovers a material misstatement – even after the closing – they may seek damages pursuant to the reps and warranties you signed in the purchase agreement. Even worse, they may offset any payments due to you via a set-off.

Lowers Perceived Risk: Honesty reduces a buyer’s perception of risk. Reducing risk increases value. How do buyers assess risk? They use a combination of legal, financial, and operational due diligence, along with gut feelings. Different buyers use “gut feel” to varying degrees. For example: 

Trust Streamlines Negotiations

Even after the closing, you will need to have a relationship with the buyer. Honesty builds trust and serves as the foundation for this relationship, and frankly, it’s easier to negotiate with a friend than a foe.

I can recount dozens of transactions in which the buyer told me they trusted the seller and agreed to expedite due diligence and immediately move to the closing. I often hear the same from sellers – it’s refreshing to hear when a seller trusts a buyer and has built a strong relationship with them. If the seller trusts the buyer, the seller is often more comfortable disclosing sensitive information during due diligence, which can speed up the due diligence process. This would not be possible without trust, honesty, and disclosure, which are the foundations of building a solid relationship.

Put yourself in the other party’s shoes. Who would you feel more comfortable writing a $50 million check to? 

Here is how William and Vinny would likely respond to the following scenarios:

What was your revenue last year?

Who is your top competitor?

If you’re a buyer, who are you going to be more likely to do business with, all other factors being equal? Being transparent and honest can go a long way.

Use Honesty and Disclosure To Build Trust

Disclose Material Facts Early: This gives you the opportunity to put a positive spin on any problems before the buyer discovers them. Doing so allows you to go on the offensive. The alternative – being defensive – always makes you look bad, regardless of the veracity of your position. 

Disclose Before the Buyer Asks: This gives you the opportunity to put your own spin on the situation and engenders trust. If a buyer uncovers a material fact before you disclose it, you could experience a loss of trust that might take weeks or months to regain. Full disclosure prevents this possibility and builds trust. 

Avoid Hype: If you wish to introduce positive opinions regarding the state of your industry, do your research. Find articles that have been written by, or quote, trustworthy sources, and share them with the buyer. If caution is in order – if, for instance, the author of a particular article is overly optimistic – say so. The buyer will respect your discreet perspective.

Build a Strong Relationship: If you focus on building a strong relationship first, everything else is more likely to fall into place as the transaction progresses. Naturally, different buyers have different feelings regarding the importance of the relationship, and you should adapt your approach accordingly. 

Put Your Best Foot Forward: Point out the positive traits regarding your business, but be sure to balance these with a discussion of any potential downsides. As an entrepreneur, you’re likely an optimist, but you must temper your optimism with realism. Show humility when possible – there’s no better tool for building trust than humility.

Beware of Unscrupulous Buyers: It’s wise to modify your position and style depending on the type of buyer you’re negotiating with. If you lack M&A experience, it’s best to rely on an advisor’s opinion. A skilled advisor will know when a buyer is acting aggressively or taking advantage of you. You must know when to modify your position and style based on the buyer’s approach, and you must know when to dig in. 

Be Careful What You Put in Writing: Put only facts in writing. Always convey subjective information through a phone call or a face-to-face meeting, not in writing. Your CIM should contain a careful analysis of your business and industry. It may include definitive statements regarding the state of your industry and the potential for growth. You’ll have ample time for this document to be scrutinized carefully and refined by your team of advisors – including your attorney, CFO, M&A advisor, and others – before it’s released to a buyer. Imagine anything you put in writing before a judge. Collectively, your statements could be used against you post-closing if the business fails or if there’s a material misstatement or other breach of contract. 

Let the Buyer Form Their Own Narrative: Provide the raw material that’s sourced from third parties, as discussed above, so the buyer can come to their own assumptions that serve as the basis for any projections. In other words, tell the buyer where the tortillas, beef, lettuce, and cheese are in the kitchen, but let them prepare their own burrito. Give the buyer the facts and then let the buyer tailor them to their specific needs, desires, or tastes. Their conclusions will have more credibility and be more meaningful in their minds than any assumptions you’ve spoon-fed them. Here’s an example of a wrong approach and a right approach:

The trick is to get the buyer to ask you what the ingredients are and let them assemble their own recipe. For example, let’s say you mentioned you have a new product in development. 

Any buyer who senses you’re dishonest will either head for the hills or triple their level of scrutiny during due diligence.

Conclusion

The ability to create leverage for yourself during a deal is integral to maximizing the price of your business. Understanding the ebb and flow of leverage throughout a transaction, as well as the negotiating pitfalls of sunk costs and emotional objectivity, is crucial. If you can master these skills and create a strong position for yourself, you’ll be well on your way to a successful transaction. 

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It’s wise to heed the ancient Chinese proverb, “You have two ears and one mouth, and you should use them in those proportions.” Indeed, an important tactic I’ve learned about negotiations and communication is the power of listening. It’s as deceptively difficult to do as it is simple to explain – listen before you speak. By simply working to make your buyer feel heard, by truly listening to them and letting them speak, you can steer clear of many of the common pitfalls of negotiation.

Let’s go through some of the advantages of working to listen before you speak at the negotiation table.

Fully Understand the Buyer’s Position

Listen to the buyer’s points in full before responding. I can’t tell you how many times I paid the price of not listening early in my career. A buyer would reach out to me and begin to voice their concerns. I would immediately respond by interrupting and attempting to address what I thought their concerns were, or should be. In most cases, I was wrong, and my unwillingness to listen frustrated the buyer. Eventually, I learned it was more effective to keep my mouth shut and fully listen to the buyer before responding, even if the buyer initially made an insulting statement regarding the business I was representing. By patiently listening, I could fully understand the buyer’s position and point of view, which helped foster trust. 

Buyers Talk Themselves Out of Their Own Concerns

I eventually began to view these conversations as a poker game – the more I got the buyer to talk, the more of their cards I could see. I also learned to ask lots of follow-up questions because each tipped the buyer’s hand just a little more. I lost nothing by listening and gained everything from it. Only after I fully explored the buyer’s position by asking follow-up questions did I attempt to respond. Surprisingly, in many cases, the buyer talked themselves right through their own problems, and I offered no input other than a listening ear.

Find the Buyer’s True Concerns

When a buyer tells you a concern, it’s often a symptom of another underlying issue. How do you find out? Ask questions – lots of questions. And dig deeper. And then dig a little deeper. An excellent relationship with the buyer, especially one built on actively listening and showing that they’ve been heard, will help uncover their true concerns. For example, if the buyer expresses issues they have about your IT infrastructure, find out what their underlying concerns are. Digging deeper into the issue can help you eventually uncover their true concerns, in this case, the fact that they are worried about having a platform for the technology solutions they plan to implement. Acknowledge what the buyer is saying by occasionally repeating back what you’re hearing, and asking follow-up questions to fully understand their concerns. This line of questioning will often reveal a deeper concern than the one they initially voiced.

Address the Buyer’s Concerns Directly

In most cases, you shouldn’t immediately respond when you discover the buyer’s true concerns – you have nothing to gain by doing so. Simply tell the buyer you’ll give this some thought and get back to them. Then prepare a game plan for addressing these concerns with your advisor. Your advisor can then follow up directly with the buyer and work out a solution – doing so keeps you out of the negotiations, which helps you maintain emotional objectivity and reduces your sunk costs.

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Deal fatigue is a condition in which buyers or sellers or both feel frustrated, irritated, or exhausted as negotiations drag on. It happens frequently with business owners who are going through the process of selling their business. The more time you’ve spent preparing your business for sale, the faster it will sell, and the less likely you’ll experience deal fatigue. 

If you’re an entrepreneur, you’re likely already familiar with fatigue when trying to accomplish a major objective in your business. For example, you may have spent 50 to 100 hours trying to recruit and hire a senior manager only to be let down at the last minute by the leading candidate. While this goal may be critical to the success of your business, at some point you’ll experience fatigue and will be susceptible to taking shortcuts to accomplish your objective. In this example, if the references on your last potential hire didn’t work out, you may simply hire the next applicant and only perform a rudimentary interview and skip reference checks. You end up taking shortcuts because you become fatigued. This fatigue dramatically affects the quality of your decisions because you don’t have the energy to maintain the initial standards you set for the objective.

The same issue of compromising your initial standards can happen when selling your business. The more buyers you communicate and negotiate with, the more likely you’ll experience fatigue at some point. So, how do you prevent deal fatigue while creating a strong negotiating position? 

Spend as much time as possible thoroughly packaging your company for sale. By investing time preparing for the sale, you help ensure it unfolds smoothly and quickly, which greatly reduces fatigue. Your CIM and financials should be as accurate and thorough as possible to anticipate the most common questions all buyers will ask. This reduces the number of clarifying questions you’ll receive from buyers, which helps preserve the amount of energy you have to invest in selling your business. 

You can also experience fatigue from negotiating with one buyer. Again, the more time, money, and emotion you invest in any one buyer, the greater your sunk costs will be, and the more likely you’ll be seriously disappointed if the buyer renegotiates the price or terms or backs out altogether. Now imagine if this happens with multiple buyers back-to-back when selling your business. At some point, you’ll burn out and begin taking shortcuts and sacrificing your standards. Here, again, the best option for avoiding deal fatigue is preparation – by preparing your business for sale, you minimize the chance the buyer will discover a material fact they can use against you during due diligence.

Sophisticated buyers are aware of the natural tendency of business owners to experience fatigue as the process wears on. They may take advantage of this by drawing out the process and nibbling at the last minute. Avoid deal fatigue by developing as many options as possible and maintaining your positioning and emotional objectivity. Always have other options available in case the buyer attempts to renegotiate the price.

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The biggest mistake sellers make when they accept an offer is getting so excited that they lose focus on their business. Remember – over half of deals don’t make it to the closing table, even after an offer is accepted. If you want to close the deal, focus on running your company until the check clears.

If revenues slip during the process, expect the buyer to negotiate a lower price. On the other hand, an increase in revenue creates a stronger position to lock in your terms. Work to keep the sales pipeline full until the closing. You should also send the buyer updates regarding any new activity in the sales pipeline. Send the buyer as many positive updates regarding your business as possible. 

A steady stream of positive updates will keep the buyer motivated, which helps maintain momentum. For example, if the buyer discovers any problems during due diligence – a key customer or employee that may not be retained, for example – this issue may be offset by new positive developments in your business. You can mitigate the loss of a key customer by saying, “Yes, I understand your concerns, but we have three new potential customers in the sales pipeline that could potentially increase revenue by 10% to 20%. So while I understand your concerns regarding the loss of a customer, I feel these are more than offset by the prospects we have with these new potential customers.”

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Stay calm and collected throughout the process. Buyers will become nervous if you lose your cool. Do your best to remain emotionally objective.

Here are several tips to help you maintain emotional objectivity:

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The actual negotiating process requires far less finesse if you’re negotiating from a position of strength. If I had to choose between expert negotiating skills and a strong position, I’d choose a strong position every time. For example, when you’re in the market for a new car, it’s much more effective to negotiate the purchase when you couldn’t care less whether you walk off the lot with a car rather than when you desperately need a vehicle.

The key to creating a strong position is wanting to sell, but not being forced to. As a rule of thumb, the more options you have, the stronger your position will be. Here are some tips to help ensure you negotiate from a position of strength: 

Once you’ve created your options, you must subtly communicate to the buyer that you’re negotiating from a strong position. Deal with buyers in an interested, professional, but dispassionate tone. Communicate to the buyer that you’re prepared and motivated for the sale, but not dependent on it. Convey that you love what you do, yet now it’s best for you to move on. In essence, send the message to the buyer that you’re motivated but not desperate to sell.

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A sunk cost is an investment in time or money that has already been made and can’t be recovered. For example, if you spend 50 hours negotiating with a buyer and $50,000 in legal fees negotiating the LOI, this is a sunk cost because you can’t recover the expense.

Why are sunk costs dangerous? Enter the sunk cost fallacy.

The sunk cost fallacy describes a human’s tendency to follow through on commitments the more time, effort, or money they’ve invested, even when faced with evidence to the contrary. Many people continue to invest in a commitment regardless of whether following through is rational. The sunk cost fallacy is rooted in the human aversion to loss and the bias toward ongoing commitments. 

A prime example of a sunk cost is when you spend time or money evaluating a potential purchase, be it a home, a car, or an investment. The more time and money you invest in evaluating that decision, the more likely you are to decide to make the commitment, even if the terms or conditions are less than ideal. After all, walking away from this potential purchase would mean that you must walk away from the sunk costs of time, money, and energy you spent evaluating it. That “waste” is viewed by many people as a loss – and humans have a strong aversion to loss. In fact, studies have shown that humans have a much stronger aversion to loss than they have a desire for gain. 

So what does the sunk cost fallacy have to do with negotiating the sale of your business? Everything.

The more time and money you spend negotiating with one buyer, the more emotionally invested you’ll become in that one buyer and the more difficult it will be for you to walk away from the transaction. 

In my two decades of experience selling companies, I’ve seen grown men and women melt like butter once they’re under the spell of the sunk cost fallacy. Unfortunately, many savvy buyers know this and use it to their advantage. Fortunately, there’s an antidote – reduce your sunk costs. Lessen the amount of time, money, and emotion you invest in negotiating with any one buyer. 

How do you do this? Here’s how: 

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Many business sales fall apart during the due diligence process when issues are discovered. If the buyer unearths problems you failed to disclose, they’ll end up in a strongly leveraged position and you’ll compromise your negotiating posture as a result. This can entice the buyer to make additional demands and negotiate a lower purchase price or change other material terms of the transaction. Each item the buyer finds fault with during due diligence gives them leverage to claw back at the purchase price or terms, if they don’t abandon the transaction altogether. By anticipating and resolving issues before a buyer discovers them, you prevent the buyer from later using them as leverage against you. 

The antidote? Pre-sale due diligence. While pre-sale due diligence is optimally conducted just before putting your business on the market, it’s never too late to undertake such a self-examination. If you haven’t already done so, make this a priority – you can even implement these steps if your business is already on the market. Get your financials reviewed and in order, and perform legal and operational due diligence on your business as early as possible.

Hire a Third Party To Perform Due Diligence

I strongly recommend hiring a third party to perform due diligence on your business. An experienced professional will know what to look for and will be able to provide objective advice. Pre-sale due diligence will help you maintain a solid negotiating position and will speed up the due diligence process. Why is that important? The shorter due diligence is, the less time your business will be off the market during the exclusivity period, which can help preserve your negotiating position. Conversely, the longer due diligence takes, the longer your business will be off the market, and the stronger the buyer’s negotiating position will become as a result. 

If you have thoroughly prepared for due diligence, you can often bargain for a shorter due diligence period and stricter milestones. This can help speed up the process and therefore maintain your negotiating posture. Always remember – the longer the deal takes, the more that can go wrong. Also, the more emotionally and financially committed you become to the transaction, the weaker your negotiating position will become over time – especially when you’re dealing with savvy buyers.

Assemble an Online Data Room

Prepare a standard list of documents all buyers will request during due diligence, then organize them in an online data room before due diligence begins. You can give buyers a preview of this data room when you’re negotiating the letter of intent (LOI). The buyer will realize that this prep work reduces their risk because they’ll see that you have reviewed and addressed potential issues within your business in advance. This lowers the overall likelihood that a material problem will be discovered during due diligence that could cause the buyer to abandon the transaction. 

Letting the buyer know you’ve prepared for due diligence reduces any concerns that their investigation into your company will be a waste of time and money. Return is a function of risk – by discovering and resolving problems in advance, you reduce the buyer’s risk, which helps justify a higher price or more favorable terms – such as a shorter due diligence period or exclusivity, or both.

Your goal is not only to sell your business and move on to the next phase of your life, but to get top dollar for it. Pre-sale due diligence helps ensure you maintain your negotiating posture throughout the sales process by minimizing problems a buyer can use against you to erode your negotiation position.

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“If you are negotiating, you must do so in a spirit of reconciliation, not from the point of view of issuing ultimatums.”

– Nelson Mandela, South African Anti-Apartheid Leader

How important are high-level negotiating skills during the sales process? 

Not as crucial as you might think, at least as they pertain to you as the seller. That’s because you will likely hire an M&A intermediary or investment banker to negotiate on your behalf. But that doesn’t mean you’re entirely off the hook. 

