Buying a Business: The Term Sheet
27 February 2023: Buying a Business: The Term Sheet
Buying a business can be a complicated and arduous process.
Although we generally work for the seller, when a buyer approaches us about a business we’re offering, we often find that the buyer needs our help. Many buyers are unrepresented by a professional business broker. Worse, some are represented by a real estate agent. In either case, they’ve got no one with knowledge of the process advising them.
In such instances, we try to guide them through that process always reminding them that, 1), we work for the seller, to whom we owe a fiduciary responsibility, and, 2), we owe an ethical responsibility to the buyer of honesty, fair dealing and the maintenance of confidentiality – to both sides. And in all cases, we urge a buyer to engage either a knowledgeable business broker or a transaction attorney.
But many buyers are convinced that they can do this themselves – and for part of the process, many of them are correct. But when it comes time to start the negotiating phase, we’ve found that most buyers, regardless of how confident they seem, are actually a bit uncomfortable.
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The beginning of negotiations is when things start getting reduced to writing. And it’s at this point that we usually hear something like this: “Can you write this up?”
How we handle this – and how we teach new brokers to handle this – is to advise the buyer to start off with a term sheet.
What is a Term Sheet?
Term sheets can be extremely helpful in clarifying and simplifying the starting point of the negotiations. They are short – maybe a couple of pages – and uncomplicated. From warranties and representations to default provisions and “drop-dead” dates, purchase agreements are generally chock full of boilerplate legalese, language that can be confusing and is not pertinent to this early stage of the acquisition.
A term sheet is a document whose purpose is to outline the general terms and conditions – what we refer to as the salient points – of an agreement. It’s generally used at the very beginning of the negotiations and functions as the basis from which the more detailed purchase agreement will be born.
A term sheet is rarely legally binding – though some provisions may be; notable examples are any provisions related to confidentiality. It’s a little more detailed than a letter of intent in that it outlines the terms and conditions, in basic language, that the parties agree to.
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As a rule, term sheets for the sale of a business will include details such as the purchase price, financing terms, the scope of due diligence, specific contingencies, any approvals required of authorities, dates by which various actions must be taken, anticipated closing date, etc.
When buying a business, some term sheets are more detailed then others. For example, when a business operates across borders, multiple jurisdictions may have to approve the sale, the buyers, the financing or some other provision of the transaction. Another example is when one or both of the parties wants to add details that might or might not be considered “salient”. But in our opinion, unless one of the parties becomes unreasonable, the more detail in the term sheet generally means less friction when developing the actual purchase documents.
Why Use a Term Sheet
By describing the salient details of the transaction – including price, terms, contingencies that must be met or removed, due diligence and closing date – a well-crafted term sheet provides clarity to all parties as to how they envision the transaction will be handled. This helps ensure that both parties have a clear understanding of their roles, duties and obligations, and lessens the chances of misunderstandings or disputes as the process unfolds.
Negotiating a term sheet can save both parties time and reduce legal costs by providing an efficient way to discuss and iron out the basic language meant to address the most important terms and conditions of the deal. Resolving these critical terms and conditions can significantly reduce legal fees associated with negotiations once the purchase documents are being drawn up.
A properly structured term sheet protects both parties. The due diligence period – during which the buyer will dive deeply into every aspect of the business – will involve the disclosure of the target company’s most valuable trade secrets. But the due diligence period allows, under certain condition, the buyer to walk away from the deal. The term sheet will address confidentiality as it pertains to the information the target company has shared.
In addition, exclusivity – sometimes referred to as “no shop” clauses – will usually be part of any purchase agreement. The terms of such a provisions should be spelled out clearly in the term sheet to avoid any misunderstanding on either side.
The Bottom Line
There are other benefits to using a term sheet in the acquisition of a business.
How will outdated inventory be handled? For tax considerations, how much of the purchase price will be allocated to assets (tangible and intangible) and how much to goodwill? Are there any proprietary assets or intellectual property that are critical to the business? If so, how the parties intend to value and transfer such property should be included.
The buyer would not unreasonably want to make sure that some conditions related to the conduct of the business and parties involved during the negotiation and due diligence process are part of the terms. This may include restrictions on the seller’s ability to take on new debt or make significant changes to the business while the buyer does its due diligence and before the final purchase documents are drawn up and signed.
Warranties given by the sellers and representations of both parties should be spelled out. Will the buyer assume any liabilities? If so, they should be detailed. Does the seller want the buyer to keep all the current employees – even his deadbeat kid – employed for a certain period of time? This is a very important point and one that, should it not be disclosed until three days before closing, could tank the deal in an eruption of acrimony and the sudden materialization of countless lawyers.
In short, term sheets serve to reduce friction between the parties once the actual purchase documents are being drawn up. Using a term sheet at the early stage of the negotiation generally benefits everyone involved.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at jo*@Wo*******************.com.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
We’ve been approached by a search fund with an interest in acquiring pest control businesses in North Carolina, Virginia, Maryland, South Carolina, Georgia, or Tennessee.
If any of you know of something that might fit, please let me know.
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 500 in the world. He can be reached at jo*@Wo*******************.com