May 25, 2021
We are excited to focus today’s episode on the final phase of
our unique 16-week sales process.
Today we are focused on phase four: exclusivity/documentation.
We invite you to listen to episode 001 for more information about phase one (pre-marketing), episode 002 for more information about phase two (go to market), and episode 0016 for more information about management meetings: https://www.coladv.com/podcasts/002/
Other episodes dive deep into technical aspects and tactics used in middle market and mergers and acquisitions. We also invite you to download our 16-week sales process timeline for more information on how Colonnade Advisors typically approaches the process of selling a company: https://coladv.com/wp-content/uploads/Four-Phases-with-graphic.pdf
In our deep-dive discussion on exclusivity/documentation, the word “scary” comes up quite a few times. Rather than being scary from a horror film or haunted house, this scary is more like cold feet before a wedding.
That’s because exclusivity/documentation is when you pick your
partner and take a leap of faith with a single buyer.
You’ll learn that in this phase of the sales process, we are not
yet on the homestretch. In fact, our discussion unveils the many
challenges of this phase of the sales process that must be
simultaneously and actively managed.
You’ll hear that this phase of the sales process almost feels like a crescendo.
Our job at Colonnade is to manage this increasing set of
workstreams and pull off a successfully closed deal. Then, as
you’ll hear in the podcast episode, it’s time to celebrate.
Key topics covered in this episode:
• Preparing for the shift of power from seller to buyer
• The importance of the letter of intent ("LOI") negotiations
• How to select the winner (while keeping others warm in the
background)
• Who’s involved during the exclusivity/documentation phase
• How long the process takes, and how much it costs
• Pitfalls that we have encountered during this phase and how
Colonnade mitigates these risks with our clients
What is the exclusivity and documentation phase, and how do you get up to this point? (01:07)
Gina: "This phase occurs when a seller is exclusive with a
single buyer—we have received several bids and determined the
winner. Both parties sign an LOI at this phase, and the seller
agrees not to provide information or engage with any other
potential buyers. The seller is essentially going off the market,
which can be a bit scary because if the deal does not move forward
with the exclusive buyer for some reason, then we will have to go
back to the other bidders."
What tasks need to be completed during the exclusivity and
documentation phase? (02:11)
Gina: "During exclusivity and documentation phase, we work through
the confirmatory due diligence, which often involves a buy-side
quality of earnings report. Also, during this period, we negotiate,
finalize and execute the definitive purchase agreements and work
through any related regulatory tasks to close."
Is it possible for sellers to go through the exclusivity and
documentation phase with multiple potential buyers? (03:18)
Jeff: "In large transactions, it is possible to run multiple
parties through this phase, but it typically does not happen in
middle market deals.”
What is the importance of the letter of intent (LOI) negotiations?
(04:13)
Jeff: "LOI negotiation is critical because we want to nail down all
the topics that we think are going to be critical in negotiation
and final documentation before we commit to one party. Hammering
out these key topics ahead of time also expedites the process."
Is the highest price generally selected as the winner? (05:05)
Jeff: "Business owners do not always pick the highest price. It is
also about picking the best terms."
Listen to Colonnade’s podcast episode 007: Striking a Deal: Price &
Terms: https://www.coladv.com/podcasts/007/
Once a seller is exclusive with a buyer, is there a backup plan if
the deal falls apart? (05:15)
Jeff: "We keep the non-winning bidders warm and engaged in a
limited fashion to make sure that we have backups if the deal falls
apart.”
How do you assess the certainty to close a deal? (06:30)
Jeff: "Assessing the certainty to close comes from years of
experience working with buyers and thinking through key items such
as where is the capital coming from, what their acquisition history
is and how likely they are to close on the terms that we have
outlined."
Are there particular buyer types that are more problematic in terms
of the certainty to close? (06:35)
Gina: "One group that has caused us problems with the certainty of
close in the past is search funds or unfunded sponsors, which are
private equity investors that do not have a dedicated fund. These
funds tend to bid the highest prices, which is appealing, but they
will still need to raise the capital once in exclusivity from
institutional investors. Those institutional investors will want to
do their diligence, almost restarting the deal process, which
creates more risk of the deal not getting done."
Jeff: "About ten years ago, family offices were also in this
category to some degree. Family offices had smaller dedicated
investment teams, so the certainty of closing was considerably
lower than traditional private equity firms or a strategic buyer.
