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- [00:02]
A
Welcome to the Path to Exit, a podcast to help software and Internet founders understand the process to raise capital or sell their business.
- [00:20]
B
Hello and welcome, everyone. I'm Mike Lyon, founder and managing director of VistaPoint Advisors, and this is the Path to Exit. This show is dedicated to helping founders of software and Internet businesses understand what it takes to raise capital or sell their business and how to do it well. My guest today is Jeff Bean, managing director at VistaPoint Advisors. In this episode, we'll discuss why buyers push for exclusivity and how to approach it so you maintain leverage in the negotiations. Jeff, welcome back to the podcast.
- [00:46]
C
Great to be back.
- [00:47]
B
Let's get started and just simply talk about what is exclusivity. I think founders sometimes think of this as a given. They get an IOI or an LOI and the buyer asks for 30, 45, 60 days of exclusivity. And they assume it's just a given part of the process, but maybe talk about what it is.
- [01:03]
C
So in its simplest form, exclusivity is a period of time where, as the seller, you agree to not engage with other buyers. Buyers will ask for exclusivity, typically in an IOI or an LOI, or term sheet. We think of LOI and term sheet as pretty interchangeable. There'll be a period in there of days. Those periods you mentioned, 30, 60, 45 days. And some degree or definition of what that means in terms of, like, you can't talk to these parties. If you get interest from another party or an offer, you might have to share those. So it's actually one of the few binding points within an loi. So everything else in an LOI are things that are really important, right? Valuation, key business terms. None of those are really binding. The exclusivity period is. And so it's a very important piece of the negotiation.
- [01:49]
B
I feel like founders think of this as like a smaller detail when they get a bid, right? They obviously look at the valuation and the structure and all that. But really, this discussion around exclusivity, whether you give it or not, how long you give is actually really the negotiation behind the negotiation, and it's really a discussion in leverage. So, for example, if the seller has a ton of interested buyers that are moving really quickly and doing a lot of diligence, they're either not going to give exclusivity or give a very brief window with a lot of outs. If you give 60 to 90 days of exclusivity to a buyer, what you've communicated is that this was probably a process of one and you have no leverage. This truly sets you up for everything that happens following the LOI or term sheet or ioi, whatever you're talking about. It's really one of the most important things you can negotiate. And how you negotiate it's really important. Jeff, talk about buyers always have a good reason for why they want exclusivity. Tell us what they say are the reasons they need exclusivity for.
- [02:47]
C
Buyers will justify it through. This is a market term they'll justify it through. They're getting ready to spin up a bunch of expensive diligence work streams. And this was kind of like a good faith part of the future partnership that they should have exclusivity to give them comfort that they can close the transaction on the agreed terms. They also sometimes will make the case, and we kind of laugh at this sometimes here internally, that it'll be quicker to get a deal done if they just give exclusivity, which in some respects is actually the exact opposite of that. So those are some of like the ways they try to justify it.
- [03:16]
B
And I would say the first thing that happens whenever you grant a buyer exclusivity is things slow down, right? There's no more competition. They have this window where they have it locked up and they might even be thinking, hey, let's say we only got 30 days of exclusivity. They might be thinking it's 45, but they assume you're going to extend it. So they have a lot of good reasons. Interestingly enough, though, generally the seller is spending money on all these sane items. They're spending money on lawyers. They're probably spending a lot of money to get all the diligence done. So it's presented as we need this. One thing that's important to think about is with most large strategic buyers and the bigger private equity funds, they've got a ton of management fees, they have a lot of capital to do their business. And so if they spend a bunch of money on diligence and the deal doesn't close, for most firms it's actually not that big of a deal. It's just the cost of doing business. Every once in a while, you'll see a really small firm where this does matter a lot for them. And I would view that as a red flag if there's such a small fund that they can't spend money on diligence. It speaks to, frankly, the quality and the ability for that firm to close. So you're trying to separate what's kind of BS on this, right? What they're just trying to do to get you in this low competition type process versus is it really a cost to them that they can't handle? So now that we've talked about the reasons why they say they want exclusivity, what's your view, Jeff, on why they really want it?
- [04:35]
C
I think it gives them an option on the business and it eliminates all competition. Nothing happens in exclusivity that's really good for the seller other than just the deal closing. Right. Valuation doesn't get any higher and obviously you have no more leverage as a seller to push on valuation at that point anyways. So they want to eliminate competition. It preserves their ability to transact. And a lot of times it also allows them to put the business under a microscope during this period where they'll evaluate performance. And if they haven't done enough business diligence, particularly to get to a close, they're able to kind of have this free option, if you will, where they can evaluate the business. And they might be doing this with multiple companies simultaneously, particularly if you're a PE fund, because you have a lot of optionality in terms of what type of companies you're investing in and there's not strategic synergies behind the transaction potentially. And so you're able to put multiple companies under a microscope and then really end up closing on the transactions where they perform well during this period. And so it allows them a lot of flexibility to do that. There can be cases where they might even not necessarily have the capital yet to transact. So maybe they need to raise capital from a debt provider or there could be just other reasons that they want to buy time before they're getting ready to close.