While your advisor will manage the negotiations, it’s you who must provide them with a position of strength from which to negotiate. 

In this chapter, I offer eight tips to help you do just

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A mutual exchange of information is reasonable and to be expected as the transaction unfolds. Any buyer who refuses to release information to you regarding their qualifications signals they’re either not serious or are unqualified. 

Screen Buyers in Phases To Assess Their Interest

If a buyer isn’t known in the industry or you doubt their financial wherewithal, requiring the buyer to jump through a number of hoops before they receive sensitive information on your business allows you to assess their interest level and financial qualifications. Most buyers understandably get frustrated or offended if you attempt to screen them all at once early in the process. The solution is to use a phased approach, both in screening and in releasing information to the buyer.

How to Screen Companies

When screening lesser known companies or buyers, such as independent sponsors, you can ask for financial statements, references, a buyer profile, a disclosure statement, and a list of past transactions, if applicable. You can also independently research the key people you’re dealing with by Googling them or researching their social media profiles. In addition, you can obtain their IP address from the metadata in emails and documents, which can supplement your search. I’ve used this trick multiple times to uncover buyers who aren’t who they say they are. These are all simple procedures that anyone can implement to minimize risk of putting sensitive information in the wrong hands and help you avoid major headaches later on.

The best weapon in M&A when selling your business is candor.

Conclusion

Here’s a reminder of the sequence of events that lead up to the management meeting:

The maxim, “Honesty is the best policy,” does indeed have merit. Be careful regarding any ad hoc representations or documentation you create. Stick to the facts. If you wish to garnish the facts, avoid doing so in writing. 

Make sure you stay focused on running your business through this period of meetings and negotiations so you continue to have a strong company to sell. Doing so will help you maintain your emotional objectivity.

Keep these tips in mind:

Throughout this process, you’ll deal with a wide variety of buyers. Some buyers take a zero-sum game approach and will attempt to win at all costs, doing little to hide their aggressive negotiating style. Others may be more subtle regarding their approach. They may hide their true intentions and attempt to use your honesty against you. A firm but respectful position is best in these cases. Regardless, employ a professional if you lack experience, and remember – the best weapon in M&A when selling your business is candor.

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Managing highly sensitive details about your company is paramount. You want to keep control of your information to prevent it from getting into the wrong hands, such as a competitor, or being released at the wrong time, such as early in the process before you’re satisfied you have a serious buyer.

The following section contains recommendations about when and how to send sensitive information to potential buyers. 

Use a Phased Release of Information

If you’re concerned about confidentiality, the best option is to implement a phased release of information. In a phased release, facts and figures are given to the buyer at different stages, with more sensitive information released in later stages in the process. Information can be provided in summary form early on and then in greater detail later in the negotiations. For example, it may make sense to email the buyer a snapshot of your financial statements before emailing them a profit and loss (P&L) statement. This summary could contain only the gross sales, gross profit, and EBITDA for several years. More detailed information can be released later in the process after they have expressed explicit interest.

Any buyer who refuses to release information to you regarding their qualifications signals that they are either not serious or unqualified.

What Financial Information To Send the Buyer 

Most M&A intermediaries send a set of normalized or adjusted financial statements to buyers after the buyer reviews the CIM and expresses interest, providing the potential buyer with an idea of the current state of the company. Always send normalized or adjusted financial statements. Never send your raw financial data unless your financials don’t require any adjustments. Most buyers prefer to request three years of P&L statements. A list of your monthly revenue for the previous three to five years is also helpful in identifying any seasonal or cyclical trends in your business.

When dealing with buyers, I always send normalized financial statements, including a common size analysis, and information on percentage changes from year to year. I send these financials to a buyer in a spreadsheet format, which allows the buyer to readily perform their own analysis, make notes, and prepare pro forma profit and loss statements based on any synergies or changes they anticipate making to the business. 

When To Give Year-to-Date Financials to the Buyer

At some point in the sales process, a prospective buyer is likely to request interim financial statements for your business before they submit an offer. You should be in a position to provide this information, but here are a few important points to keep in mind:

You can also use your YTD financials as a tool to gauge interest and further qualify a buyer. I recommend intentionally withholding your interim financial statements from your CIM. Doing so forces the buyer to request them directly. If the buyer goes out of their way to ask you for updated financial statements, you can reasonably assume that such a request is a good sign.

Warning: If the buyer sends you a detailed request for additional documents, such as tax returns, before they submit a letter of intent, they’re likely attempting to shop your business for financing. This is a warning sign and common among less experienced corporate buyers – the buyer should request your permission to share your confidential information with third parties before doing so. Stop the process immediately and talk with the buyer. You don’t want them shopping your business without your knowledge or consent.

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Interested buyers will always take the next steps without any prodding. Some buyers make an offer after the first meeting, and some don’t. There’s no magic formula, but it’s not unusual to have as many as three meetings with a serious buyer before they submit a letter of intent. 

Know When It’s Time To Move On 

Is the buyer requesting a fifth or sixth meeting? In such cases, don’t waste your time – move on to the next buyer. Remember, when selling a business, you’re making certain representations regarding your company that aren’t verified until due diligence begins, so five or six meetings shouldn’t be necessary. Save the in-depth investigation of your business for the due diligence period after you’ve accepted an offer from the buyer. 

A few meetings should be enough for the buyer to decide whether they want to make an offer and move forward. If the buyer can’t make up their mind after the fourth or fifth meeting, another meeting is unlikely to do the trick. At some point, the buyer must tackle their fears head on and make the leap of faith. Additional information rarely appeases these buyers’ fears. While this indecision is uncommon among private equity firms and other sophisticated buyers, you may encounter this vacillation among less experienced corporate buyers.

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The initial meetings and phone calls with buyers are relatively low-key. 

Let the buyer ask as many questions as they want and answer them as clearly and forthrightly as possible. Explain your business and its operations as thoroughly as you can. Be enthusiastic. Show pride in your company. Weave in interesting tidbits about its history. You can also mention your ideas about growth potential, as well as what you like and dislike about your business.

Those are the “do’s.” Here are the “don’ts” regarding your initial calls and meetings with buyers:

Be consistent with the details you present to buyers because any inconsistencies will be noticed.

The Importance of Honesty

Be honest. You’ll establish credibility by being up front about your business’s downfalls. For instance, point out aspects of your business the buyer might consider changing, such as implementing new advertising strategies or pursuing new markets.

The Importance of Consistency

Memorize the information in your CIM. Be consistent with the details you present to buyers because any inconsistencies will be noticed. If a buyer doubts what you say because your claims are inconsistent, you’ll lose the sale. For example, if you say your markup is 35% in your CIM but later claim it’s 40% when you meet with the buyer, the buyer will feel they need to validate all your claims and will take little of what you say at face value thereafter.

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Once the potential buyer has signed a non-disclosure agreement (NDA), they’ll receive your confidential information memorandum. Buyers usually prefer to ask a few specific questions over the phone if they’re interested before meeting in person. Most private equity firms and some corporate buyers are comfortable making an offer on a business without conducting a site visit. In fact, it’s common for many sophisticated buyers to reach the closing without ever meeting you in person or conducting a site visit.

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“No man does anything from a single motive.”

– Samuel Taylor Coleridge, English Poet

Buyer meetings are far more than a forum for you to answer questions. Through these meetings, you’re not only selling your business, you’re also selling yourself. You want to assure your buyer that you’re prepared, honest, composed, and serious about selling your business. Working to foster a healthy relationship with your buyer not only saves you time and effort in the long run, it can actually increase the value of your business as a whole. It’s a key aspect of selling a business that’s often overlooked, but this chapter will discuss some steps you can take to make it a positive, successful experience. 

When meeting with a potential buyer, remember the Golden Rule – treat others the way you want to be treated. Here’s what I mean:

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Once you recognize the type of buyer you’re dealing with and their behaviors and expectations, it’s time to dig deeper. Understanding more about your buyers will allow you to weed out the pretenders, thereby spending more time on serious buyers and less on the dreamers. Let’s look at some practical applications for assessing buyers. 

Motivation

A key part of your initial due diligence should be spent assessing the buyer’s motivations. How motivated do they appear to be? Do they quickly return your calls and emails? Are they eager to move forward, or are they overly critical of your business? 

A motivated buyer will eagerly jump through hoops. They’ll quickly return phone calls and emails. Despite any potential roadblocks, they’ll be keen to move forward. You don’t have to chase motivated buyers down – instead, they chase you down.

In 1964, Associate Supreme Court Justice Potter Stewart was asked to define hard-core pornography, to which he responded: “I shall not today attempt further to define the kinds of material I understand to be embraced … but I know it when I see it … ”

My response is the same when attempting to identify a motivated buyer – I know one when I see one. If you’re in doubt, it’s unlikely they’re truly serious about buying a business.

Why Buyers Disappear

Buyers can disappear for any number of reasons. Maybe their priorities unexpectedly changed. Maybe, as in the case of a corporate buyer, there was an internal shakeup and the person you were dealing with is “no longer with the company.” Maybe the economy – or their slice of the economy – took a nosedive, prompting a spending freeze or more caution going forward. Maybe they found a better deal.

Stuff happens.

The solution is simple – don’t get emotionally involved with any one buyer. This doesn’t mean you shouldn’t be aggressive about selling your business. You should be a go-getter, but keep a level head and focus on running your business during the process and remain emotionally detached from any specific buyer.

Another point is, don’t become too emotionally attached to the idea of selling. Many sellers seem overly eager to sell their company and spend far too much time and effort thinking about the process, so they end up neglecting their business in the short term. EBITDA often declines as a result, and the value of their business suffers. Keep the pedal to the metal up until the day of closing if you want to maximize the purchase price. 

Conclusion

Here are the key points to bear in mind as you screen potential buyers:

Screening potential buyers will help ensure you’re dealing with serious buyers who have the means and determination to follow through on the purchase, saving you time and money in the long run. Understanding the differences between various buyer groups will help you decide how to best approach marketing your business while also maintaining confidentiality. 

Another point worth making again is – confidentiality is critical.

Keeping the details of your business secure is of paramount importance throughout your sales process. You want to maintain control over your sensitive business information while still approaching potential buyers, including your competitors, especially when a competitor approaches you. If you’re dealing with a direct competitor, it may be wise to have your attorney prepare a customized NDA. In this section, I offer advice on how to protect your sensitive business information from direct competitors who you may end up in conversations with.

Here are six tips on how to strengthen your NDA when dealing with competitors. 

Tip 1: Prepare a Buyer-Specific NDA

Have your attorney prepare an NDA that’s specific to the buyer you’re negotiating with. A standard NDA is normally sufficient during the preliminary stages. But if you’re dealing with a direct competitor and are releasing highly sensitive information, your attorney should customize an NDA for that specific buyer. 

Tip 2: Prepare a Separate NDA for Different Categories of Information

Separate NDAs can be prepared for various categories of confidential information. For example, the following scenarios may require a different set of legal strategies and language to protect you – if the buyer meets with key employees vs. if the buyer meets with key customers vs. if you share proprietary pricing with the buyer.

Confidentiality is critical.

Tip 3: Customize the NDA

An NDA often must be customized for certain types of buyers. For example, a wealthy private individual should be dealt with differently than a direct competitor. Private equity groups are also managed differently than competitors. 

The process should be more stringent with competitors since these transactions represent more risk to you. The protection an NDA offers varies based on the language contained within it. In middle-market transactions, the NDA is commonly negotiated with buyers, especially if the buyer is a potential competitor.

To determine which clauses to consider modifying in an NDA if you’re dealing with a competitor, consider the following questions:

You can also consider addressing the following in your NDA when dealing with a competitor:

Tip 4: Ask the Buyer’s Representatives to Sign an NDA

Always ask the buyer to obtain a signed NDA from their representatives before releasing your information to them. If the representatives don’t sign your NDA directly, the buyer should be held liable for any breaches made by their representatives. The buyer should also disclose their representatives’ names and contact information if they receive information on your business to avoid your confidential information from being widely disseminated without your permission. 

Tip 5: Have the Buyer Sign Multiple NDAs

You can also consider asking the buyer to sign a different NDA at various points in the transaction as the negotiations advance. Each NDA can contain progressively more restrictive language and terms as you release more sensitive information. 

For example, a buyer may not be interested in signing an NDA that contains a non-solicitation or a no-hire clause early in the process. But the buyer may agree to this language in an NDA later in the process if you agree to let them meet with your employees during due diligence. 

Your attorney may need to draft an NDA before you allow the buyer to meet with key customers. This is rare in most transactions, but there may be cases where customer concentration is an issue, and the buyer may ask to talk with key customers before they agree to the closing. If this is the case, it may be necessary to negotiate an NDA with the buyer before allowing such conversations to take place.

Tip 6: Clauses to Consider Modifying

Here are some additional clauses within the NDA that you may consider modifying:

Before you invest time and energy in negotiating with prospective buyers, you should first establish that they’re sufficiently motivated and financially capable of acquiring your business. Doing so will help ensure you’re negotiating with a qualified buyer and motivate you to invest more time and energy into the process.

Most buyers who aren’t serious won’t go to the trouble of completing a detailed buyer profile, so the fact that the screening process takes time will itself help weed out tire kickers. If a less-known potential buyer submits an offer, such as an independent sponsor, they should provide you with source documents to verify their financial ability to complete the transaction, which will allow you to screen them more thoroughly and with confidence.

Part of your initial due diligence also includes assessing the buyer’s motivation level. When dealing with potential buyers, ask yourself the following questions: 

Keep in mind that overly critical buyers usually don’t have serious intentions of buying a business. Also, the process for screening buyers may change slightly depending on their type – whether the buyer is a direct competitor, a strategic buyer, or a private equity firm. 

The sale of a business can be compared to a sales funnel. There are major steps along the way, and buyers drop off at each step.

Reasons for Screening Buyers

If you’re financing a portion of the sales price or if a portion of the purchase price is contingent, you should screen the buyer just as any bank would. But even if you aren’t, you should still make sure that your buyer’s finances are in order. This is particularly important because: 

Use a Phased Screening Process

Releasing information in phases saves time, preserves confidentiality, and ensures that unqualified buyers aren’t provided sensitive information about your business. This is necessary because most buyers will refuse to be thoroughly screened at the initial stages when they haven’t yet decided to take a closer look. Buyers will often be particularly wary of disclosing their information before they receive details on your business. The solution to these problems is to ask the buyer for qualifying information in stages as they progress through the steps of acquiring your business. 

The first step in determining if they’re serious is to ask the buyer to sign a non-disclosure agreement (NDA) and buyer profile. Once buyers have completed these documents, they will then have access to your confidential information memorandum (CIM), which contains more details on your business.

If the buyer is interested after they review your CIM, they may ask to meet you personally or request additional information, such as financial statements, prior to a meeting. 

The beginning stages of the process from the buyer’s perspective look like this:

Once the LOI has been received, you will review the buyer’s information and accept, reject, or counter the offer. Due diligence begins after an offer is accepted, at which time a further mutual exchange of information ensues. At the beginning of the sales process, you’re making claims that aren’t verified until an offer is accepted and the buyer moves into due diligence. 

Releasing information in phases saves time, preserves confidentiality, and ensures that unqualified buyers aren’t provided information about your business.

Uncooperative Buyers

The sales process can be long and arduous. Finding a cooperative and realistic buyer who’s easy to work with is just as important as finding someone willing to pay your price. The following section covers some examples of problematic buyers and how you should respond to them.

Buyers Who Refuse To Be Screened

Most deals with buyers who refuse to be screened or are otherwise uncooperative end up falling apart. These buyers will try to bargain for much more than you initially agreed to. They may also threaten lawsuits, threaten to leak word of the sale to competitors, and more. Don’t waste your time with them. Find a buyer who’s easier to work with and who is cooperative enough to get a deal done. Remember, all transactions require cooperation from both the buyer and seller. If you encounter a buyer who seems exceptionally rigid or demanding in your initial conversations, move on.

Buyers Who Refuse To Complete a Buyer Profile

Refusing to provide information is a red flag. Don’t waste your time with uncooperative buyers. I don’t recommend providing information to any buyer who refuses to disclose any information about themselves. Even if they are qualified, refusing to complete a simple form is a red flag, and it’s difficult to progress with the transaction with uncooperative buyers.

