Dr McDeal title Exclusivity: are you in or out?

So what is exclusivity?

It is a legally binding commitment given by the potential seller of a business to an acquirer not to deal with competing bidders for an agreed period of time. A vendor generally agrees not to: continue any ongoing discussions with rival bidders; solicit or procure, directly or indirectly, competing offers for the business; respond to any unsolicited approaches or offers; or disclose any information about the business to a third party.

Why should I give it?

Most purchasers insist that you grant them a period of exclusivity before starting their due diligence investigations into your company. There are two reasons for this. Firstly, they want breathing space to complete the acquisition without worrying about competing bidders. Secondly, due diligence is an expensive exercise, regularly costing purchasers more than £250,000 in fees. This represents a significant risk for the purchaser, so in return it expects a commitment from the seller not to negotiate an alternative deal with rival acquirers.

What about a non-refundable deposit?

Buying a business is not like buying a house, where the purchaser typically has to put down a 10 per cent deposit that it may sacrifice if it does not complete the purchase. There are very few examples of acquirers making a non-refundable deposit to secure exclusivity. I can think of only two instances in 300 completed deals where this has been achieved and in both instances the purchaser was a direct competitor of the business being bought. In these cases, the acquirers would have presented a serious threat if, having completed their due diligence, they had then walked away armed with the benefit of a unique and detailed insight into a rival’s operations. While on the one hand, ‘if you don’t ask, you don’t get’, you need to recognise that it is unlikely you will be able to secure a deposit. Even if you do, the terms of any refund are likely to be fairly restrictive. For example, if the purchaser’s due diligence discovers a material and previously undisclosed problem in the business, they will insist on walking away with their deposit back in their pocket.

When should I grant it?

Most experienced purchasers seek exclusivity as early as possible – even before they have made an indicative offer for the business - in order to ‘lock out’ any competition. But vendors are usually savvy enough to realise that they will draw no advantage from granting exclusivity so early. There is nothing like healthy competition between rival bidders to enhance your company’s valuation. Generally you should only grant exclusivity after an acceptable offer has been received and the major features of a deal negotiated and agreed. This milestone is often marked by the buyer and seller signing a heads of agreement (sometimes called a letter of intent) setting out the commercial terms of the deal and a timetable for its completion.

What period of exclusivity is reasonable?

The nature of an individual deal will influence how long it will take to close and therefore what a reasonable exclusivity period will be. The complexity of the business to be acquired, its geographic spread and whether the purchaser needs to raise funds will all have a bearing. In the glory days of 2001, deals could take as little as four weeks to complete from signing heads of agreement, whereas in the dog days of 2002 the same deal could have taken up to 12 weeks. A reasonable exclusivity period for a ‘typical’ deal in the current climate might be around six weeks for a trade sale and up to eight weeks for a management buy-out.

How should exclusivity be structured?

It is often not appropriate for a seller to grant a simple six-toeight week exclusivity period. Increasingly, it makes sense for exclusivity to be linked to the progress achieved during the due diligence and legal phases of the sale. It may therefore be sensible to insist on a review meeting after the financial due diligence has been completed (say, after four weeks). At this point the acquirer must confirm that no serious issues have arisen that would put the agreed deal at risk. If this confirmation is forthcoming, a further two to four weeks’ exclusivity may be granted; if not, the parties can deal with the issue before moving ahead or alternatively

What if I receive an approach?

Exclusivity operates on two levels: what the specific, legally binding terms of exclusivity in the heads of agreement say but also what has been agreed in the spirit of the transaction. Sloppily drafted exclusivity clauses may well give a seller some ‘wriggle room’ to discuss a deal with other purchasers. A frequent oversight is where exclusivity prevents the seller from proactively seeking rival bids but fails to anticipate offers being received ‘passively’. If you
receive an unsolicited offer while bound by exclusivity the best advice is to either ‘park it’ until you are legally free to pick up the conversation or, if the new offer is much more attractive, to come clean with your first bidder and seek to lapse exclusivity on the basis that you have decided against selling to it anyway. Whatever the specific terms of the exclusivity clause, there is clearly a moral obligation on a vendor to be above board with their acquirer.

What if I breach an exclusivity agreement?

Always talk to your lawyer if there is a risk of your breaching exclusivity, as very exclusivity arrangement is different. Very few clauses specify penalties in the event of a breach, which means that contract law will determine the outcome. Generally, a purchaser will have to demonstrate that it has suffered actual loss as a result of the breach. The loss of the opportunity to acquire the business probably does not count, as a seller is under no obligation to sell to an acquirer until the deal is legally completed. However, the purchaser may have incurred significant professional fees and this is the seller’s main financial exposure. The likely cost of reimbursing the purchaser for these fees needs to be balanced against the terms of the rival offer. Needless to say, it is best to avoid the courts and pursue a negotiated settlement if a breach occurs.