But that has changed over the last decade where family offices have
shifted to become credible buyers."
How long does it take to get from signing the LOI to closing?
(08:45)
Gina: "We generally put 30 to 45 days in the LOI with a provision
that both parties can extend the period of exclusivity by mutual
written consent based on putting forth best efforts. The time to
close depends on the industry. For example, some industries may
need regulatory approval or use complex accounting methodologies,
which would require more time."
What are the components of confirmatory diligence, and how are
these workstreams sequenced? (10:06)
Jeff: "There is HR, accounting tax compliance, regulatory, legal,
IT, and others. Running these workstreams in parallel is key
because it is the easiest way to minimize time to close, but you
cannot get to the legal documentation until all these other
workstreams are completed."
At what point do you expect the first turn of the purchase
agreement from the buyer? (12:30)
Gina: "Pushing to get that first turn of the purchase agreement is
very important. We frequently put the purchase agreement in the
data room before the LOI, and we expect a markup of it along with
the LOI or an issues list, which will help expedite the
process.”
Who pays for the costs associated with confirmatory diligence and
documentation? (13:38)
Gina: "The seller pays for the seller's costs, and the buyers pay
for the buyer's cost."
Jeff: "In the context of a rollover deal, where the company is
getting bought by a sponsor, the surviving entity ends up absorbing
costs from both sides."
What are the typical costs incurred during this phase for sellers
and buyers? (14:31)
Gina: "The seller can expect to pay for tax counsel or tax
accountants if there is tax work to be done, an attorney to assist
with negotiating terms, a tax lawyer, and other types of counsels.
Buyers can expect to encounter legal fees, accounting fees,
consulting fees, IT, technology consulting, and HR consulting."
How much does this phase cost for both the sellers and buyers?
(14:31)
Gina: "Ballpark is anywhere from $75,000 to a couple hundred
thousand for a seller. On the buyer's side, a couple hundred
thousand easily on diligence for a middle market transaction that's
valued $75 to $125 million.”
From the seller's side, who is typically involved during the
confirmatory diligence phase? (15:55)
Gina: "Confirmatory diligence is a big undertaking, and sometimes
the knowledge level about the company needs to go beyond the deal
team that has been involved to date. At this stage, other people in
the company may need to be made aware of the transaction (e.g.
sales management, IT, HR, etc.), which can be tricky."
What types of issues generally come up in employment contract
discussions? (18:57)
Gina: "One issue that comes up is pay, which we manage by building
out expected compensation levels in the financial model. The second
issue is the bonus structure, and the third is vacation. The most
important issue that comes up is non-compete, who gets one and what
the terms are."
Which employees will generally be subject to non-competes?
(19:25)
Jeff: "There is usually a non-compete for selling shareholders that
will be getting proceeds from the deal and non-equity participants
that are key to the ongoing entity.”
What are the risks associated with employment agreements and
non-competes, and how do you mitigate these risks? (20:52)
Jeff: "The risk with non-equity participants that are key to the
business is that they could choose not to go with the new buyer for
whatever reason. This can result in a domino effect from a price
change to the deal not happening at all. One tactic that we use is
to encourage our seller clients to put in place some type of
transaction and retention bonus."
Gina: "When Colonnade is working on a transaction, we ask a lot of
questions upfront. We will often ask who has employment agreements
and what are the terms of those agreements. For business owners
that are thinking about selling in a few years, they should be
thinking about who their key employees are and how to get them
under employment agreements now."
What are the different types of employee bonus plans associated
with a sale? (23:17)
Jeff: "One is transaction bonuses which are for employees who are
essentially doing two jobs during the deal process. The second is
the retention bonuses that ensure employees are not going to leave
when the deal closes."
What is Hart Scott Rodino ("HSR"), and how does it impact the
transaction? (23:59)
Gina: "HSR is one type of regulatory approval that might be needed
to close a deal. HSR applies to companies of a certain size, which
will need to be approved by the government for anti-trust
reasons.”
Jeff: "The amount increases every year, but HSR impacts
transactions roughly around $80 million in transaction value. There
is a filing fee, and it is about a 30-day process.”