Buyers Who Don’t Respond 

A common question involves wondering how many times you should follow up and my advice is simple – you shouldn’t have to chase down a buyer. I recommend following up a maximum of two or three times. A buyer must be sufficiently motivated to go through the process and has plenty of opportunities to change their mind, so don’t go running after them. If you have to chase a buyer or “push” them through the sales process, it’s unlikely they will follow through to closing the sale. A lack of follow through on the buyer’s part is a red flag that they lack sufficient motivation to complete the transaction, and I recommend avoiding any buyers you need to pursue to move the deal forward.

Verifying Information on the NDA

Should you verify the information on the NDA? No. Based on my experience, only a small number of buyers provide inaccurate information, so verifying each buyer’s information is impractical and will likely scare them away this early in the process. Few buyers lie on their buyer profile, especially when you ask them to sign the document. Buyers know that their representations are verified later in the process, and few will falsify this information.

The screening process involves releasing information to the buyer in phases. This means that as you release more information about your business, you’ll also request information from the buyer, which will provide you with an opportunity to verify their data at a later stage in the transaction.

What Happens After the NDA is Signed

The sequencing of events in any deal is important. Here are my tips for what to do after an NDA has been signed:

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“Seller beware.”

– Denise Barnes, American Entrepreneur and Writer

A major mistake entrepreneurs often make in the early phases of a transaction is dealing with buyers who aren’t qualified. This is true even in the middle market. You can waste vast amounts of time weighing the merits of an offer without first obtaining background information on the buyer. 

Just as buyers perform due diligence on you and your business, performing due diligence on buyers is paramount. Screening potential buyers is, in fact, one of the most critical first steps in the sale process. This is such vital information that I have already stated some of it in Chapter 14 titled “Keeping the Sale a Secret.” Its importance cannot be overstated.

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One of the first steps before you go to market is to compile a potential buyer list. Once you’ve identified the group of buyers most likely to purchase your company, your M&A advisor will reach out directly to this list of curated buyers and send them a teaser profile on your company to pique their interest. The confidentiality of your business is maintained throughout the process because the teaser profile doesn’t disclose your company’s identity.

M&A advisors call this a private auction. You will need to have a large buyer list in order to create the spirit of competition necessary to conduct a successful private auction, which will generate the best return for your business. As I’ve mentioned before, the success of any auction is directly proportional to the number of qualified participants. 

The Buyer List

A buyer list is key to maximizing your price. The more qualified buyers who are competing to acquire your company, the higher the price you will receive. At Morgan & Westfield, during our preliminary conversations with clients, we ask them who may be interested in buying their company. Many business owners name five to ten potential buyers and then draw a blank when asked to expand the list. Often, most of these initial five to ten buyers are either too small or too large to be suitable candidates. As a result, there may be only two to three potential buyers to approach. In most cases, this list isn’t large enough and puts the owner at a great disadvantage when trying to sell their company.

When you engage an investment banker or M&A advisor to sell your business, one of their initial tasks is to prepare a list of potential acquirers – ideally containing between 100 and 200 potential buyers. That being said, it’s helpful if you prepare a preliminary list of companies you believe may be suitable candidates. You know your industry best and are in the most suitable position to compile the initial list. Your advisor can then expand the list and research contact information for any companies you’ve provided or that they’ve discovered. 

While it’s possible to sell your company with a small list of buyers in certain instances, it’s important to create as many options as possible to maximize your purchase price. A list of at least 50 buyers is necessary for most companies – between 100 and 150 names is even better. The preferred size of the list depends on the type of business and your industry. An ideal roster should include at least 50 to 100 names. Smaller lists may sometimes be sufficient if the interest level of the names on the list is high or if the companies have aggressively pursued you in the past.

In most cases, a list of 100 to 200 buyers is necessary to produce the 30 to 40 conversations required to receive 5 to 10 letters of intent.

Preparing the Buyer List

Consider buyer size and fit, as well as what the likely buyers for your business will value most, before compiling your buyer list. Prepare a spreadsheet with two tabs – one for potential buyers and one for potential sources of buyers. I recommend first researching direct competitors, then any indirect competitors, and finally any companies in related industries. The buyer list should contain the following columns: 

Check to see if the company has recently made any acquisitions. If so, take note of any details of transactions you’re aware of, including the industry, name of the company, and size. Your spreadsheet should also contain a list of the sources for your research and any relevant contact information. 

Preparing this list in advance maximizes your chances of success. By planting this seed in your mind early on, you’ll take notice any time you stumble upon a potential buyer that might make a good candidate. When you do, simply add them to your list. The larger your list, the higher your chances of maximizing your price. Not only should the list be large, but the buyers on the list must be targeted. Your list should contain buyers who are not only in a position to acquire you, but who are also a good fit in terms of both size and product or service mix. Your list can also include sources of information that you can use to prepare the buyer list, such as industry directories, publications, and events.

Your list doesn’t need to include financial buyers unless the financial buyer owns a portfolio company in your industry. Your M&A advisor or investment banker will have access to databases of private equity firms and will be able to research which firms are active in your industry. Your list also doesn’t need to include any individuals because these buyers can be reached through general advertisements in targeted publications.

Preparing for a Private Auction

A key aspect of preparing an extensive buyer list is the ability to court several buyers at once, thereby creating a private auction. If you wish to maximize your price, it’s necessary to produce a carefully orchestrated frenzy of activity through a private auction. You need a large list to do this. In most cases, a list of 100 to 200 buyers is necessary to produce the 30 to 40 conversations required to receive 5 to 10 letters of intent.

It’s only through this competitive bidding process that you maximize the price. The more LOIs you receive, the higher you drive up the price. If buyers realize they’re the only one negotiating with you, they’ll know they have you pinned in a corner. Not only will you receive a lower price, but you’ll also be susceptible to renegotiations during due diligence because you’ll be in a weak bargaining position.

The Ideal Corporate Buyer

When preparing your buyer list, what should you be looking for? In this section, I’ll describe the key characteristics of the ideal corporate buyer.

Synergistic

The companies on your list should offer products or services complementary to yours, sell to the same customers, or sell through the same distribution channels as your company. In other words, there should be some synergy between your company and the buyer. These complementary aspects accomplish two important objectives:

  1. They give the acquirer sufficient motivation to complete the transaction.
  2. They offer the possibility of synergies, which can drive the price up. 

Acquisitive

When deciding who to approach, it’s advantageous to consider who is most likely to acquire your business and their specific motivation for doing so. An ideal buyer has acquired multiple companies and demonstrated the ability to actually complete transactions – not just talk about completing transactions. The more acquisitions the corporate buyer has made, the more likely they are to buy another company. Consider how many acquisitions they have made in the past. What prices have they paid? How common are acquisitions in your industry? While it’s still a feasible strategy to approach buyers who have not made acquisitions, your chances are significantly higher with any buyer who has demonstrated a strong preference for pursuing inorganic growth.

Size Matters

The buyer should be at least three times the size of your company. Most smaller companies aren’t ready, willing, or able to spend millions, or tens of millions of dollars to acquire a competitor. There are exceptions, but in general, only mid-sized and larger companies grow through acquisitions. Be particularly wary of smaller companies that contact you. Why? Smaller companies tend to be busy putting out fires and chasing the next big customer rather than proactively creating a team focused on developing and executing an acquisition strategy. If you started your company from scratch, perhaps you can relate. Smaller companies typically grow organically by slowly increasing their marketing and advertising budgets. They don’t have large enough cash reserves to pursue acquisitions as a growth strategy. Attempting to sell your business to smaller companies is, therefore, an ineffective strategy that can waste an enormous amount of time and risk a leak in confidentiality. While these deals sometimes happen, the ideal buyer will be at least three times your size. 

Bear in mind, when it comes to the size, the buyer should be big enough, but not too big. If the buyer is too similar in size to your company, they will often be too risk-averse, and the transaction may represent too much of a gamble for them. The larger the buyer, the less risk the transaction represents, and the more likely they are to pull the trigger. 

The primary criteria larger companies use to determine if an acquisition makes sense is EBITDA. These companies usually have a minimum EBITDA requirement that must be met before they’ll consider the acquisition. Why? The answer is simple – it takes just as much in resources to complete a $5 million deal as it does to complete a $50 million deal. And, the professional fees involved in an acquisition are similar, regardless of the size of the transaction. As a result, the percentage of fees decreases as the deal size increases, so it’s often more cost-effective to complete larger acquisitions.

For example, a $5 million deal may command fees and expenses of $200,000, or 4% of the total transaction size, while a $50 million transaction may command fees of $300,000, or 0.6% of the total transaction size. The percentage of fees and expenses decreases as the size of the transaction increases. As a result, doing larger deals is more cost-effective. A company must invest in 25 businesses – each having EBITDA of at least $1 million per year – to have the same impact as buying a single company with EBITDA of $25 million. So, buying larger companies is more efficient, both from a cost and time perspective.

While no magic number exists for determining the right size, the acquisition of your business should also be able to move the needle for the buyer. If you own a business generating $1 million in revenue, approaching companies generating $500 million in revenue is less likely to work than approaching smaller companies. As a result, most buyers focus on acquisitions that are 5% to 20% of the size of their companies. If the acquisition is unlikely to make a dent in their business, they’ll be unlikely to consider it. Yes, there are exceptions, but you shouldn’t count on exceptions for one of the most important transactions of your life. This truth applies to both corporate buyers and financial buyers, such as PE groups. 

Imagine if you were purchasing a company similar in size to your own. Get out your checkbook and write yourself a check for exactly what you want to sell your company for. If you want $50 million for your company, write yourself a check for $50 million. Now, imagine writing a check of that size to acquire one of your competitors. Do you have the guts to make the leap?

Now, try the same exercise, but cross a few zeroes off the check. There’s no doubt you’ll still be careful, but your appetite for risk will have increased. The same holds true with buyers in the real world. I see far too many entrepreneurs in sole negotiations with one buyer – and that buyer is the sole owner of a company similar in size to their own. In most cases, the owner can’t stomach the risk and will seek to offset it by a large earnout or by driving the price down. After many months of negotiations, the owner is often terribly disappointed when they receive a low offer that consists of little cash down with a majority of the purchase price paid as an earnout. If you’re desperate and not looking to maximize your price, such a strategy can work. But, if you want to receive the highest price possible, it’s important that the buyers on your list are the appropriate size and that the acquisition of your business doesn’t represent a significant amount of risk for them.

Here’s another example illustrating the importance of size when it comes to acquisitions:

In 2019, Blackstone raised the largest-ever private equity fund of $26 billion. If the average transaction size were $10 million, in order to invest their $26 billion, Blackstone would have to complete 2,600 acquisitions over a five-year period ($26 billion / $10 million = 2,600 acquisitions). To reach that target, they would have to complete two acquisitions per day, assuming 250 workdays per year or 1,250 days over a five-year period (1,250 days / 2,600 acquisitions = 2.08 acquisitions per day). Given that a typical private equity group considers 100 companies for each acquisition they make, they would have to consider 260,000 potential acquisitions to complete 2,600 successful acquisitions. In other words, they would have to consider 208 potential acquisitions per day. This obviously isn’t feasible. It wouldn’t be practical for a large private equity fund to consider acquisitions of this size because they would have to complete more acquisitions than would be possible. 

This is a long-winded way of telling you not to bother approaching Blackstone if you wish to sell your $10 million company.

Obtaining Contact Information

Once you’ve prepared your list, it’s time to compile contact information on the buyers. Ideally, the buyer will have a corporate development department. The corporate development department will oversee acquisitions and will often have information on their website regarding the types of acquisitions they prefer to make. Companies with corporate development departments are active acquirers and are much more likely to pull the trigger than a passive acquirer that lacks such a department. 

For larger companies, another alternative to attract the attention of a potential acquirer is by contacting the manager of a division whose dominion could benefit from a complementary product like yours. I call this individual an “internal champion.” Not only should the company be sufficiently motivated to complete the transaction, but the individuals involved in the transaction should be, as well. So, in addition to preparing a list of potential buyers, your list should also include the names and contact information of people in those companies who have decision-making power and who can personally benefit from the acquisition.

Other Ways To Find Buyers

An alternative to approaching buyers directly is marketing in publications such as trade magazines. The risk of this strategy is a leak in confidentiality, so it should be carefully considered before you implement it.

Here are the types of publications that might be suitable for marketing your business:

There are many other contacts you can reach out to in order to broaden your marketing strategy. These professionals are in contact with potential buyers in your industry on a regular basis. Keep in mind that if you establish a relationship with any of these professionals and it results in a successful sale, it’s best to compensate them for their facilitation. Here are a few professionals who may have a buyer in mind:

Conclusion

Keep in mind this critical point – know your buyer.

Want to get ahead of the game? Know your buyer. Want to maximize your return? Know your buyer.

Knowing who your probable purchaser is will help you determine the steps you need to take to prepare your business for sale and determine the ideal marketing strategy to maximize your company’s value.

If you’re most likely to be approached by an individual buyer, for instance, you’ll want to focus on minimizing the perception of risk. If you expect to sell to a private equity firm, start building a strong management team if you don’t already have one. If you’ll be looking for a corporate suitor to come knocking, be sure to build value in your company that can’t be easily replicated.

Then there’s the buyers’ list – a mini database assembled by you and your advisors of names, numbers, and background information of companies that might be interested in what you have to offer. The bigger the list, the better, as the idea here is to create a private auction. Once a potential buyer realizes they’ve got competition for something they want, they’ll likely be more willing to pay up. Keep in mind how the numbers shake out: a list of 100 to 200 buyers is necessary to produce the 30 to 40 conversations required to generate 5 to 10 letters of intent.

Let the bidding begin.

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Before examining each buyer type in greater detail, here’s a brief overview of the three main types of buyers in the middle market:

  1. Financial Buyers: Financial buyers primarily consist of private equity (PE) firms and value a business based predominantly on its EBITDA, without taking into account the impact of any synergies. These are some of the most common buyers of mid-sized businesses and have two principal goals – generating a high return and achieving a successful exit. Their key considerations when evaluating the attractiveness of a business are profitability and growth potential, as well as acquiring a business with a strong management team. When selling to a financial buyer, focus on building a strong management team and increasing EBITDA. 
  2. Corporate Buyers: Corporate buyers come in two types – strategic and non-strategic. While strategic buyers bring synergies to the table, non-strategic buyers don’t. Non-strategic buyers are usually direct competitors, although this rule doesn’t always hold true. While there are distinctions between these two types of corporate buyers, the goals, considerations, and tips for dealing with them remain the same.
    • Strategic: A strategic buyer is any buyer that achieves synergies as a result of the acquisition. Strategic buyers, also known as synergistic buyers, are considered the holy grail of buyers and may pay a higher multiple than others if they can’t easily replicate what your business has to offer. Strategic buyers have longer holding periods than financial buyers and usually have no defined exit plan. Strategic buyers place high importance on the synergies your business has to offer them and focus on the long-term fit of your business with theirs. When selling to a strategic buyer, focus on building value that’s difficult to replicate and hire an M&A intermediary to manage negotiations and conduct a private auction.
    • Non-Strategic: A non-strategic buyer is any buyer that doesn’t gain synergies from the acquisition. Non-strategic buyers are usually direct competitors who know your industry well and aren’t willing to pay top price unless they’re acquiring some aspect of your business they can’t easily replicate, such as a valuable customer list. If your business is asset-intensive with less than favorable margins, selling to a non-strategic buyer may be your only suitable option. These buyers are often seen as the buyer of last resort because they usually pay the lowest price. Selling to a direct competitor carries an additional risk – a potential leak in confidentiality. When selling to a direct competitor, hire a professional to negotiate on your behalf, build value that can’t be replicated, carefully track the release of confidential information, and never act desperate. 
  3. Wealthy Individuals: Individuals commonly acquire businesses at the bottom end of the lower middle market, and sometimes larger businesses (i.e., Twitter), if they are Elon Musk. For example, a general partner of a private equity firm may branch off and acquire companies on their own behalf, or a corporate executive may raise money from investors to acquire a business in their industry. Because these buyers are concentrating their investment in one business, they often stick to less risky investments and prefer to buy a business with a proven track record. When selling your business to an individual, focus on minimizing the perception of risk.

Now that you understand the three types of buyers, here’s a more detailed explanation of each type.

Financial Buyers

Financial buyers primarily consist of private equity, or PE firms, for short. Private equity groups are the most common buyers of mid-sized companies in many industries. There are approximately 8,000 professional PE firms worldwide. Apart from PE firms, there are also family investment offices and other types of investors that function similarly to PE firms.

