Selling your business will be complicated, emotional and, almost definitely, stressful. Once you decide to sell your business, the first step is usually hiring an intermediary – either a business broker or an investment banker. The intermediary will ask you to enter into an engagement agreement. This person is working for you and with you, so sellers frequently choose not to have a mergers and acquisitions attorney review the engagement agreement before signing it. Besides, you may think, what could go wrong? Plenty! To avoid uncertainty while ensuring a clear understanding of the specific terms you are committing to, at what cost, and for how long, hire an M&A attorney to review the engagement agreement.
Here are some deal points to keep in mind when entering into engagement agreements with intermediaries:
The agreement should provide a reasonable period of time for the intermediary to prepare a confidential information memorandum and market your business. This is known as the exclusivity period. The exclusivity period should be an amount of time that you and the intermediary believe is reasonably sufficient to market your business and close a deal; however, there should be a defined end point. A defined termination date will guide and incentivize the intermediary and create an orderly exit from the relationship with the intermediary.
The termination rights in the agreement should specifically address who can terminate whom, and under what circumstances. It is not fair, for example, for the intermediary to have broad discretion in terminating the agreement, while you remain bound until the exclusivity period ends. The circumstances that can trigger a termination and the ramifications of termination should be clearly set out in the agreement.
The agreement may require a retainer, which can either be a one-time payment or periodic payments to the intermediary in exchange for securing its services. Ideally, the retainer payment(s) will be offset against the intermediary’s ultimate commission (generally referred to as a success fee) earned at the close of the deal. While the amount of the retainer is important, the period of time over which payments are made is a crucially important factor in this business relationship. If the intermediary is guaranteed to receive numerous retainer payments throughout the duration of the exclusivity period (or even indefinitely, until either party terminates the agreement), then the intermediary has far less incentive to broker a deal as expeditiously as possible.
Both the timing of payment and definition of “transaction value” are important terms in the agreement that can significantly impact your financial obligations when the deal closes. For example, a contract term requiring the full commission to be paid upon closing could result in a major out of pocket payment if you do not receive the entire purchase price up front. Often times, the purchase price is comprised of cash plus a promissory note made in favor of the seller (referred to as “the seller taking back paper”). If you take back “paper” and pay the intermediary at closing on the full transaction value, you might not walk away from the table with cash; rather, you might have to dig into your own pocket to cover all of the closing costs. Note that purchase price and transaction value are not necessarily the same. Purchase price is what you are to receive as consideration for the sale. Transaction value is comprised of the purchase price plus the buyer’s assumption of certain liabilities as well as other items. It is crucial to take particular care when defining these terms in order to avoid unanticipated obligations later on in the business relationship.
Finally, pay particular attention to the tail period, which entitles the intermediary the right to receive a commission on deals entered into after the engagement agreement has been terminated, usually contingent on the transacting parties having been introduced by the intermediary. The purpose of the tail is generally to ensure that the seller does not have the ability to cut the intermediary out of the deal once the buyer is identified. Bear in mind that a term like “introduced” can be very broadly interpreted. A simple mention of the ultimate buyer in a communication between the intermediary and the seller could be considered an “introduction.” It is generally best to narrowly define what may trigger a tail period commission, if any at all, by tailoring terms that require a more credible or tangible introduction between the ultimate buyer and seller.
Remember, what could go wrong?
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