Exclusivity Agreements: When and How to Use Them

A recent DealBook email questioned the utility of exclusivity agreements for M&A discussions against the dramatic backdrop of Skydance's exclusivity expiring for its Paramount bid.

Many large public companies are sold without exclusivity, as shareholders expect to get the best price. In fact, those deals often feature the opposite of a no shop, particularly if the company hasn't run an auction process: After signing the purchase agreement, the target may even have a "go-shop" period that is subject to a lower termination fee if a better offer is obtained within the timeframe.

The story is different, and rightfully so, for M&A deals involving private company targets. There are a number of reasons for that:

Buyers want some indication that the seller is serious about a transaction prior to incurring significant diligence costs.

In the absence of SEC filings and audited financials, diligence for private companies can be more in depth in some instances than for their public counterparts.

Similarly, diligence and legal expenses can be higher for private companies relative to deal size.

M&A transactions with private company targets receive less publicity prior to closing and don't have to announce transactions via 8-K filings, making it less likely that a superior proposal will emerge, implicating directors' fiduciary duties to their shareholders.

Given the foregoing, buyers and sellers of private companies should both expect no shops to be part of transactions and they are indeed a typical deal feature. There are some nuances to pay attention to, though, which we'll dive into below.

In the beginning, we discussed that no shops should be expected in private company transitions. That's not the end of the discussion, though. Before moving forward with a particular bidder, sellers need to understand that exclusivity will alter deal dynamics going forward.

By granting exclusivity, the seller cedes some negotiating leverage, as the seller cannot use competition to drive better terms with the current suitor.

A buyer with exclusivity will feel more secure in its position, which can lead to re-trades.

If the deal does not conclude or a definitive agreement isn't signed by the end of the exclusivity period, sellers often continue to negotiate with the same buyer because of the sunk costs (legal, distraction of diligence, etc.) and inertia moving forward with the current buyer. Particularly with a sign-and-close transaction, buyers sometimes dawdle, knowing the seller doesn't want to have to start the process over.

With the above factors in mind, what should a seller do to mitigate the negative consequences of exclusivity?

1) Sellers should take a cue from savvy buyers and insist on LOIs that set forth as many key deal and legal terms as possible. Kicking the can down the road can elongate the process with a buyer that turns out not to be a fit, and that can make it harder for a seller to walk away. A skeletal LOI can also encourage buyers to take atypical stances on omitted terms in the definitive documents. If the buyer is going to re-trade, force her to do so explicitly.

2) If the deal isn't right, the seller should walk. This can be tough after what can be months of legal negotiations and diligence, but the hard call is often the right one.

Continuing on exclusivity / no-shop provisions, let's turn to the meat and discuss some key terms

Initial Exclusivity Period: Usually, the time period lasts from 30-90 days and is intended to afford the buyer the opportunity to conduct sufficient diligence to sign a binding purchase agreement. If the purchase agreement will use a simultaneous sign-and-close or won't include a diligence out so that the buyer can get out of the deal if she uncovers red flags, the period should be longer (taking into account extensions); if the purchase agreement has a diligence out, the period can be shorter because there will be time for additional diligence post-signing.

Unsurprisingly, LOIs with shorter no shops are favored by sellers. Buyers often use short exclusivity periods to make their offers more compelling, but they do need sufficient time to conduct financial and other key due diligence. It's a balance. Sellers should understand that a buyer's proposed period may be unrealistic, and the buyer may be guessing that the momentum of the deal and sunk costs will get the seller to extend the period when needed.

Extensions: Typically, buyers will build in automatic extensions so long as the buyer is continuing to negotiate in good faith. These should be subject to cap. For example, 30 days without the consent of the seller.

Price Confirmation: Sellers often add provisions that terminate exclusivity if the buyer does not confirm the purchase price and/or other key terms upon the seller's request or if the buyer attempts to renegotiate.

Prohibited Actions: During the exclusivity period, sellers are typically prohibited from continuing to market the business for sale and from entertaining other offers.

Some sellers may attempt to push to be allowed to continue marketing the business and take back-up offers. That should be rejected by buyers.

For Main Street deals, it takes brokers minutes to turn off listings on BizBuySell and elsewhere. For upmarket deals, the banker simply stops reaching out to new buyer targets. In either case, it's pretty simple.

The ability to take back-up offers effectively negates exclusivity during the LOI stage. Remember, the LOI isn't binding, so if a better back-up offer comes in, the seller can simply let the exclusivity period and LOI expire.

Notice: Sometimes, buyers will add provisions requiring the seller to inform the buyer if it receives inquiries during the notice period. These can be new, unsolicited inquiries or inquiries from prior suitors attempting to re-engage.

There are additional nuances to exclusivity, but those are the basics to keep in mind when assessing no shops.