Private equity groups raise money from institutional investors, which are called their limited partners, and then invest those funds into private companies on behalf of their investors. Most are structured as a limited partnership, with the PE firm serving as the general partner and the institutional investors serving as the limited partners. PE firms usually operate multiple funds simultaneously with each fund having a lifespan of 10 years and two 1-year extensions. The PE firm normally has a holding period of three to seven years for each business in which they invest. The PE firm makes a profit either from distributions it pays itself out of the company’s earnings, paying down the debt used to acquire the business, or from selling the company at a higher price than it paid.

Goals

Financial buyers value a business based solely on its numbers without considering the impact of any synergies. If the financial buyer owns a similar company in their portfolio, then they can be considered a strategic, corporate buyer. PE firms focus on the return on investment, technically called the internal rate of return (IRR), as opposed to any strategic benefits of the acquisition. Most PE firms target an IRR of 20% to 30% per year. This means they must generate a return on invested capital of two to three times the initial investment when they exit the investment or re-sell it in three to seven years. IRR is heavily dependent on the holding period, or the amount of time they hold the investment, which is why they try to turn around their investments as quickly as possible. The shorter the holding period, the higher their IRR. A strong management team must be in place to do this, which is why nearly every PE firm requires the existing team to remain to operate the business after they acquire it.

PE firms purchase a company as a stand-alone entity. The changes they make to the business post-closing are designed to improve profitability and make the company more attractive to a future acquirer. They’re always building the company up to turn it around and sell it in the shortest time possible. As a result, financial buyers analyze a company’s cash flow on a stand-alone basis, without taking into account any synergistic benefits, with the objective of enhancing the capacity to increase earnings and the value of the business over the next three to seven years. The only exception is PE firms that own a company in their portfolio that may achieve strategic benefits as a result of the acquisition. 

PE firms are experts at scaling companies through creating strategic relationships, building strong management teams, and developing efficient sales and marketing programs. The goal for many PE firms is to sell the business to a strategic buyer at a much higher price than they paid for it. They achieve returns through two objectives – increasing the EBITDA of the business they acquired and increasing the multiple through something called “multiple expansion.” Multiple expansion is when the multiple increases as EBITDA increases. For example, a company with a $2 million EBITDA might fetch a 5.o multiple, whereas a company with a $5 million EBITDA might receive a 7.0 multiple. If they manage to increase EBITDA by 150% to $5 million from $2 million, they will have increased the value of the business by 250% due to multiple expansion.

Financial buyers analyze a company’s cash flow on a stand-alone basis, without taking into account any synergistic benefits, with the objective of enhancing the capacity to increase earnings and the value of the business over the next three to seven years. 

In order to scale companies, PE firms use something called “the private equity toolkit,” which consists of the following:

To execute the tools in their toolkit, PE firms need a strong management team. Unfortunately, this is an area where many PE firms are unwilling to compromise. While they’re often willing to implement the tools outlined above even if the previous owner hasn’t installed these systems, many aren’t willing to build a new management team from scratch. One of their major considerations is, therefore, the strength of the existing management team.

Price is an important consideration for financial buyers because the business is typically run as a stand-alone company post-closing unless they own a similar company in their portfolio. PE firms don’t usually plan to integrate a newly purchased company with another company post-closing unless they own a platform company in the industry. In that case, they can be thought of as a strategic buyer. As a result of the lack of synergies, PE firms are restricted as to the multiples they can pay, and these multiples are fairly easy to predict. The price they can afford to pay is heavily dependent on the cost of debt and their capital structure due to their use of leverage. As financing becomes cheaper and more available, the price PE firms may be willing to pay for a business can exceed that of strategic buyers.

A PE firm may also go on an acquisition frenzy, acquiring multiple small competitors and rolling them up into one large entity with the goal of consolidating the industry. This is known as a roll-up. PE firms begin a roll-up by purchasing a platform company, which is typically a company generating a minimum of $20 million in annual revenue. They’ll then complete a series of small, tuck-in acquisitions to round out the capabilities of the platform company by adding customers, technology, and other products to their lineup. Roll-ups are a great time to sell if this is occurring in your industry. With a roll-up, the goal of the PE firm is an ultimate sale of the rolled-up company at a significantly higher multiple than they paid for the individual tuck-ins that now comprise the rolled-up entity – a.k.a. multiple expansion.

Learn More

If you’d like to learn more about how private equity firms operate and think, I suggest listening to our M&A Talk podcast episode called The Private Equity Toolkit with Michael Roher. You can find it in the Resources section of our website at morganandwestfield.com. Michael is a senior partner at BlueArc Capital and has over 35 years of private equity experience. In the episode, we talk about the primary methods PE firms use to increase the value of companies they acquire. This will give you a deeper understanding of their objectives and the thought process they use to scale the companies they acquire to create value for their investors. 

Considerations

PE firms use significant leverage (i.e., debt) when purchasing a company because the leverage increases their internal rate of return. If leverage, or bank debt, is used to acquire your business, your business must generate enough cash flow to cover the debt service. As a result, a PE firm can’t pay more for your business than your numbers dictate. Because PE firms use significant debt to acquire companies, this means they’re usually limited to acquiring companies that produce consistent cash flow, as opposed to high-growth, speculative companies that normally attract the interest of venture capital firms. The primary exception to this rule is growth equity, which is equity capital offered by private equity firms to companies to scale their operations. However, PE firms that offer growth equity seldom employ leverage in their capital structure. On the other hand, PE firms specializing in buyouts employ significant leverage in their capital structure and are therefore limited to acquiring companies that produce consistent cash flow to meet their lender’s requirements.

Private equity firms almost always prefer to retain both you and your existing management team. After all, private equity firms are financial buyers, not operational buyers, and will need someone to run the company post-closing. If you and your management team don’t stay to operate the business post-closing, the PE firm must bring in a team to operate it. This increases risk and lowers the value of your business, and few PE firms are willing to do this.

Tips for Dealing With Financial Buyers

The PE firm will usually incentivize you to stay involved by requiring you to retain at least a 20% interest in the business post-closing. Selling to a PE firm allows you to sell a portion of your company now, thereby diversifying your risk. You can then sell the remaining portion in the future, potentially achieving a second, larger exit in three to seven years when the PE firm re-sells the business. 

For example, you sell 80% of your shares now and retain 20% of the company post-closing. The remaining 20% equity may lead to a larger exit for you than the initial 80% sale. 

When dealing with financial buyers, I recommend the following:

Understanding your competitors’ strategies and objectives enables you to take concrete steps to target buyers most likely to pay the maximum price for your company.

Corporate Buyers

Corporate buyers can be competitors, customers, or suppliers. These buyers may be looking to enter new markets or acquire proprietary products, technology, or access to customers. In some industries, corporate buyers may be the most common type of buyer. Corporate buyers have an entirely different set of objectives than PE firms and often pay a higher multiple than others if they can’t easily replicate what your company has to offer. 

Corporate buyers consist of two subcategories – strategic and non-strategic. Strategic buyers realize synergies from acquiring your company, whereas non-strategic buyers are usually direct competitors seeking to acquire your business as a low-cost alternative to organic growth.

Why Corporations Acquire

Most innovation occurs in small start-ups as they’re more agile and willing to take greater risks. Small businesses are naturally more innovative than big businesses. Larger companies acquire smaller companies because of that innovation and then leverage their own resources to bring that innovation into the mainstream. 

Examples include Uber and Lyft unseating much larger competitors in the $40 billion taxi industry, Airbnb making a significant dent in the $570 billion global hotel industry, and Amazon, which started out as a humble seller of books, now dominating the $870 billion e-commerce industry. 

Companies make acquisitions because it’s difficult, if not impossible, to predict winners in product launches, partnerships, strategic alliances, or other forms of corporate development. By completing many acquisitions, a company can increase its odds of success. To improve their chances of success, competitors establish corporate investment funds to acquire smaller competitors. Most larger companies have sizable, dedicated teams exclusively devoted to making acquisitions. Note that I said acquisitions, not “an acquisition.” Companies attempt to defy the odds by completing a series of acquisitions, as opposed to relying on a single acquisition.

Jeff Bezos famously told his employees, “One day, Amazon will fail.” To think that the founder and CEO of one of the largest companies in the world expects to fail highlights the dynamic changes that have taken place in business in the past generation. Large companies have high failure rates. They often have too many resources. Losses are huge when an innovation fails at a large company. By acquiring other companies, large businesses reduce their long-term chances of failure.

Corporate buyers can be competitors, customers, or suppliers. These buyers may be looking to enter new markets or acquire proprietary products, technology, or access to customers.

Strategies for Acquisition

Even though the reasons for making an acquisition may be similar from company to company, acquisition strategies vary significantly. Some companies, such as 3M, acquire hundreds of small companies at early stages, therefore lowering valuations. Other companies wait for significant customer validation before considering an acquisition and end up paying higher premiums. 

Acquisitions are one of many corporate development strategies for companies. Well-funded companies establish corporate development plans to supplement their strengths and mitigate their weaknesses. Corporate development plans include many strategies, such as:

In business, where there are no guarantees of success, a corporate development plan is designed to maximize a company’s possibility of long-term success. M&A is one of many strategies in a company’s corporate development plan. M&A is only one weapon used within corporate development, but the aim of corporate development is universal – to maximize company, and therefore shareholder, value. By understanding your competitors’ strategies and objectives, you can take concrete steps to target buyers most likely to pay the maximum price for your company.

Types of Corporate Buyers

Here are the different types of corporate buyers:

Goals

Corporate buyers also consider the amount of time it may take to recreate your value proposition. If time is sensitive and the company must move quickly in the industry, it may make more sense for them to acquire your company due to the lost opportunity cost of building a business from scratch. For corporate buyers, it all boils down to the “buy vs. build” decision.

Unlike PE firms, corporate buyers often have no defined exit strategy and typically plan to fully integrate your company with theirs and hold it indefinitely. For this reason, they’re often willing to consider acquiring companies that many PE firms would take a pass on, especially if the acquisition produces a synergistic benefit for the company.

Some of the most common reasons corporate buyers purchase companies are to acquire a customer list, new product, or service capabilities, or to access a new market. In many cases, it makes more financial sense for a corporate buyer to grow through acquisitions than to grow by creating new products and services or by acquiring new customers. 

Non-organic growth happens most often in mature industries. Some examples include the cellular industry with T-Mobile’s acquisition of Sprint and MetroPCS, growth in media companies such as AT&T’s acquisition of Time Warner Cable or Walt Disney’s acquisition of Twenty-First Century Fox, and consumer products with Heinz’s acquisition of Kraft. These are examples of mature industry acquisitions in which organic growth has slowed, and the most suitable option for increasing revenues is to “buy growth” as opposed to “build growth.”

The corporate buyers’ decision always boils down to this classic “buy vs. build” paradigm – that is organic growth (sales) vs. inorganic growth (acquisitions). Companies in any industry either grow organically (build) or inorganically through acquisitions (buy). Corporate buyers make this decision based on which form of growth is less expensive and represents the least amount of risk. They will purchase a business because the company they’re looking to acquire offers them a benefit they can’t easily create on their own, or offers it faster than they can create on their own in fast-moving markets.

But the decision-making process is different for non-strategic buyers. The goal of non-strategic buyers is to acquire your company at a low enough price that doing so would be a more economical avenue of growth than pursuing growth organically. Their only way to do this is to drive the price down as far as possible. They are often seen as the buyer of last resort because they usually pay the lowest price. These buyers know your industry well and don’t want to pay for goodwill. The value of your company lies in what the buyer can’t easily recreate. For example, if you want $20 million for your business and the buyer could achieve the same level of revenue by investing $5 million into marketing, they’re unlikely to buy your company if it costs more than $5 million.

The following are several specific reasons a company may acquire your business:

The value of your company lies in what the buyer can’t easily recreate. 

Considerations

Selling to a direct competitor carries a key risk – a potential leak in confidentiality. Approaching direct competitors can be dicey, and it’s possible word will get out. If it does, your competitors are likely to use this against you and may attempt to poach your customers or employees. This can further undermine the value of your company and may even kill a deal you’re currently negotiating. A breach of confidentiality is less likely and impactful when dealing with indirect competitors, and this is often the preferred route if you choose to hire an investment banker.

Otherwise, corporate buyers focus on the long-term fit with their company and synergies, as well as the ability to integrate your company with theirs. All corporate buyers will recreate whatever value you have to offer (i.e., build) if they can do so at a lower price than it would cost to acquire your company (i.e., buy). 

Unfortunately, corporate buyers play it close to the vest and don’t disclose the mechanics of their decision-making process, but it’s important to know that they’re carefully weighing their options behind the scenes. As noted above, if they can recreate what your business has to offer at a lower cost than what they would need to pay to acquire your company, then they will. Luckily, the reverse is also true – if they can’t recreate what your company has to offer, they may be willing to pay significantly more than other buyers. The value they can afford to pay is often significantly greater than the fair market value. This is called “strategic value” and is impossible to measure because these buyers don’t disclose the synergies they’ll receive as a result of the transaction, and, therefore, you can’t calculate the value they receive from the acquisition.

You won’t know how much a corporate buyer is willing to pay until you actually sell your company. That’s why it’s important to negotiate with as many buyers as possible to drive up the price. These buyers will neither disclose their specific reason for acquiring you, nor will they share their projections or other financial information with you. As a result, you won’t know exactly why they’re acquiring you or the synergies they’ll reap from the acquisition. Fortunately, you don’t need to know why they want to acquire you if your strategy involves conducting a private auction and negotiating with multiple buyers to drive up the price. A private auction is the only way to uncover the maximum price buyers are willing to pay. 

If you’ve ever been to an auction, you know what I mean. In a typical auction, buyers bid against one another until the final stages, in which a handful of bidders are left bidding against one another. In the last lap of the auction, two buyers may be left as they desperately try to one-up the other bidder. And finally, one buyer unfolds their cards and makes their final move by offering a dramatically higher price in an attempt to deter the one remaining buyer. In some cases, several more rounds may ensue. Other times, the other buyer may simply cede to the last standing bidder. 

In most auctions, the price is too high for all buyers but one. But for that last buyer, the price is worth it. That’s the goal of an auction and why many threaten to withdraw their offer if you even mention the word “auction.” Such a ploy is no different than showing up to an auction and threatening to bow out if any other bidders show up. 

In the M&A world, a private auction is conducted similarly, albeit privately. An investment banker will carefully negotiate with multiple interested parties through several rounds of negotiations to unveil the maximum amount one buyer is willing to pay to acquire your company. If you own a company that could be sold to a corporate buyer, the only way to know you’ve maximized the price is to conduct a private auction. Establishing the value of your company isn’t based on a democratic vote. You won’t poll all the buyers in the industry and average their responses to determine what your company’s worth. Rather, the price you receive is the maximum price one buyer is willing to pay. 

Many corporate buyers will approach you out of the blue and submit an attractive offer to acquire your company. This buyer has one goal – to avoid competing against other buyers. If they convince you to do this, you’ve just become your own worst enemy and trapped yourself in a corner. Unless you want to conduct an auction with just one buyer, I recommend against this. On the other hand, a carefully orchestrated competitive environment will boost the price. If your business will be sold to a corporate buyer, this is the only way to ensure you’ve maximized your price.

Tips for Dealing With Corporate Buyers

When dealing with corporate buyers, whether strategic or non-strategic, I recommend focusing on the following areas:

Individual Buyers

High-net-worth individuals comprise the minority of buyers of most middle-market businesses. However, if your company is valued at less than $10 million, it’s likely a meaningful percentage of your target audience will, in fact, be high-net-worth individuals. 

Many of these buyers are referred to as “independent sponsors” or “fundless sponsors.” Whatever we call them, their numbers are significant. Globally, there are currently over 14 million high-net-worth individuals with financial assets valued at more than $1 million, and over 225,000 ultra-high-net-worth individuals with financial assets valued at more than $30 million.

Independent sponsors operate similarly to private equity firms, but they haven’t yet raised capital from investors. Many are C-level executives looking to break into an industry as entrepreneurs and may have casual commitments from investors they know. The major risk with independent sponsors is that they make an offer on your business that you accept, but then they can’t obtain the capital to complete the acquisition. 