How long does it typically take from signing the legal documents to
closing? Who owns the company during this period? (26:13)
Jeff: "It can be 30 days or longer, depending on the different
types of approvals. For financial services deals where there is
generally regulatory approval, it is often 30 or 60 days. During
this period, the seller and buyer essentially both own the
company."
Can sellers request a break fee if the deal does not close?
(27:00)
Gina: "In highly competitive, larger transactions, there will be
break fees, but in middle market M&A, it's highly unusual to
have a break fee. That is because there is not enough diligence
that has been done before the signing of the LOI. Without all the
information, it is unlikely that buyers will agree to a break fee
because they may find out many things during confirmatory
diligence."
What are typical pitfalls encountered during the
exclusivity/documentation phase? How does Colonnade mitigate these
risks with seller clients? (28:58)
Gina: "One is indemnification, which reps and warranties insurance
can mitigate.”
Listen to Colonnade’s podcast episode 010: Escaping escrow: Reps &
Warranty Insurance: https://www.coladv.com/podcasts/010/
Jeff: "Another pitfall that we have seen involves who owns the
intellectual property. To mitigate this risk, we address this issue
early in diligence.”
Gina: “Another is when the buyers want to speak with the seller
company’s top clients. We try to delay that conversation until as
late as possible in the process. We want to get to the point where
we feel comfortable that we have covered all the major issues, and
we're likely to close."
Jeff: “The last pitfall that comes to mind is tax, where two
parties can have a different view on tax regulations in a given
jurisdiction. Our job is to push things forward and cut through all
the issues as quickly and efficiently as we can.”
What dynamics are typically in play right before a deal closes?
(39:02)
Jeff: “What I find is when people are the angriest and they're
about to throw up their hands, that's when we know we've got a
deal, it's sort of where everyone's been pushed to their limits.
Everyone's had to give and take, and they're just about ready to
walk away, and then the deal signs.”
Gina: “And then we celebrate.”
Host Information
Gina Cocking
Gina Cocking serves as the Chief Executive Officer of Colonnade
Advisors. She returned to Colonnade as a Managing Director in 2014.
Gina began her career in investment banking at Kidder Peabody, was
an analyst at Madison Dearborn Partners, and an associate at J.P.
Morgan & Co. She was a Vice President at Colonnade Advisors from
1999 to 2003. She left Colonnade to gain operating experience as
the Chief Financial Officer of Cobalt Finance, a specialty finance
company. She went on to become the Chief Financial Officer of
Healthcare Laundry Systems, a private equity-backed company for
which she oversaw the successful sale to a strategic acquirer. Gina
served as the Line of Business CFO – Consumer Banking and Lending
at Discover Financial Services. Gina serves on the Board of
Directors of CIB Marine Bancshares, Inc., a bank holding company
based in Brookfield, Wisconsin, that operates banking offices in
Illinois, Indiana, and Wisconsin. Gina received her BA in Economics
and an MBA from the University of Chicago. Additionally, Gina holds
the Series 24, 28, 79, and 99 securities licenses.
Jeff Guylay
Jeff Guylay is a Managing Director of Colonnade Advisors. Prior to
joining Colonnade in 2000, Jeff was an investment banker at J.P.
Morgan in the firm's Mergers & Acquisitions and Fixed Income
Capital Markets groups in New York. He also spent several years in
J.P. Morgan's Chicago office. Jeff has over 20 years of M&A and
investment banking experience and has served as lead execution
partner on over 25 M&A and financing transactions at Colonnade.
Jeff received an MBA from Northwestern University's Kellogg
Graduate School of Management and a Master of Engineering
Management from the University's McCormick School of Engineering.
Jeff received a BA from Dartmouth College and a BE from Dartmouth's
Thayer School of Engineering. Jeff holds the Series 7, 24, 63, and
79 securities licenses. Jeff serves as a director of the non-profit
Nurture, an organization dedicated to enhancing the nutrition and
wellness of children and families.
About the Middle Market Mergers & Acquisitions Podcast
Get the insiders' take on mergers and acquisitions. M&A
investment bankers Gina Cocking and Jeff Guylay of Colonnade
Advisors discuss the technical aspects of and tactics used in
middle market deals. This podcast offers actionable advice and
strategies for selling your company and is aimed at owners of
middle market companies in the financial services and business
services sectors. Middle market companies are generally valued
between $20 million and $500 million.