When selling a privately-held company, at some point in the deal process you will have to enter an exclusivity or “no shop” period. At this stage in the process, you’ve narrowed down your buyer pool to the most attractive buyer and have signed a letter of intent.
During the exclusivity period, you agree not to carry out further talks with other interested parties. This gives the buyer time to carry out due diligence and complete all the necessary legalities that go into purchasing a business.
The due diligence process is time consuming and expensive for a buyer, so exclusivity provides a good sense of assurance that you are moving forward with them. I’ve seen some smaller deals go to closing without exclusivity, but once you’re in the lower middle market there’s too much cost involved for buyers to proceed without it.
Giving exclusivity can be scary because you’re basically turning your back on other buyers for a period of time. At this point, you’re facing two risks: One, the buyer will back out and you’ll be back to the starting point. Two, the buyer will try to re-trade the deal, changing purchase price or other terms.
If you enter into exclusivity and the deal falls through, you lose a lot of ground in the sale process. Other interested buyers may have moved on to other deal opportunities. And some may be put off by not being your first choice.
Here are some of the tricks and tips we’ve learned over the years to protect your interests and lower risk at this time:
First, make sure you’re looking at more than the purchase price. You want a buyer who fits your vision and company culture. If either of these isn’t a good fit, it could be the reason the deal blows up.
You also want to vet your buyer’s financial wherewithal and general integrity as much as possible. You might secure a letter from their lender, indicating they’re authorized to do the deal, for example.
If you’re working with a private equity firm or strategic buyer who has made multiple past acquisitions, you can ask for references from past sellers. Talk to those former business owners and find out if your buyer does what they say they’re going to do. Did they close on time? Were they fair? How was the post-sale transition?
Try to negotiate as many elements of the deal as possible into the letter of intent (LOI). Some people believe a LOI should simply cover the basics, leaving the details for later in the process. But that approach is ripe for misplaced assumptions and misunderstandings.
Outline deal structure and get specific about the working capital target. This is a key area of disagreement, so beware of entering into a vague agreement suggesting the working capital formula “will be mutually agreed upon by both parties.”
As for the exclusivity period, try to keep it as short as reasonably possible. We generally aim for 60 days or less with a good faith renewal clause of 15 to 30 days.
Some buyer groups will come in asking for 90 to 100 days of exclusivity. Generally, you don’t really need that much time if everyone is going to make the deal a priority, use specialists, and work to close.
Shrewd (unethical) buyers will ask for an extended due diligence period and then drag the deal out. They know that the longer they extend due diligence, the further away you are from Plan B. They might even be hoping to push you toward burnout, knowing they’ll be able to renegotiate the purchase price if your sales start to decline.
To keep the due diligence period at 60 days or less, start with an all-hands-on-deck meeting. Get all key players in a room and get everyone to buy-in to a deal timeline and expectations. Then assign a deal coordinator to track schedules and hold everyone accountable.
Another strategy to reduce the exclusivity period is to conduct “reverse due diligence.” Basically, this means your own advisor team conducts due diligence up front, before you go to market. If you know what might concern a buyer, you can present the deal accordingly. Or you can hit the pause button, fix the issue, and go to market with a cleaner company.
Entering into exclusivity is a scary process. As a seller, you will naturally lose some leverage at this time. But if you prepare ahead of time and do your own due diligence on the buyer, you can significantly minimize the risk.
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