For companies valued at less than $10 million in which the business is unlikely to appeal to a PE firm or corporate buyer, selling to an independent sponsor may make sense. Many businesses may have flaws that deter most PE firms and corporate buyers, such as a lack of a strong management team or high customer concentration. These businesses often appeal to independent sponsors because they don’t have to compete against a private equity firm or corporate buyer. If this describes your business, an independent sponsor may be your ideal buyer.

For individuals, the perception of risk kills more deals than the absence of opportunity.

Goals

Individual buyers are looking to purchase an income stream. That’s usually their number-one goal. Because acquiring your business creates no synergies for them, they’re limited to valuing your business based on the income it produces. If they happen to own another similar business, they can be classified as either a corporate or industry buyer. Otherwise, they’re restricted to valuing your business based on the income it generates. Unlike PE firms, individual buyers are willing to consider a less-than-pristine business. For example, even if your business lacks a strong management team, many individuals will consider acquiring it. This is good news for anyone who owns a business that possesses certain characteristics that may deter other groups of buyers.

A large company that I’m representing in the New England region has three active owners involved in the business. Most professional buyers are passing on the opportunity because of the concentration of management responsibilities among the three owners. However, we’re inundated with independent sponsors who are interested. If you own a business on the smaller end of the lower middle market, expect to deal with quite a few individuals, the majority of whom will be independent sponsors. In some cases, this may comprise the majority of your target market.

These buyers use the parlance of Hollywood – that is, “show me the money, baby.” For these individuals, it’s all about income and minimizing the perception of risk. While opportunity or untapped potential will be attractive to them, it won’t motivate them to the degree that certain risks will de-motivate them. These buyers scan businesses they’re interested in acquiring, looking for areas that represent significant risks. Because an individual is concentrating their investment in one company, they can’t afford to take risks. The factors that present risk to these buyers vary from business to business and are somewhat a matter of perspective. The advice of an experienced M&A advisor will be valuable in identifying risky areas of your business that need to be mitigated before you go to market if you think this will be your primary audience of buyers.

Considerations

For these individuals, the process of buying a business can be more emotional than for other buyers. That’s because buying a business is a risky proposition that often requires parting with a substantial portion of their net worth. For this reason, individuals often stick to less risky investments and prefer to acquire companies with proven track records. Most stick to industries with which they’re familiar. Individual buyers finance the purchase of a business primarily through a combination of their own cash, cash from investors, seller financing, and bank financing. Most individuals acquire businesses valued at less than $10 million in transaction size. 

Tips for Dealing With Individuals

When dealing with individual buyers, I recommend minimizing the perception of risk in your business. For individuals, the perception of risk kills more deals than the absence of opportunity. While risk and opportunity are two sides of the same coin, these buyers don’t always see it that way. Individuals have a skewed perspective toward loss aversion. Loss aversion is the tendency to prefer avoiding losses over acquiring equivalent gains. Some studies suggest that losses are twice as powerful psychologically as gains. Loss aversion implies that a loss of $100,000 packs a bigger psychological wallop than a gain of $100,000.

Individual investors are extremely averse to loss because they are investing their own money and are concentrating their risk in one acquisition. To counter this strong bias toward loss aversion, you should retain an M&A advisor to objectively analyze your business and identify ways to make it more attractive to these types of buyers through minimizing the perception of key areas of risk in your business. When I perform an assessment for a client, for example, I analyze the company as a potential investor would. I prepare a report that contains a determination of the business’s marketability, an analysis of the risks and opportunities, potential deal killers, methods of reducing risk, and a list of steps the owner can take to minimize risk in the business and maximize its value. I recommend you do the same.

Key Points

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“The golden rule for every businessman is this: Put yourself in your customer’s place.”

– Orison Swett Marden, American Author

One of the first lessons in Marketing 101 is – know your audience. Who are they? Where are they? What buttons can be pushed? What incentives need to be dangled? If you’re not armed with this basic information and more, it’s going to be a tough sell no matter what you’re offering, be it widgets or an entire business.

The importance of knowing your audience is especially true when it comes to selling your company. By educating yourself about the different types of buyers in the marketplace, you can identify who’s most likely to acquire your business, then design a strategy to target that group of buyers to make your business as appealing as possible to them. Knowing your audience is essential to developing a marketing strategy to sell your company and maximize your price. 

The exact reasons companies make acquisitions vary widely and can be difficult to discern, but common patterns do emerge. Using those patterns, it’s possible to draw generalizations that assist you in deciding what to focus on. In the section that follows, I explore the three different types of buyers along with the goals, considerations, and risks associated with each. 

Knowing your audience is essential to developing a marketing strategy to sell your company and maximize your price.
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The guide below will walk through the most common clauses in a confidentiality agreement and common issues that may arise in drafting and negotiating the agreement.

Warning: The content below is dangerously exciting. If you think most Stephen King books are thrilling, then buckle up. Just kidding – the content below is highly detailed and excessively dry for most. If you’re particularly concerned about the exhaustive language contained in a non-disclosure agreement, then read on. Otherwise, feel free to skip the remainder of this chapter.

Introductory Paragraph

Most confidentiality agreements open with an introductory paragraph. It’s important not to skip this paragraph as several important points are covered. Keywords here have been bolded for emphasis:

“This Agreement is made and entered into between the undersigned, both individually and on behalf of undersigned’s business entity, its officers, directors, partners, shareholders, employees, brokers, agents and advisors (collectively “Buyer”), and Seller. Buyer has requested certain information for purposes of evaluating and investigating a possible acquisition through transfer of assets, stock, partnership interests, or otherwise, merger or joint venture involving all or part of the interests of the Seller (“Transaction”). Therefore, parties agree as follows: Buyer shall not disclose any information concerning the Seller, [other than as legally required] whether provided by Seller or by any third parties on behalf of Seller, and whether provided before, during, or after the effective period of this Agreement, except to Buyer’s employees, officers, advisors or other associated persons for the sole purpose of evaluating the Transaction, and only provided that such persons have agreed in writing to be bound by this Agreement.”

What the Introductory Paragraph Really Means 

Definition of Confidential Information

The definition of confidential information is customarily one of the first paragraphs in an NDA and includes a general introductory paragraph, such as the one above. It’s sometimes also called “Definition of Evaluation Material,” “Confidential Information,” or simply “Information.” 

The seller’s goal is to define confidential information as broadly as possible and then explicitly list exclusions in a separate paragraph, which is typically called “Exclusions from Confidential Information.” Sellers attempt to broaden the scope by expanding the definition to include information that’s conveyed orally regardless of who disclosed it and in whatever form at any time (before or after executing the agreement). The seller will also attempt to include information “derived” from the “confidential information,” such as analyses, forecasts, or other compilations.

Buyers narrow the scope of the definition by including the phrase “to the extent” to prevent entire documents from being characterized as “confidential information” just because they contain one singular piece of confidential information. Alternatively, buyers prefer to use a narrow definition, attempting to exclude information conveyed orally or from third parties, information obtained before execution of the agreement, or requiring you to stamp information “confidential.”

The risk to the buyer of an expansive definition of “confidential information” is minimal due to the limited requirements of the agreement – to keep the information confidential. The potential for you to allege a breach and prove damages is minimal, and the evidentiary burden is on you to prove that the buyer disclosed confidential information. Therefore, in most cases, the parties agree to an expansive definition and then limit the definition by way of explicit exclusions. 

The type of information that can be included under the umbrella of confidential information is broad in scope. Confidential information doesn’t have to be limited to written information – it can also include information that’s transmitted orally. Any information that flows between the parties can be considered confidential. While this isn’t an exhaustive list, here are some common examples of confidential information passed between parties:

This information can even range from schematics and photographs to strategic plans, customer lists, and financial data. It’s collectively referred to as “confidential information” or “proprietary information” throughout the agreement. 

The definition of confidential information is sometimes subject to negotiation. The seller often seeks a broader definition, such as “all information relating to the seller, which is disclosed to the buyer.” The buyer may seek to narrow the definition or require that “confidential information” be stamped by the seller. 

You may also want third-party confidential information to be deemed confidential. The buyer will want to narrow the definition of confidential information in order to avoid being “tainted” by the information. The definition can be narrowed by:

In reviewing the confidential information, the buyer may produce reports or summaries derived from the confidential information. The definition of “confidential information” should include these studies and analyses – often referred to as “derived information.”

As a result of the limited requirements of the agreement on the buyer and the fact that the evidentiary burden is on you, confidentiality and NDAs are rarely negotiated in practice. This is in direct opposition to the letter of intent (LOI) and the definitive agreement, which are heavily negotiated documents.

Examples of definitions of confidential information: 

“Evaluation Material includes, without limitation, the Transaction and the Seller’s intellectual property, products, services, technical and business information, and contact lists, together with all analyses, compilations, summaries, notes and data [derived information], and information conveyed in any form whether oral, visual, written, or electronic, and whether provided to Buyer before or after the date of this agreement.”

“Any information concerning Seller, regardless of form, manner or nature of information, which is provided to Buyer, and any notes, summaries, compilations, analyses or other documents prepared by Buyer to the extent that they contain or are based on, in whole or part, information provided to Buyer.”

“All of the Disclosing Party’s (i.e., Seller) business plans, present or future, or potential customers (including the names, addresses, needs and/or any other information concerning any customer or consumer), marketing, marketing strategies, pricing and financial information, research, training, know-how, operations, processes, products, inventions, business practices, databases and information contained therein, its wage rates, margins, mark-ups, finances, banking, books, records, contracts, agreements, principals, vendors, suppliers, contractors, employees, applicants, skill sets of applicants, sales methods, marketing methods, costs, prices, price structures, methods for calculating and/or determining prices, contractual relationships, business relationships, compensation paid to employees and/or contractors, and/or other terms of employment, employee evaluations, and/or employee skill sets.”

Common Issues in Defining Confidential Information

Here’s a summary of the most common issues you may encounter when defining confidential information:

Example: “Seller has no obligation to provide Buyer any confidential information, and Seller retains the right, in its sole discretion, to determine what information to provide to Buyer.”

Exclusions From the Definition of Confidential Information

Immediately after the “Definition of Confidential Information” there’s normally a paragraph listing specific exclusions to the definition. Your definition of confidential information should be as broad as possible in scope, and then you should list any exclusions separately.

The buyer will want broad exceptions to the definition of confidential information. Typical exclusions include information: 

Disclosure Period

Information not provided during the disclosure period is also sometimes excluded from the definition of confidential information. You should include language that covers information disclosed prior to the execution of the agreement to ensure that all information is protected, regardless of when it was disclosed.

Sample Language and Commentary

In cases where you’re approaching direct competitors and must share highly sensitive information, preparing your business for sale is of paramount importance to ensure a brisk, problem-free sale, which thereby minimizes the possibility of damage. As a final note, disclosing sensitive information is a necessary evil when selling your business and is sometimes unavoidable, especially when selling to a competitor. 

Include language that covers information disclosed prior to the execution of the agreement to ensure that all information is protected, regardless of when it was disclosed.

Permitted Uses 

Also called “Restrictions on Use.” This section determines what the buyer can do with the information and ordinarily restricts the buyer to using the information solely for evaluating the transaction.

“Confidential Information will be used solely for the purpose of evaluating a possible acquisition and for no other purpose, including in any way detrimental to Seller.”

Buyers sometimes object to the phrase “in any way detrimental to Seller” and contest that such language could be broadly characterized to prohibit the buyer from using the information to compete with you, given that such competition would be “detrimental to Seller.” 

Financial buyers who own a portfolio company in your industry may also consider this language overly restrictive due to the difficulty of separating the buyer’s understanding of the industry from their knowledge. This issue is exacerbated by the fact that private equity firms and other financial buyers may evaluate hundreds or thousands of transactions per year. It may become an administrative impossibility to track thousands of NDAs across hundreds of portfolio companies in dozens of industries in which they may operate. 

In practice, the risk of damage is far less when disclosing information to a private equity firm than to a competitor, unless you’re dealing with an executive at one of the private equity firm’s portfolio companies. The executives you will deal with at a private equity firm are normally located at the corporate office and aren’t involved in the operations of their portfolio companies. 

For this reason, most investment bankers prioritize their buyer list according to risk and normally contact financial buyers first in the process due to the lower amount of risk involved. They will only contact direct competitors if they’re likely to pay a premium price. They will also contact direct competitors later in the process once the positioning and messaging are tightened up from feedback from the initial round of buyers. The initial conversations with buyers will highlight problems in your information memorandum so that these can be addressed and strengthened as the sales process unfolds.

Definition of Representatives

Confidentiality agreements restrict the buyer from disclosing confidential information to third parties, though an exception is often granted that allows the buyer to disclose confidential information to the buyer’s “Representatives” for purposes of evaluating the transaction. 

Most NDAs include a reference to the buyer’s employees, officers, advisors, and affiliates in the “Definition of Representatives” section. Buyers prefer an expansive definition, but such a provision can expose the buyer to increased liability if they retain liability for breaches made by their “Representatives.” 

Read this section diligently before signing. For example, the language may include “financing sources” without a clear definition of what the “financing sources” actually are. This could be extended to include any party that’s providing “financing,” whether debt or equity, and in any amount. With some creative thought, this could be used as a tool to vastly expand the scope of the NDA to include third parties without your explicit consent. 

“Representatives shall include the directors, officers, employees, agents, affiliates, [potential] financing sources, or third-party advisors.”

At a minimum, any third parties should be bound by the terms of the NDA, and the buyer should remain liable for any breaches made by third parties and bear responsibility for ensuring their representatives comply with the terms of the agreement. 

A possible exception exists for professionals who have an implied duty of confidentiality, such as attorneys and accountants. Additionally, use by any third parties should be explicitly limited to evaluating the transaction and for no other purpose – also covered in “Permitted Uses.” The following is sample language addressing the buyer’s liability toward their “Representatives”:

“Buyer will ensure its Representatives comply with the terms of this agreement and will be responsible for any breach of this agreement by its Representatives.” (Liability will be imposed on Buyer for breaches caused by Representatives.)

“Buyer shall keep all Confidential Information received by it confidential and shall not disclose Confidential Information, in whole or part, to any person, except to Buyer’s Representatives who need to know the Confidential Information for purposes of evaluating the Potential Transaction, provided that such Representatives are informed by Buyer of the confidential nature of the information and comply with the terms of this Agreement.” (No explicit liability imposed on Buyer for breaches caused by Representatives.)

In some cases, buyers will agree to take measures to ensure compliance with the confidentiality agreement by its representatives but absolve themselves from strict liability from doing so, with the exception of insiders, such as directors, officers, or employees. 

As an alternative, you could request that the buyer’s representatives sign a separate NDA, thereby offering you a direct remedy to the third party – for example, you could sue the third party directly, in addition to suing the buyer – or add the representative as a signatory on the NDA by way of a joinder, thereby accomplishing the same objective. 

Without a separate NDA with third parties or the buyer being liable for third-party actions, an NDA is toothless against the actions of third parties. In essence, you would lack the ability to enforce the NDA’s terms directly onto third parties, and the buyer would bear no responsibility for the third party’s actions. As a result, no one would be on the hook. 

The buyer should therefore bear responsibility for the actions of their “Representatives” in the absence of a separate NDA or joinder signed with the “Representatives.” Finally, the buyer should also be compelled to inform you in the event of a breach of confidentiality by their “Representatives,” as provided in the language below:

“Buyer agrees to promptly inform Seller in the event of a breach of confidentiality made by itself or its representatives and will assist Seller in remedying the breach.”

Many confidentiality agreements state that a breach caused by a “Representative” of the buyer will be treated the same as a breach by the buyer. If so, the buyer would have strict liability for the actions of its representatives. This helps ensure the buyer will exercise a high degree of caution in protecting your confidential information. 

Some buyers attempt to avoid strict liability for the actions of their advisors. If the advisor is playing a critical role in the sale process, it may be wise to ask the third-party advisor to sign a separate CA. This allows you to enforce the CA directly on the representative. As mentioned previously, attorneys and accountants have an implied duty of confidentiality, and their professional obligations are normally viewed as sufficient.

At a minimum, any third parties should be bound by the terms of the NDA, and the buyer should remain liable for any breaches made by third parties and bear responsibility for ensuring their representatives comply with the terms of the agreement. 