- [05:43]
B
I think you brought up a great point. Some of these bigger firms might only close 10 to 20% of the deals they have under LOI. And a way for them to kind of help manufacture return is they get 10 of them in exclusivity. They do diligence on all of them. They either find some issues and I'm using find and air quotes to try and retrade the company because they think they're tired, right? They've been exclusivity for 45 days. They just want a deal done. So they give them some certainty but cut the price that builds in a return for them. Or as Jeff said, maybe two of those 10 just dramatically outperformed. And so they close those deals because now they're in the money, if you will, already based on the performance of the business. And so this is A tool that buyers use to figure out which deals they want to do, how they want to do them, and the more nefarious buyers out there will try and tire you out and then basically retrade you. It's kind of a strategy, maybe. Let's talk a little bit about when is a good time to give exclusivity versus not give exclusivity. So in general, we work on some deals where we never give exclusivity or we give like two, three, four days, but sometimes you have to give a little bit more. Let's talk about what point in the process it's actually appropriate to do it, and what are you looking out for?
- [06:52]
C
That's a great question. So buyers are often asking for exclusivity at the IOI stage. And frankly, we kind of want to see that, but we're not going to grant it. Right. So the fact that they're asking for it is a positive because that means in some respects that they want to get to a closed deal. If they weren't asking for it, I think we'd be a little confused. But we would never grant it at that stage. We're only granting exclusivity, really at the LOI or term sheet stage. And so that's post ioi, and ideally that's on the path to getting the deal closed. And the commercial diligence is done. We're not taking business commercial diligence risk on this exclusivity period. It's purely papering confirmatory diligence at the most. And there's different degrees of how far we're able to push the boundaries on achieving the diligence risk and taking that off the table in advance of granting exclusivity. And so the typical work streams that we would see would be like accounting diligence, tech diligence, legal diligence, market diligence. Those are the four. And so if we're able to get most of those fully completed or on the path to completion, when we're signing an LOI or term sheet, it could be a couple days or maybe a couple weeks of exclusivity. And that ability to have a short window of exclusivity allows us to keep full optionality in the process. Because we didn't give a buyer 45 days of exclusivity. If something happens on day 40 and you're forced to go back to the market, the market's gone. Like they've moved on. Right? It's been 40 days. If we give a buyer seven days of exclusivity and we're four or five days in, or maybe we're seven days in at the most, and something happens. We still have our optionality, right? We still have second and third place. They're still at the table. And so it allows us to keep our leverage up with the buyer, get to a close. And if that window lapses, right. If say we're seven days in and we gave seven days, we're out of exclusivity again. Right. And so we're able to keep the optionality alive. And that is really powerful. And when we go through a brief period of exclusivity and come out on the other side, we have immense leverage at that point to get the deal done. And you'd be shocked how oftentimes what was an important legal issue in exclusivity suddenly just evaporated once the exclusivity window closed.
- [08:53]
B
Absolutely. A couple of things I think we view as non negotiables on this trade off between diligence and giving exclusivity. If you give a buyer exclusivity and they are still doing market work, you're just playing with fire there, right? Lots of buyers will pass over market work. That should all be done. They should like the TAM of the market. They should like your positioning in the market and the product. That should be a done deal. I don't think there's ever a case where you should give exclusivity where they haven't done that work. When you get into some of the other confirmatory diligence, we would love to see accounting diligence done, particularly for founder led bootstrap businesses, because sometimes there's some risk in there in terms of interpreting the accounting. And buyers, if they figure that out inside of exclusivity, they will try and retrade you. They will talk about the revenue multiple they were paying, or the EBITDA multiple, or the retention. They will pick something to try and retrade. So accounting would be very nice to be done. Then we get into things like tech diligence. I would say tech diligence we think is also important. It's also not that expensive in terms of getting done. The one where I think there's the most negotiation is over legal, because once they fire up legal, it is really expensive. We would love to see them fire up legal, do all their diligence and more importantly start negotiating the purchase agreement. Mainly because if you negotiate that outside of exclusivity, the seller has way more leverage than the buyer. So I think that's the Rubric, you kind of use for things that have to be done. But we see a lot of sellers put themselves in a bad position because they got really excited about the IOI or the LOI and gave no thought to how much diligence had been done. And then there's a big change in terms and you're stuck with, do I just eat it and do this deal or do I restart my process? We think most of these retrades are because the seller made a mistake because they gave exclusivity too soon. One thing I just wanted to double underline. Despite the fact that we don't love giving exclusivity, it does freak us out if a buyer doesn't ask for it. So if we get a bid in and they don't even ask, to us, that means they have no idea if they want to do the deal. They're just trying to get more information. And that doesn't happen that often, but it happens frequently enough and you should definitely pay attention to it. It's generally not they're trying to be friendly, right? It is. There's something they don't understand and so that's why they're not even asking for it. Jeff, talk about if you do give exclusivity, some of the tools we use to manage it a little bit, like timelines, things they have to get done during a certain window. If you give exclusivity, how can you manage it a little bit?
