A period of exclusivity is a common feature of mid-market deals, but why should you grant it to an acquirer or investor?
What does it mean?
Exclusivity is normally the quid-pro-quo for an acquirer or investor beginning to spend serious money in due diligence and legal fees. By granting them a period of exclusivity, you reassure them that you’re not going to allow them to incur extensive costs, then go off to do a deal with someone else.
During the exclusivity period, you commit not to engage with any other actual or potential acquirer/investor, and not to solicit further interest from any one either.
Are there alternatives?
Although a period of exclusivity is the norm in the mid-market, there are exceptions – depending on the process, you might be able to run two or more acquirers/investors in parallel right down to the line, or might be able to use a cost underwrite (agreeing to pay the aborted deal costs of an under-bidder) to achieve a similar outcome.
But most acquirers or investors in most circumstances won’t feel comfortable unless they’ve been granted a reasonable period of exclusivity.
When should I grant it?
Exclusivity is normally granted at the point you agree the headline terms of a deal – either in a negotiated LOI or in heads of terms.
Up to this point, the acquirer/investor probably hasn’t incurred very much cost in agreeing the deal. After all, all they’ve had to do is review the information you’ve given them, brainstorm some synergies, perhaps informally sound out their own advisers (lawyers, accountants, bankers) for some free advice as to how to approach the transaction, and negotiate with you. So far, no invoice.
But once you’ve agreed heads of terms or an LOI, and you move in to the due diligence and legal phases, the acquirer’s costs start to mount very quickly. They need to engage financial, legal, technical, insurance, tech and commercial due diligence specialists to review much more detailed information on the business. They will also have their lawyers begin spending significant time drafting the final legal agreements.
Timing is Everything
So they want to know that you won’t allow them to rack up significant costs, then ditch them and do a deal with someone else. But agreeing exclusivity allows the balance of power to shift towards an acquirer or investor – at this point, there is no competitive tension because the acquirer/investor is no longer competing with the other participants in the process – you’ve agreed only to deal with them. So if they’re going to get nasty, this is probably when they will, and you don’t want to tie your hands for too long.
How long should it be?
What counts as a reasonable exclusivity period? A month would be considered short, three months a little leisurely, and two is roughly normal.
One way to maintain a degree of control, and prevent the balance of power shifting too far, is to make the continuation of exclusivity conditional on the acquirer/investor achieving certain milestones. While they’re never perfect, and a wily acquirer/investor can game the system if they really want to, you can have exclusivity fall away if, for example, due diligence isn’t finished and draft reports circulated by a certain date, or first-draft legal documents sent over to your lawyers to review.
What happens when it expires and the deal isn’t done? Should I renew or extend it?
In general, you are probably going to extend exclusivity, especially if it expires but everyone has been working pretty hard to keep things moving forward. Deals often take longer than expected and it isn’t necessarily anyone’s fault.
In this kind of no-blame situation (where no one has been deliberately going slow), if you refuse to extend exclusivity the acquirer/investor is probably going to ‘down tools’ – stop doing any work, and tell all their advisers to stop doing any work as well. This brings the whole process to a halt, and the only way to get it moving again will be to extend or renew exclusivity.
It’s normally better to avoid this kind of show-down, as the only way out is for you to back down. Better to make a virtue of a necessity, and volunteer a limited extension – perhaps week by week, conditional on further key milestones or real progress towards an agreed completion date.
If you’ve been abiding by exclusivity, and went with the best deal on the table in the first place, you aren’t necessarily giving much away by doing this. You probably don’t want to go back to square one with an underbidder and start the whole negotiation process again, or go back to the beginning of due diligence and a pick up a blank piece of paper on the legals. Better to push on and get the deal done.
But don’t let them push you around
But sometimes an acquirer/investor will drag their heels or demonstrate that they lack any intent to get the deal over the line in a sensible timeframe. This sometimes occurs when they believe that you have no alternative to doing the deal with them.
In this situation, don’t let yourself be hamstrung by exclusivity. Terminate it or allow it to lapse, tell your counterpart why, and re-inject some (actual or perceived) competitive tension. This might just be the shock they need to get on with it and complete the deal.