Confidentiality Regarding the Transaction

Sellers normally want to preclude the buyer from disclosing that negotiations are taking place or from disclosing specific terms of the negotiations, such as the price of the business. By the same token, buyers may also seek to prevent you from disclosing the terms of the transaction to other potential bidders, which serves to prevent you from “shopping” the buyer’s offer, or using one offer to drive up another. 

In most cases, the buyer will desire that this clause be mutual, whereby you’re also obligated to keep quiet regarding the deal. You should retain the right to disclose to other buyers that you’re in negotiations with another buyer without specifying the terms of the potential transaction. This allows you to leverage an offer without violating the terms of the NDA. Here is sample language:

“Each party agrees that it will not disclose to any person (other than its Representatives) the fact that discussions or negotiations are taking place, any terms of negotiations, or the identities of the parties thereto.”

“Without the prior written consent of the Seller, or as required by law, you will not disclose to any person: (i) the fact that investigations, discussions, or negotiations are taking place regarding a potential transaction, (ii) any of the terms, conditions or other facts regarding the potential transaction, or (iii) the existence of this Agreement.”

Standards of Care

An important point that must be covered in any confidentiality agreement is the standard of care by which the parties will be required to protect the confidential information. Most NDAs require that each party treats the confidential information in the same way it treats its own. But, this treatment should be acceptable only if the buyer has reasonably high standards for handling their own confidential information. 

Therefore, before signing a confidentiality agreement, it would be prudent to investigate the buyer’s practices regarding maintaining the secrecy of their own information. If those practices are substandard or nonexistent, the confidentiality agreement should contain specific provisions concerning limiting access to confidential information.

Permitted Disclosures 

Most confidentiality agreements allow disclosure in select circumstances, for example, when required to do so by law. The following is more information regarding the two most common types of permitted disclosures.

Disclosures to Third Parties

The agreement may either limit disclosure of the information to certain third parties, such as buyer representatives on a need-to-know basis, or prohibit disclosure to third parties entirely.

In order to evaluate the proposed transaction, the buyer may have to share the information with their advisors and employees. The buyer should inform these advisors of the confidential nature of the information and require these individuals to sign NDAs or agree to be liable for their breach.

Disclosure Required by Law

Most NDAs allow the buyer to disclose confidential information if required pursuant to a court order, but only to the extent required by law. In cases when the buyer is required by law to disclose confidential information, such as by governmental authorities, you should request advanced notice and also include language that requires disclosure only after a written opinion is obtained from their legal advisors. You can also modify the language to ensure that it’s “required” as opposed to “requested,” or attempt to limit the scope of the disclosure. This gives you an opportunity to defend the request before the information is disclosed. 

“Required” may be considered too strict by the buyer. “Requested” may be deemed a more reasonable standard so the buyer can cooperate with authorities instead of risking penalties or damaging relationships with authorities for not doing so, as shown below:

“In the event either party is required [requested] by law to disclose any of the Confidential Information, such party shall, to the extent permitted by law, provide the other party with prompt written notice and make such disclosures without liability.”

Some sellers prefer to obtain a legal opinion before granting the request to the buyer, though buyers may soften this language by modifying it to include “consulting with an attorney” or “upon the advice of outside counsel.” “Outside” is included, as the parties often prefer a neutral party’s advice, as opposed to the buyer’s or seller’s counsel. Additional modifiers may be included regarding efforts taken to obtain counsel, such as “best efforts” or “commercially reasonable efforts.” The agreement should also address who will bear the expense of obtaining a legal opinion or seeking legal counsel. A common approach to this is that the seller should bear the expense of protecting their own information.

Return of Information

Most NDAs require that at the end of the disclosing period, the buyer must return the confidential information, including copies or analyses. Given the prevalence of electronic data, the degree to which this protects you is questionable. 

In practical terms, it’s difficult to return all confidential information, especially information provided to third parties, such as the buyer’s “Representatives.” Many buyers forget to permanently delete electronic copies, including emails. Buyers prefer to destroy information, which is simpler and less costly than returning it. Despite the fact that many NDAs include a requirement to “return” information, few parties follow through on the promise. In reality, most NDAs are only reviewed in the event of a breach. Here is some sample language addressing “return of information”:

“At Seller’s request for any reason, Buyer will promptly return to Seller or destroy all Confidential Information … ”

“Buyer shall use commercially reasonable efforts to return or destroy Confidential Information stored electronically.”

An exception exists for buyers in regulated industries that are required by law to retain copies of certain information to comply with regulatory requirements. In these cases, buyers draft exceptions to their obligation to return or destroy information. This allows them to comply with document retention or other compliance policies or to address electronic information, which is often archived but difficult to destroy. As a safeguard in these cases, you may wish to retain certain precautions to ensure the request is legitimate by offering you the opportunity to review, approve, or be immediately informed of the request before any confidential information is shared, as in this example:

“Buyer may retain a copy of Confidential Information in the offices of its outside counsel, to the extent required to defend any litigation relating to this Agreement, or to comply with any legal or regulatory requirements or document retention policies.”

In most cases, the “Definition of Confidential Information” also includes the buyer’s analyses, compilations, and other models (i.e., “derived information”). The seller usually agrees that derived information will be destroyed, as opposed to returned, as buyers seldom desire to share their own analyses, since they may contain proprietary information.

Finally, a differentiation may be made between “certify” vs. “notify,” the latter being less restrictive on the buyer. 

Communications

Most sellers desire all communications to be funneled through them and wish to prevent the buyer from talking to third parties, such as employees, customers, or vendors. Exceptionally punctilious buyers will modify the language to ensure this does not serve as a backdoor non-compete by excluding “contacts made in the ordinary course of business.” Here’s a common clause I see regarding communications:

“Without the prior written consent of the Seller, you will not initiate any communications with the Seller’s employees, officer, director, agent, affiliate, supplier, distributor, or customer of the Seller regarding the Transaction and Confidential Information, except in the ordinary course of business.”

Non-Solicitation

You may wish to avoid having the buyer poach your employees, and you can do so by way of a non-solicitation or no-hire agreement. A non-solicitation agreement is less restrictive on the buyer than a no-hire agreement. In most cases, “non-solicits” and “non-hires” have a limited duration or may be limited in scope to specific employees, such as managers or other key employees, as in this example:

“Buyer agrees that, for a period of two years from the execution of this Agreement, Buyer will not solicit to hire any [officer or management-level] employee of the Seller without the prior written consent of the Seller.”

Any prudent buyer will wish to minimize their concerns of having to track the activities of their HR department to comply with the terms of the confidentiality agreement, especially if they evaluate more than a few potential transactions per year. The following language is intended to limit the scope of the non-solicit:

“Provided that Buyer will not be prohibited from using non-targeted or general solicitations which are not targeted at Seller’s employees, using search firms as long as such firms do not specifically solicit Seller’s employees, or hiring anyone who contacts Buyer independently without being solicited by Buyer.”

In larger companies, there’s also an issue regarding disclosure. How would a buyer inform their HR department not to hire someone from XYZ company (i.e., the “seller”) without raising eyebrows? Wouldn’t such a request raise unnecessary suspicions? 

To soften the requirements, buyers may limit the restriction to those who have access to confidential information, limit the scope of the non-solicit to executive-level employees, or limit the scope to only those employees introduced to the buyer. Alternatively, they may replace the “no-hire” with a “no-solicit,” which would prevent the buyer from actively poaching your employees but would allow the buyer to hire them in a generalized search or through search firms.

If you’re dealing with a private equity firm, you may be worried the PE firm will offer more lucrative terms to your management team than other buyers and that the management team will form a coup to intentionally derail any deal they don’t agree with. In these cases, I recommend the following language:

“Buyer agrees it will not engage in discussions with Seller’s management regarding the terms of their employment post-closing or until the earlier of (i) seller’s written approval, or (ii) the date a definitive agreement is executed between the parties.”

Buyers may also attempt to draft the non-solicit to be “two-way” if you’ll have contact with the buyer’s employees. This mutual language is most common when the buyer is a direct competitor.

No Obligation to Proceed

Most NDAs include a statement that the mere fact the parties entered into an NDA doesn’t give rise to an obligation to sign a definitive agreement. While it’s common knowledge that a CA doesn’t bind the parties to consummate a transaction, it’s good practice to state that neither party is obligated to consummate a transaction until a written agreement has been signed, as follows:

“ … until a written agreement between Seller and Buyer has been executed, neither party shall be under any obligation to consummate a transaction.”

“Each party reserves the right, in its sole discretion, to reject any proposals made by the other party, and to terminate negotiations at any time and for any reason.”

No Grant of IP rights

NDAs should include a clause that prohibits the buyer from licensing any intellectual property contained in the confidential information. Confidentiality agreements should also contain a provision stating that no implied license to the technology or information is granted to the buyer. 

The language should further state that all tangible embodiments of the information such as models, data, and drawings be returned upon request and in no event later than the end of the agreement term, and that the buyer shall retain no copies.

Disclaimer of Accuracy and No Warranties

A “no warranty” clause is a statement by you that you make no warranty that the information is accurate or complete. Such a clause facilitates the free flow of information by limiting your liability regarding the accuracy of information until a definitive agreement is signed. If the parties then proceed to a definitive agreement, that agreement will contain reps and warranties related to your business. At that point, you’re customarily required to include extensive reps and warranties in the purchase agreement.

Here’s seller-friendly language regarding the accuracy of the information:

“Seller makes no representation or warranty, express or implied, as to the accuracy or completeness of the information … ”

“Buyer agrees that Seller shall have no liability to Buyer resulting from the use of Confidential Information or any errors or omissions.”

Reps and warranties are heavily negotiated in NDAs, but can only be negotiated in the context of tradeoffs and specific contexts. In practice, sellers are more comfortable making certain representations once they understand the specific concerns and objectives of the other party. For example, you may be more comfortable making a representation regarding the accuracy of your financials once you’ve built a strong, personal relationship with the buyer. This may only come after you understand the buyer’s concerns regarding your financial statements and their reasoning behind the desired representation. It’s sensible that the NDA include language that limits representations to those made at later stages, such as those included in a definitive agreement. It’s common for the buyer to request language that you have a “good faith belief” that the information is accurate, despite any of your implied duties. Many sellers resist this language by striking it entirely or adding a modifier.

A “no warranty” clause is a statement you make that the information is accurate or complete. Such a clause facilitates the free flow of information by limiting your liability regarding the accuracy of information until a definitive agreement is signed.

Dispute Resolution, Enforcement, Remedies, and Relief

The agreement should include a statement about breaches made by the buyer so as to entitle you to equitable – and legal – remedies. CAs are hard to enforce, and money damages are hard to prove or may not sufficiently compensate you. You will want to retain the right to equitable relief and to seek an injunction. 

The most common legal remedy for breach of an NDA is to sue for money damages. The parties may agree to certain damages in advance of a dispute by including a liquidated damages clause that contains agreed-upon damages for breaches. But, given the nature of secrets, it can be difficult to determine reasonable damages. A common approach is to acknowledge that breaches can’t be cured by monetary damages alone. The NDA may also provide equitable relief – remedies that require a party to act or refrain from certain actions – in the form of temporary restraining orders and court-ordered injunctions that bar the breaching party from using or disclosing confidential information. 

Money damages may not be an adequate remedy for most sellers, so it may be necessary to include the ability to obtain equitable relief. Arguably, you may have the right to pursue an injunction even if the agreement lacks this language. The agreement should also require the buyer to disclose any breaches or violations of the NDA.

The forum selection and choice of law clauses are usually written separately, but they also impact how a dispute is resolved. Most parties agree in advance that in the event of a dispute, they will submit to the jurisdiction and laws of a particular state. This means that if either party wants to bring a claim, it must do so in the state named in the agreement and that state’s laws will govern the decision of the court or arbitrator.

Most buyers agree to some version of equitable and injunctive relief, as in this example:

“You agree that the Seller would be irreparably harmed by a breach of this Agreement and that money damages are not an adequate remedy. You, therefore, agree to grant specific performance of this Agreement and injunctive or other equitable relief in favor of the Seller as a remedy for such breach, without proof of actual damages, and you further waive any requirement for the securing/depositing of any bond in connection with such remedy. Such remedy shall not be deemed to be the exclusive remedy for a breach of this Agreement, but shall be in addition to all other remedies available by law.”

Injunctive relief can’t be obtained through arbitration, which is why few NDAs include an option for arbitrating any claims. Here’s a relatively standard clause:

“Money damages would not be sufficient remedy for any breach of this Agreement, and the Seller [both parties] shall be entitled to seek equitable relief, including, without limitation, injunction and specific performance, as a remedy for such a breach. Such remedies shall not be deemed to be the exclusive remedies for a breach of this Agreement, but shall be in addition to all other remedies available by law.”

Indemnification and Legal Costs

In the absence of an indemnification, each party shall be responsible for its own attorney’s fees in the United States, with the possible exception of Alaska. The “loser pays” rule prevails in Canada, the United Kingdom, and most European countries, but not in the United States as a matter of statute (i.e., the parties must agree contractually). Buyers may agree to a “loser-pays” clause but may resist signing a “one-way attorney fees” provision, as in this example:

“Buyer agrees to indemnify and hold harmless Seller from any loss arising out of a breach of this Agreement.”

Term

NDAs commonly have terms of two to three years. The period of time depends on the strategic value of the information to you and how quickly the information may become obsolete. The term of the NDA will depend on what kind of information is being disclosed and is usually tied to the economic life of the confidential information. 

Buyers require termination of the CA to avoid any ongoing administrative obligations of ensuring compliance and monitoring the terms of the agreement. Buyers normally prefer to limit the term as much as possible.

Some sellers push for an absence of a termination date, arguing that the confidential information remains valuable for a longer period. This could be persuasively argued in the case of IP that may have a longer life than the term of the CA, and separate terms can be drafted to address specific categories of information. Other provisions may contain different terms, such as a non-solicitation agreement.

You should avoid ending the term when a definitive agreement is signed because many transactions fail to close, as this clause addresses:

“This Agreement shall expire upon the earlier of five years from the execution of this Agreement, execution of a Definitive Purchase Agreement between the parties, or upon the consummation of a Transaction between the parties.”

[Modified] “This Agreement shall expire upon the earlier of five years from the execution of this Agreement or upon the consummation of a Transaction between the parties.”

Assignment

Thought should be given to whether the CA could be assigned to a new buyer or successor. In the absence of such an assignment, it may be impractical for a retired seller who no longer has a vested interest in the business to enforce the CA on the buyer. In the case of a stock sale, such an assignment may be unnecessary. Here is an example of common language addressing the issue of assignment: 

“This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors. Any assignment of this Agreement without the prior written consent of the other party shall be void.”

Choice of Law and Forum

Most sellers seek to be governed by the law of the state in which they’re incorporated. Buyers seldom refuse this request unless the buyer has significant negotiation leverage. If the parties are located in separate states, they may choose a neutral state in which neither party has a home field advantage. Clauses requiring arbitration are rare in CAs because the parties usually seek specific performance, which can’t be obtained through arbitration. The parties also sometimes include a clause waiving the right to a jury trial. Here’s a common example:

“This Agreement shall be governed by the laws of the State of Alaska. Each party hereby irrevocably concerts to submit to the exclusive jurisdiction of the courts of the State of Alaska for any action, suit, or proceeding arising out of or relating to this Agreement.”

Clauses to Consider Modifying

Here’s a detailed explanation of the specific language contained in most NDAs that you may consider modifying. 

Definition of Confidential Information: This is a commonly negotiated section. Many agreements broadly define confidential information and then make specific exclusions. This section should specifically address any confidential information you’re particularly concerned about. For example:

“Confidential Information” means information about the Company and its Customers, Customer Prospects, and/or Vendors that is not generally known outside of the Company, which you will learn of in connection with your employment with the Company. Confidential Information may include, without limitation: (1) the terms of this Agreement, except as necessary to inform a subsequent employer of the restrictive covenants contained herein and/or your attorney, spouse, or professional tax advisor only on the condition that any subsequent disclosure by any such person shall be considered a disclosure by you and a violation of this Agreement; (2) the Company’s business policies, finances, and business plans; (3) the Company’s financial projections, including but not limited to, annual sales forecasts and targets and any computation(s) of the market share of Customers and/or Customer Prospects; (4) sales information relating to the Company’s product roll-outs; (5) customized software, marketing tools, and/or supplies that you will be provided access to by the Company and/or will create; (6) the identity of the Company’s Customers, Customer Prospects, and/or Vendors (including names, addresses, and telephone numbers of Customers, Customer Prospects, and/or Vendors); (7) any list(s) of the Company’s Customers, Customer Prospects, and/or Vendors; (8) the account terms and pricing upon which the Company obtains products and services from its Vendors; (9) the account terms and pricing of sales contracts between the Company and its Customers; (10) the proposed account terms and pricing of sales contracts between the Company and its Customer Prospects; (11) the names and addresses of the Company’s employees and other business contacts of the Company; and (12) the techniques, methods, and strategies by which the Company develops, manufactures, markets, distributes, and/or sells any of the products.”

