The Art of the Deal Sheet: 10 Key Negotiation Points
Deal sheets, terms sheets, heads of agreements, letters of intent, memorandums of understanding, deal memos – whatever you call them, these typically short and simple documents play a vital role in the direction and outcome of a corporate transaction.
From our experience, when negotiating a potential deal and putting together a terms sheet for the transaction, the following 10 items should help to ensure a smoother and more robust process during the sale negotiations.
All too often the parties to a transaction get caught up in the excitement of closing a deal that they overlook key structuring decisions.Whether a transaction is structured as an asset sale or share sale can have significant tax and risk implications. The proposed purchase price should take into account the potential tax liabilities and other risks arising out of a particular structure, so it is important to link the proposed price to the deal structure (and seek appropriate tax advice).
How and when the purchase price is to be paid, whether it comprises cash and/or shares, whether a deposit is required, whether there is an earn-out involved (and the parameters for calculating it) and what adjustments (if any) there will be to the purchase price (eg for outstanding liabilities of the business and accrued employee entitlements) need to be carefully considered and articulated in the terms sheet.
3. Due diligence
The extent of any financial, legal or other due diligence and the process for it should also be agreed early, including what categories of documents are to be disclosed, how long information will be available to be accessed and what staff will be available to respond to questions raised during the due diligence process. There is no one-size-fits-all approach to due diligence – the size and structure of a proposed transaction and the target business will determine what is appropriate in the circumstances.
It is not uncommon to find parties address this important point with a throw-away line that the documentation will include warranties ‘of the kind usually found in a transaction such as this’. Unfortunately this may not adequately protect your interests and is open to interpretation (and costly disagreement) when it comes time to prepare the documentation. If there is a specific matter or factual position that you need certainty on, make it clear that a warranty or indemnity supporting this position will need to be provided.
Restraints and non-compete provisions often play a major role in protecting the value of a business. An astute purchaser will want the terms sheet to expressly state the extent, location and duration of any restraints / non-compete provisions that their offer is based on, whilst a seller should also want certainty on this as the price they are willing to accept for the proposed transaction may be affected by the restrictions they will be subject to following completion.
6. Intellectual property
Identifying precisely what intellectual property forms part of a proposed transaction and where it lies is a vital discussion point. If a technology platform or computer software is key to the viability and/or value of a business, ensuring the seller validly holds the intellectual property or has robust licence agreements in place ensures its value to the business is able to be protected and transferred.
People are often the most valuable asset of a business, particularly service-based businesses. Depending on which side of the transaction you sit, you may need to specify in the terms sheet which employees (if any) are vital to the business and how the parties plan to keep these employees committed to the business moving forward.
8. Conditions precedent / post-completion obligations
If there are certain things which need to occur before the transaction can complete these should be clearly expressed in the terms sheet. For example, you might need to obtain the consent of a third party to the transfer of a key contract or obtain regulatory approvals.The amount of working capital to be left in the business and pre-completion dividends from the target company to the seller (common areas of disputes) should also be discussed. Similarly, any post-completion obligations you wish to impose on the other party (such as any post-completion adjustments and any transitional arrangements for integration) should also be included to avoid these potentially becoming ‘deal-breakers’ when the transaction documents are being prepared.
9. Transaction documents
Once the key terms are agreed, you should then turn your mind to the documentation which will be required to effect the transaction and who will be responsible for drafting these documents. One all-encompassing agreement might seem like a logical choice, but it might be preferable to separate elements of the transaction into discreet documents for legal, accounting or registration purposes. The party preparing the documents tends to have greater control over the direction of the transaction and is also often best placed to contain costs.
10. Binding or non-binding
A critical but often overlooked aspect of terms sheets is whether the parties intend for them to be legally binding. If a proposed transaction is subject to the parties entering into formal legal documentation, this must be clear in the terms sheet. If it is not, the parties may inadvertently commit themselves to completing the transaction just by signing the terms sheet. It is common for only some parts of the terms sheet to be legally binding (eg confidentiality and exclusivity) and the rest to be subject to formal legal documentation.
By addressing the above points during the initial deal negotiations you should be able to save considerable time, expense and aggravation over the course of the transaction. The key deal terms may extend beyond the above 10 points, so you should always seek appropriate advice to ensure the terms sheet is tailored towards your specific needs.