Definitions of Representatives: Many NDAs allow the buyer to share sensitive information with their “representatives” without your explicit consent, but some agreements don’t define what a representative is. I don’t recommend this. The NDA should require that the buyer obtain your consent before releasing the confidential information to third parties. The agreement should also define what a representative is. Here’s an example clause that offers a clear definition of “Representative”:

“For purposes of this agreement, the term “Representatives” shall mean your affiliates, and you and your affiliates’ respective directors, officers, employees, agents, and advisors (including you and your affiliates’ financial advisors, attorneys, accountants, and other consultants); [provided that any such advisors shall not also be, or at any time in the future become, a co-bidder or source of equity or debt financing].”

Permitted Uses: The NDA should state that confidential information can only be used for purposes of evaluating the transaction. For example: 

“The Receiving Party hereby agrees that the Evaluation Material will be used by it or its Representatives solely for the purpose of evaluating a possible Transaction and not for any other purpose, including in any way detrimental to the Disclosing Party, and will not be disclosed by the Receiving Party and its Representatives to any other person; provided, however, that any of such information may be disclosed to the Receiving Party’s Representatives who need to know such information for the purpose of evaluating any such Transaction and who agree to keep such information confidential and to be bound by this agreement to the same extent as if they were parties hereto. The Receiving Party will be responsible for any breach of this agreement by its Representatives and agrees to take at its sole expense all reasonable measures to restrain its Representatives from prohibited or unauthorized disclosure or use of the Evaluation Material.”

Disclosures Required by Law: Most NDAs allow the buyer to release confidential information if compelled to do so by law. Strongly worded – on your behalf – NDAs allow you to mediate these claims and otherwise offer you several protective mechanisms before the information is released. Here’s an example of such language:

“In the event that the Receiving Party or any of its Representatives is required, based on the written opinion of the Receiving Party’s outside legal counsel, to disclose all or any part of the information contained in the Evaluation Material under the terms of a valid and effective subpoena or order issued by a court, governmental body of competent jurisdiction or stock exchange, the Receiving Party agrees to immediately notify the Disclosing Party of the existence, terms, and circumstances surrounding such a request, so that it may seek an appropriate protective order and/or waive the Receiving Party’s compliance with the provisions of this agreement (and, if the Disclosing Party seeks such an order, to provide such cooperation as the Disclosing Party shall reasonably request at the Disclosing Party’s expense). In the event that such protective order or other protection is denied and that Receiving Party or any of its Representatives are nonetheless legally compelled to disclose such information, it or its Representatives, as the case may be, will furnish only that portion of the Evaluation Material that Receiving Party’s outside legal counsel advises it in a written opinion is legally required and will exercise all best efforts to preserve the confidentiality of the remainder of the Evaluation Material. In no event will the Receiving Party or any of its Representatives oppose action by the Disclosing Party to obtain a protective order or other relief to prevent the disclosure of the Evaluation Material or to obtain reliable assurance that confidential treatment will be afforded the Evaluation Material.”

Return or Destruction of Information: Many NDAs require the buyer to return or destroy the information if they decide not to pursue this transaction. This clause is becoming irrelevant given how commonly information is now shared electronically and the current state of technology.

Access to Employees: This is a hotly debated topic. All NDAs should restrict access to employees in the early phases of the transaction. If you wish to grant access to your employees, I highly recommend having your attorney draft an NDA that addresses the non-solicitation of your employees before you allow the buyer to meet with your employees:

“Without the prior written consent of the Company [or the Company’s investment bank], neither you nor any of your Representatives will initiate or cause to be initiated (other than through a financial advisor designated by the Company) any (a) communication concerning the Evaluation Material; (b) requests for meetings with management in connection with a potential Transaction; or (c) communication relating to the business of the Company or any of its affiliates or a potential Transaction, in each case with any officer, director or employee of the Company or any of its affiliates.”

Non-Solicitation of Employees: This is also a hotly debated section, and some buyers refuse to sign an NDA that contains this language in the earlier stages of the transaction. You can soften the non-solicitation of employees by stating that the buyer agrees to not actively pursue your employees, but that your employees can be hired if they apply through general means (e.g., employment advertisements). Here’s an example of that softened language: 

“For a period of three years from the date hereof, the Receiving Party agrees that, without the prior written consent of the Company, it and its affiliates will not directly or indirectly hire or solicit any current employee of the Company; provided, however, that the foregoing shall not apply to generalized searches for employees by use of advertisements in the media that are not targeted at employees of Seller.”

Disclaimer Regarding Accuracy: To protect yourself, the NDA should state that you’re not making any warranties regarding the accuracy of the information, especially early in the transaction. Here’s a common example: 

“The Receiving Party understands that neither the Disclosing Party nor any of its Representatives has made or makes any express or implied representation or warranty as to the accuracy or completeness of the Evaluation Material. The Receiving Party agrees that, except for any breach of this Agreement, neither the Disclosing Party nor its Representatives shall have any liability to the Receiving Party or any of its Representatives or stockholders (or other equity holders) on any basis (including, without limitation, in contract, tort, under federal or state securities laws or otherwise), and neither the Receiving Party nor its Representatives will make any claims whatsoever against such other persons, with respect to or arising out of: a possible Transaction, as a result of this Agreement or any other written or oral expression with respect to a possible Transaction; the participation of such party and its Representatives in evaluating a possible Transaction; the review of or use of content of the Evaluation Material or any errors therein or omissions therefrom; or any action taken or any inaction occurring in reliance on the Evaluation Material, except and solely to the extent as may be included in any definitive agreement with respect to any Transaction.”

Term: All NDAs should include a term. Most NDAs contain a term of two to three years. Go for the longest term you can get.

Choice of Law: I recommend choosing your home state.

Injunctive Relief: The NDA should specifically allow you to obtain an injunction in the event of immediate damage.

Assignment: Most NDAs aren’t assignable, and the NDA should clearly state whether it is.

Conclusion

Understanding a few basic points about confidentiality agreements helps ensure they can protect you while selling your business. By examining their language and negotiating their terms, you can assure that they aren’t unnecessarily softened by ambiguities or ignorance of the meaning of terms used in the agreement.

As with any agreement, there is no “one size fits all” approach, and you should consider professional advice before taking action. The best way to make sure the NDA is enforceable is to give careful consideration to the factors outlined above – especially since the protection of ideas and trade secrets is inherently difficult.

In addition to drafting an NDA, here’s a summary of the steps you can take to help ensure confidentiality:

When it comes to selling a business, maintaining confidentiality is key. Paying heed to these strategies in coordination with a well-drafted confidentiality agreement will help ensure discretion is maintained throughout the process. 

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Maintaining confidentiality is essential when it comes to selling your business and one of the primary tools for doing so is a properly drafted non-disclosure agreement. Many critical issues that will help preserve confidentiality are addressed in a properly drafted NDA, including non-solicitation and other “sales process” issues. While it’s tempting to assume that all NDAs are boilerplate, a mistake at the stages of negotiating and signing a non-disclosure agreement can close off critical options later in the process. In extreme cases, leaks can destroy your business. 

In nearly every M&A transaction, a confidentiality agreement (CA) is executed, but a CA is only one of many tools in your toolkit you can use to maintain confidentiality during the sale process. The information in this section is essential if the terms of a confidentiality agreement are crucial to the sale of your business, especially if you’re approaching direct competitors, which always carries a high risk.

Topics Covered

At a minimum, an NDA will usually cover the following:

With regard to the confidential information, the buyer is obligated to the following, assuming the NDA is properly drafted:

The Importance of a Properly Drafted NDA

A properly drafted confidentiality agreement sets expectations with buyers, which is critical to the M&A process. A well-prepared agreement signals to buyers that you’re well represented.

The language in M&A confidentiality agreements has evolved over the years and is no longer restricted to language that addresses only confidentiality. Despite the implication of the name “confidentiality agreement,” many additional critical issues are often addressed in the agreement, such as non-solicitation and other sales process issues. 

If an investment banker represents you, expect your advisor to have a template. Because most M&A advisors represent sellers, their template will be seller-friendly. If your situation is unique, consult with your attorney to draft a custom NDA. In most cases, buyers request few changes to the language contained in your NDA, but you should be prepared to negotiate the terms of the agreement as requests can vary depending on who the buyer is.

In practice, most NDAs are drafted by the disclosing party, which is usually the seller in M&A transactions. Sellers negotiate with multiple buyers, and maintaining consistent language across the agreements simplifies the process for them. Most NDAs never make it past the first stage of selling a business when the information memorandum is released to the buyer, and you may execute NDAs with dozens of potential buyers during the sale process.

A properly drafted confidentiality agreement sets expectations with buyers, which is critical to the M&A process.

Goals of a Non-Disclosure Agreement

There are two main goals of drafting an NDA – controlling the behavior of your buyer and offering mechanisms for litigation. The specifics of these two goals are as follows: 

Goal 1: Control Behavior

The primary goal of the NDA is to prevent confidentiality breaches from happening in the first place. If the terms of the NDA are clear, this objective is likely to be achieved. Therefore, drafting an NDA that’s clear, concise, and devoid of legalese is important.

That being said, it’s often wise in smaller transactions to reiterate the confidential nature of the information to the buyer during the initial phone conversation or meeting. This is doubly important if you believe the competitor hasn’t completed any acquisitions before and isn’t aware of the importance of confidentiality. 

If the buyer attempts to negotiate the language of the NDA, this can be a good sign. Unfortunately, some buyers don’t thoroughly read the terms of the NDA and inappropriately assume that the language in the NDA is boilerplate. Therefore, when a buyer attempts to negotiate the language of the NDA, you know they’ve read it through, which is good. This can be an indication that the buyer closely monitors their commitments and intends to abide by them.

Goal 2: Offer a Mechanism for Litigation

If an NDA is violated, your primary option is to litigate. While you can deliberate for hours regarding the definition of confidential information, it won’t matter if the buyer doesn’t understand the language contained within the NDA. With that being said, I believe the primary goal of an NDA is to control and prevent the behavior, which is Goal 1. If the first objective to “control behavior” is achieved, litigation, which is the second objective, isn’t necessary. If the NDA doesn’t achieve the first goal of controlling behavior, your only remaining option is to sue the buyer to enforce its terms. Luckily, this is rarely necessary, despite the fact that this is one of the main objectives of a non-disclosure agreement. If you do need to litigate, a well-drafted non-disclosure agreement will contain mechanisms that facilitate its enforcement, whether that includes an injunction, liquidated damages, or arbitration.

Now that the purpose of the NDA has been explained, here are several tips on how to strengthen the NDA when dealing with direct competitors.

There are two main goals of drafting an NDA – controlling the behavior of your buyer, and offering mechanisms for litigation. 

Prepare a Buyer-Specific NDA

Ask your attorney to prepare an NDA specific to the buyer with whom you’re negotiating. A standard NDA is normally sufficient during the preliminary stages with most buyers. But, if you’re dealing with a direct competitor and are releasing highly sensitive information to them, your attorney should prepare an NDA specific to that buyer. 

An NDA often has to be customized for certain types of buyers. Using a boilerplate NDA can leave you open to loopholes depending on the type of buyer. For example, we manage private equity firms differently than competitors. Our process is more stringent with competitors. In middle-market transactions, the terms of an NDA are negotiated with most buyers, especially if the buyer is a potential competitor. Therefore, because the language can vary in an NDA, it makes sense to afford yourself more protection when dealing with direct competitors. 

Topics to consider modifying if you’re dealing with a competitor include:

You can also consider including the following language in the NDA when dealing with a competitor:

Prepare a Separate NDA for Different Categories of Information

Separate NDAs can also be prepared for different categories of confidential information, with different language necessary for different scenarios. 

For example, each of these scenarios may require a different set of legal strategies and language to protect you – the buyer meets with key employees vs. if the buyer meets with key customers vs. if you share proprietary pricing with the buyer.

Ask the Buyer’s Representatives to Sign an NDA

Always ask the buyer to obtain a signed NDA from their representatives before releasing your information to them. If the representatives don’t sign the NDA, the buyer should be held liable for any breaches made by their representatives. The buyer should also disclose their representatives’ names and contact information if they receive information on your business. 

Have the Buyer Sign Multiple NDAs

Ask the buyer to sign a different NDA at different points in the transaction as the negotiations progress and as you provide additional confidential information to the buyer in stages. Each NDA can contain progressively more restrictive language and terms as you release more sensitive information. 

For example, a buyer may not be interested in signing an NDA that contains a non-solicitation or a no-hire clause early in the process. But, the buyer may agree to this NDA language later in the process if you agree to let the buyer meet with your employees during due diligence. 

It may be necessary for your attorney to draft an NDA before you allow the buyer to meet with key customers. This is rare in most transactions, but there may be cases where customer concentration is an issue, and the buyer may want to talk with key customers before they agree to close. If this is the case, it may be necessary to negotiate an NDA with the buyer before allowing such conversations to take place.

How an NDA Fits in the Sale Process

For transactions in the middle market, most intermediaries first provide a teaser profile to the prospective buyer before requesting that the buyer sign an NDA. Middle-market buyers prefer to see if the business is a good fit before committing to the terms of an NDA. The teaser profile and NDA are often contained in the same document, and the buyer is asked to sign the NDA if they’d like to access the confidential information memorandum (CIM) on your business. Since moving forward is contingent on this document, the NDA is usually signed early in the process.

When to Execute a Confidentiality Agreement or NDA

The NDA is usually the first document signed in a transaction and sets the tone for the negotiations, making it a critical component in the sale process. Depending on the type of business you’re selling, the name and location of the business can be highly sensitive. You may want to protect that information until you know the buyer is genuine and sincere.

The goal of your intermediary is to protect your sensitive and confidential information while providing enough information to a potential buyer so the buyer can decide whether to pursue your business. Needless to say, this is a delicate balancing act. 

If your business is being sold through an M&A intermediary, the NDA will usually be executed before your business’s name is disclosed. If an owner has been approached by a competitor directly, an NDA is often signed before substantive discussions take place or before you share confidential information with the buyer.

The NDA is the first document to be signed in a transaction and sets the tone for the negotiations, making it a critical component in the sale process. 

Types of NDAs

There are two basic types of NDAs – a unilateral NDA and a mutual NDA. Most NDAs don’t clearly state whether the document is unilateral or reciprocal, but this can be discerned after briefly reading the contract. Here are the basic differences: 

  1. Unilateral: Only one party is obligated not to disclose confidential information in a unilateral or one-way agreement. Most NDAs when selling a business are unilateral, whereby the buyer is the recipient and you’re the disclosing party, and you have no reciprocal obligations.
  2. Mutual: In a bilateral or mutual agreement, both parties provide information that’s intended to remain secret. This type of agreement is common when businesses are considering some form of a joint venture or merger.

Nuances in Buyer Groups

As a matter of custom, nearly all private equity firms will agree to sign an NDA. On the other hand, venture capitalists, who are financial buyers investing in speculative opportunities, rarely agree to sign NDAs. Entering into an NDA increases the risk that the venture capitalist (VC) may face charges of trade secret misappropriation if the VC develops similar information in the future or inadvertently discloses or uses the information. This is the primary reason that VCs don’t sign NDAs.

Problems, Tips, and Strategies

Even savvy sellers run into problems regarding the nuances of the language in NDAs, the timelines of negotiations, and specific definitions. Here are some common issues I’ve seen, along with tips for avoiding or navigating through them: 

FAQs About Non-Disclosure Agreements

Here are some of the most common questions about NDAs:

How common is it to negotiate confidentiality agreements?

It’s rare for parties to refuse to negotiate the terms of an NDA. The first draft is always negotiable, but the degree to which the parties negotiate depends on their individual bargaining strength. Every buyer, whether a corporate or financial buyer, has their own idiosyncrasies in terms of the language they look for in an NDA, based on the history of their transactions and what may have gone wrong in the past. In practice, a minority of buyers request changes to a confidentiality agreement. But, the later you request an NDA from a buyer, the more prone a buyer is to attempt to negotiate the terms of a non-disclosure agreement. To prevent a buyer from attempting to negotiate a non-disclosure agreement, it’s best to request that they sign one as early as possible in the process.

The first draft is always negotiable, but the degree to which the parties negotiate depends on their individual bargaining strength. 

What’s the role of my attorney and M&A advisor?

Every M&A advisor will have a template they use when drafting a non-disclosure agreement. Your attorney will become involved if you have unique needs, such as trade secrets that need to be protected, if your marketing strategy includes approaching competitors, or if a buyer requests significant changes to your investment bankers template.

Do advisors sign NDAs?

Private equity firms nearly always sign non-disclosure agreements when scouting for acquisitions, but few venture capitalists will sign them. Most M&A advisors and investment bankers will sign an NDA, though some will view the request as naive due to their implied duty of confidentiality. Professionals, such as PE firms, venture capitalists, M&A advisors, and investment bankers, wouldn’t be working for long if they were in the business of stealing ideas. Attorneys and accountants will sometimes sign an NDA if the situation is unique, such as if they’re a part-owner in a competitive firm, but they’re bound by an implied duty of confidentiality, so requesting them to sign an NDA is considered unnecessary in most situations.

Should you sign a buyer’s “standard NDA”?

There’s no such thing as a “standard NDA.” Attorneys and M&A advisors have templates, but those vary drastically from company to company. So always ask your attorney to review the NDA before signing. Any company with a legitimate interest will be willing to negotiate the terms of its NDA.

Are NDAs one-way or two-way agreements?

Many NDAs are drafted as one-way agreements in which you only attempt to restrict the buyer’s actions. Buyers often modify the NDA if they’re disclosing confidential information to you, or at least to protect the terms of the transaction, so you can’t shop the buyer’s offer.

What’s signed after the confidentiality agreement?

A letter of intent is customarily signed after the parties have exchanged information and the buyer has expressed an interest in moving forward into due diligence. After due diligence is completed, the parties replace the LOI with a definitive agreement, such as a purchase agreement, asset purchase agreement, or definitive purchase agreement. This definitive agreement is normally signed at the closing to consummate the transaction, although in some cases, it may be signed in advance of the closing.

Can the buyer disclose the specific terms of the negotiation after the CA expires?

Yes, unless the CA specifically prohibits this. An alternative is to remove the expiration date altogether, though a majority of buyers will argue that it may be difficult to monitor compliance with the agreement long-term if there’s no expiration date. It’s also important to note that some jurisdictions may not allow a perpetual term.

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Not only should you consider whether to tell your employees, there are also several other key stakeholders you may consider confiding in.

Professional Advisors

Telling your professional advisors is almost always a safe bet, assuming they are, in fact, professionals. They’re accustomed to their clients selling their businesses and are unlikely to be surprised at the news. Professional advisors, such as accountants and attorneys, don’t like surprises, and involving them early in the process may benefit you.

Landlord

Landlords are also accustomed to businesses being bought and sold, and the news is unlikely to shock them. Informing your landlord early on also carries the benefit of being able to pre-negotiate the terms of the transfer in some cases.

Family

I recommend informing those closest to you, especially if you live in the same house. Keeping the sale a secret from your nearest family members will be nearly impossible in any event. Also, it could result in hard feelings once they learn of the sale, especially if they hear about it through “unofficial” channels. If your family members work in the business, this should be handled with extreme caution.

Friends

I recommend telling only your closest friends about your plans, as most will have a difficult time keeping their lips sealed. If you trust and share a close bond with a friend or two, this confidant can be a safe person to talk to during the process, providing emotional stability for you during more stressful periods of the transition.

Suppliers

I don’t recommend informing your suppliers unless you believe they could be a source of potential buyers. Telling your suppliers is risky because they probably do business with your competition and are likely to spread the word.

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When it comes to selling your business, time is fickle. It’s your friend before your business is on the market, and your enemy the moment your business is on the market. The longer it takes to sell your business, the higher the probability of a leak. And that’s not good for business. 

There are three primary reasons for maintaining confidentiality:

  1. Employees: If your employees learn about the sale, they may become nervous regarding their job security. As a result, they could begin to look for employment elsewhere. In other cases, employees can feel betrayed and could form a small coalition to compete directly with you. 
  2. Customers: Both existing and potential new customers may learn of the possible sale and become nervous that a new owner may substantially change your business model or increase pricing, so they could begin looking for alternate solutions through your competitors.
  3. Competitors: Competitors may use knowledge of the sale to poach your employees and customers, or cause other harm to your business. 

Doesn’t a non-disclosure agreement (NDA) ensure confidentiality, you may ask? A signed NDA alone doesn’t assure confidentiality, but it’s a critical component of doing so and prevents a leak in most cases. But as a rule of thumb, the longer it takes to consummate a transaction, the higher the probability word will get out prematurely.

The real purpose of a confidentiality agreement is prevention, but it’s not the only tool you should use. A well-drafted NDA should be combined with additional actions for maintaining confidentiality. 

Prepare for the Sale in Advance 

An ounce of prevention is worth a pound of cure, and selling your business is no different. To preserve confidentiality, ideally, you should prepare for the sale years in advance. The right preparation goes a long way in ensuring a quick, smooth transaction, thereby minimizing the possibility of a leak and its consequential damage. 

Inform Employees 

In most cases, the only way an employee’s career can grow is if your business grows. At the same time, most entrepreneurs reach a stage where they’re “milking the cow” and no longer have the desire to grow their business. This limits employees’ growth, which can be demotivating for your staff. Luckily, most employees understand there’s a time for every entrepreneur to sell. New ownership makes sense at key stages in the life cycle of any business, which can spell opportunity for a driven employee. 

For example, if the buyer is significantly larger than your company and has access to more resources, a new owner may provide a pathway of growth for employees through opportunities outside the organization. Imagine if 3M bought a $20 million company. Which situation would offer an ambitious employee more opportunity – a career at the $20 million company or in any one of countless divisions at 3M? In addition, new ownership may also bring capital to the table to expand the business, which could represent another opportunity for superstar employees. In nearly all acquisitions, the buyer desires to significantly grow the business post-closing and is willing to take significant risks in doing so. That means that the sale of your business could offer your employees opportunities for growth and upward mobility. 

On the flip side, employees resting on their laurels may be understandably nervous about the prospects of new ownership. To be sure, the majority of employees are honest and hard-working, but there are bad apples in any bunch. In several cases, buyers have told me they found some employees who were barely working in a business, yet they were receiving full salary and benefits. A transition can be an excellent means of purging the business of this “dead weight.” 

Draft a Non-Disclosure Agreement

While an NDA isn’t bulletproof, it does prevent a leak of confidentiality in most cases. Often, a leak is negligent, and the offending party isn’t intentionally trying to harm your business. The real purpose of a confidentiality agreement is leak prevention, but it’s not the only tool you should use. A well-drafted confidentiality agreement should be combined with additional actions for maintaining secrecy. As an example, for highly sensitive information released to competitors, it may be wise to enter into a separate agreement or a multi-part NDA that addresses the disclosure of that information. I’ll dive deeper into NDAs further in this chapter, but for now, just know that they’re an important tool in maintaining confidentiality.

Contact Buyers Based on Increasing Stages of Risk

When selling your business, contact buyers that represent the lowest risk to you and your company first in the process. Typically, this involves initially contacting private equity (PE) firms and indirect competitors. This is the de facto standard in most private auctions if you hire an M&A advisor to represent you.

By first contacting the low-risk, low-priority group of buyers, you reduce the risk of potentially ruining a first impression you make with high-priority buyers. The first buyers you contact will inevitably point out potential drawbacks, deal-breakers, or other weaknesses they see in your business as they consider acquiring your company. No matter how much prep work you do, there will always be small details you miss in preparing your company for sale. Contacting low-risk buyers first allows you to tighten up future buyer presentations and increases the chance of a smoother transaction.

We recently sold a large commercial cleaning company using this strategy. We initially contacted a few dozen out-of-state competitors who could benefit from expanding their geographic reach. We considered these competitors low-risk since they weren’t directly engaged in the business’s geographic market. Our strategy was to contact direct competitors only as a last resort. We started with low-risk potential buyers and were able to sharpen our approach until we found the right buyers.

Thoroughly Screen Buyers

Not only should you ask all interested parties to sign a non-disclosure agreement, but you should thoroughly screen these buyers before you provide them with sensitive information on your company. Following are several tips for doing just that:

Release Information in Phases

You shouldn’t give sensitive information to the buyer all at once. Rather, you should release it to them in stages.

As the buyer demonstrates continued interest in your business, you can disclose more and more information. In this manner, you release more sensitive information as you come to know and trust the buyer over time. You should divulge highly confidential information such as customer contracts only at later stages of due diligence. 

Release general information in the early stages of any conversation with a potential buyer. Withhold sensitive data – or any other form of information that a competitor could use against you – until later in the transaction. Only provide sensitive information much later in the process, or not at all.

You can also impose deadlines on the buyer. In some cases, you can break due diligence into stages and ask that the buyer sign off on the completion of each stage. 

For example, you can allow the buyer to perform financial due diligence first. Once they have done so, you can request they sign off on the satisfactory completion of that stage before moving to the next phase of due diligence. 

While this strategy might be possible for some businesses, it’s impractical in most acquisitions due to the iterative nature of due diligence. A more straightforward solution is to simply withhold sensitive information until the later stages of due diligence.

Know What to Release and When

Next, I’ll clarify what information is regularly, sometimes, and not shared with buyers.

Information that’s regularly shared with buyers:

Information that is sometimes shared with buyers:

Information that is not regularly shared with buyers:

Control How Information Is Released

Controlling how information is released is foundational to maintaining confidentiality. If you’re releasing highly sensitive information, you can often limit who this information is released to by using the following strategies:

In one case, we sold a company to a private, wealthy individual who stole the funds he used to purchase the business from a trust, of which he was the trustee. While such cases are rare, if doubts are raised, trust your gut and dig deeper.

In one large transaction we handled, representing the seller, two customers accounted for 40% of the annual revenue. The buyer was concerned due to the risk associated with the high concentration of revenue, but the seller was unwilling to let the buyer talk directly with the customers. We hired a third-party firm to perform customer surveys and prepared a summary report to present to the buyer.

“Buyer agrees that select evaluation material will be provided only to Buyer’s outside advisors and that Buyer will not disclose such information to Buyer’s employees in its marketing, research and development, technology or finance departments.”

Mark or Stamp Documents “Confidential”

Stamp or watermark all documents “Confidential” before releasing them to the buyer. While this isn’t a requirement of most NDAs, it’s a good practice and clearly communicates to the buyer the confidential nature of any information you share with them.

Appoint a Neutral Third Party to Facilitate Due Diligence

There’s always risk involved with sharing your sensitive business information during the sales process. An important step in mitigating those risks can be appointing a neutral third party to perform due diligence on behalf of the buyer. For example, the buyer can retain an independent third-party CPA firm to perform financial due diligence if you must share sensitive financial information. In these cases, the third party would only serve to perform due diligence – they wouldn’t pass on any of the confidential information to the buyer.

For example, if you own a software company, you and the buyer could jointly hire a third party to perform a code audit. The third party would be the only contact to have access to your software code. After they complete their code audit, they would prepare a report and present it to the buyer for analysis, limiting the number of contacts with access to your confidential software code.

A second scenario may be one in which your business has high customer concentration, and the buyer is concerned about retaining your top three customers, who account for 70% of your revenue. In this case, a third party could be hired to perform customer surveys to ensure your top clients are satisfied and are likely to be retained. A transaction could also be structured to obscure the fact that the company was acquired. We recently employed this strategy to sell a large service firm in Chicago.

Handle Breaches Immediately 

Leaks in confidentiality rarely cause permanent damage. In most cases, unintentionally loose lips cause a leak, and a quick phone call to the offending party quickly reverses the damage, if any.

In the event of a breach, immediately call the offending party. Assess their reaction to the news and their tone – listen to their story before taking any dramatic action. In most cases, the other side will apologize and immediately take steps to correct the action, such as firing the employee who initiated the breach or calling the customer to reconstruct the narrative of the story. 

When a breach isn’t clear, a phone call may serve to raise the other party’s awareness of the issue, and in most cases, the story will quickly disappear. Send an email to confirm your conversation and any actions they’ve agreed to take. This creates a paper trail in the event you need to pursue litigation in the future.

Handling Buyers Who Want to Talk to Employees

Unfortunately, buyers sometimes want to talk to some of your employees during the due diligence period. If they do, I recommend saying no and standing your ground. But, doing so requires having a poker face and a solid resolution to stand firm. Most buyers will give in, move on to other issues, and forget about it. Some buyers, however, absolutely insist. If the buyer insists on talking to a few select employees about the sale, do so only after all other due diligence matters and other contingencies have been resolved, such as financing or the transfer of the lease. In other words, the sale should be ready to close, and this should be the only remaining step.

Key Points

Maintaining confidentiality is a critical component of selling your business. A confidentiality agreement is one of many strategies to preserve privacy. A well-drafted confidentiality agreement should be paired with the strategies recommended above to ensure discretion is maintained throughout the sales process.

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“You can take better care of your secret than another can.”

– Ralph Waldo Emerson, American Author

Don’t let loose lips sink your chances of a successful sale.

If word gets out prematurely that you intend to – or already have – put your company on the market, you risk losing control of the narrative. Why does that matter? Employees who learn about your plans through indirect channels may lose your trust. Customers may jump ship. Competitors may begin poaching your employees and client base. Any of these outcomes can significantly weaken your leverage at precisely the time you need to put your best foot forward.

Fortunately, there are measures you can take to prevent the release of sensitive information – whether it’s word of the sale itself or a spreadsheet containing a list of your major customers.

You’ve no doubt heard of non-disclosure agreements. These can be a useful tool in maintaining confidentiality, and I discuss them in detail in this chapter, including providing specific passages you can use to make sure your interests are protected. I also cover a dozen strategies you can implement both before and during the sales process to help keep the sale of your business mum.

More than a century ago, Sigmund Freud famously declared, “No mortal can keep a secret.” Let’s prove him wrong.

Warning: The content in the second half of this chapter is detailed and excessively dry, unless you love poring over legal prose. If you’re particularly concerned about the detailed language contained in a non-disclosure agreement, read the latter half of this chapter. Otherwise, feel free to skip it.

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When it comes to preparing your key sale documents, it’s important to note that these documents will be released to the buyers in phases. As buyers become more serious about purchasing your business, you can release more and more specific information. This not only protects you from releasing sensitive information to competitors, it also keeps buyers actively engaged in the process. This release of information should be paired with the buyer releasing information to you, as well. Before you release key financial and operational documents, you should already know the buyer is qualified to purchase your business.

Here’s an abbreviated description of the process:

The Documents

In the beginning of the sales process, you’re making claims that aren’t verified until an offer is accepted and the buyer moves into due diligence. 

Here’s what to share before you accept the letter of intent:

Here’s what to share after you accept the letter of intent:

How the Numbers Work

When it comes to releasing information to buyers in phases, it’s important to realize that the number of qualified and interested buyers will decrease at every step of the transaction. Here’s how the numbers might work in a typical transaction:

As you can see, the sale of a business can be compared to a sales funnel. There are major steps along the way, and buyers drop off at each step. 

Conclusion

By examining the major stages of selling a business and preparing for each one, you can dramatically improve your chances of a successful sale. 

Your two-to-three-page teaser profile should be written in a way that drums up interest in your business without divulging its identity. Then, after the buyer signs an NDA, comes the CIM, a 20-to-40-page document that includes the name of the business along with more details about your company. After meeting with you a time or two to receive even more information about the business, the buyer submits an LOI, after which due diligence begins.

Congratulations! You’re on your way.

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Below is a list of additional documents you should organize into a virtual data room before putting your business on the market. While most of these documents won’t be requested until due diligence, you should begin preparing these the moment you decide to sell. Having an organized physical or electronic file of all of these documents will put you at a significant advantage and speed up the sale process. It will also reduce the perceived risk to the buyer since buyers view purchasing an organized business as less risky than purchasing a disorganized business.

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