- [11:16]
C
The first one is just the overall ask on the amount of days the timeline. So if someone's asking for 21 days versus 60 days, that signals a lot, right? In terms of their ability to close and frankly their conviction around even wanting to do the transaction. So the timeline matters. But even in scenarios where we have aggressive timelines, putting some milestones out there around, confirming maybe it's on a weekly basis or some degree of reoccurring nature that they intend to do the transaction on the agreed upon terms. That can be a tool having like a date that's reasonable but also relatively aggressive in terms of the timeline to deliver like a first draft or some maybe turn of the purchase agreement. That's another tool. We've had some scenarios where we granted partial exclusivity. So effectively, maybe we gave exclusivity to our client, like management of our client, but we as the banker were still able to keep other parties warm and engaged. And that's like a pretty reasonable way of kind of protecting the seller, but also giving the buyer some comfort. Because in reality, a buyer is not Going to close a transaction unless they have access to management, it's almost impossible. And so I think that's kind of like a hybrid approach that we've done in a couple scenarios where we felt like it really warranted our ability to keep our optionality alive. On the point of partial exclusivity, the times we've seen that done in the past is when we've had clients who really fell in love with a buyer and we, Vista Point, didn't trust them as much. We are obviously advising all the time, our clients are deciding. But there's been many a scenario where we've had clients that wanted to go with the party and wanted to give greater exclusivity than we, Vista Point, were comfortable with. And this was a mechanism that we were able to use that gave us comfort that they were going to close, but also preserved our clients options and ability to get a deal done with the broader market and keep the competition and the 10 chain on that buyer during that period of exclusivity.
- [13:03]
B
I think the important point here is not all firms are equal in this. So we've had good, bad and ugly experiences with a range of private equity firms and how they think about exclusivity, how serious it is to them, how they treat it. So firm X, you might be comfortable not giving them partial exclusivity, giving them full exclusivity for 15 days, whereas firm Y, you would not be comfortable with that because you kind of know what they're going to do. And so you're looking for ways to kind of neuter their leverage a little bit and know that this discussion around exclusivity is a strong signaling element to the buyers. So for example, if we're 2/3 of the way through the process and we tell five buyers we're not granting exclusivity, they know that this deal is hyper competitive, they're likely going to have to bid up and give us super seller friendly terms. If we start talking about 60 days of exclusivity, they think there maybe is another buyer there, but probably at a pretty big discount because why would you give them 60 days if you had other buyers? So there is a strong amount of signaling that takes place in this discussion that's not often transparent to the founders because again, they just take it as a given and the buyers do a really good job of presenting this as a given. Like obviously this just makes sense, right? But there is a strong amount of signaling in this and you gotta react to it soon. Like you can't get an loi and not react to it. You need to have a pretty big reaction if they ask for something ridiculous. Jeff, maybe talk about how what we would call conflicted bankers. So bankers who work a lot for the buy side, right. They work for the PE firms or the strategic buyers. How can you tell if they're somewhat conflicted by their approach to exclusivity?
- [14:36]
C
I think there's a couple things. One is just thinking through what the recommendations are around the process and the concept of having buyers spending money doing diligence outside of exclusivity, because obviously buyers don't love that. They would prefer to have the free option, right? To have it under exclusivity to eliminate competition. And so if you have buyers that are willing to engage in that and you have a banker or someone's recommending to maybe forego that and there's a path to close that's, quote, faster by going with one party and giving them the exclusivity to get it done, that's just flat out wrong. And I think there's maybe some motivations behind that that could be influencing it. That's probably the first one. And then I think also being overly generous with the window, there's a certain time period where buyers should be able to get deals done, and there's a market for that as well. And I think if you're really granting 45, 60, 75 day periods of exclusivity, those are just completely off market. And you really have to scratch your head and understand why someone would be recommending a period of that length when just the market commands and deals get done at much shorter time periods.
- [15:41]
B
And I think if you're talking to a banker and they present exclusivity as it's a given, and it's always make a number up, 45, 60 days, 30 days, I think that's a big red flag. The answer is it depends. It depends on how good the company is, how competitive the process is, how much negotiating leverage we have. Like everything in life, it depends. But if you get the boilerplate answer, frankly, I think that's a big red flag. Either they're more focused on the buyer's interest, or frankly, they just don't have a lot of experience in pushing for this and don't understand the importance of it.
- [16:12]
C
Also just has a huge view on valuation. Right. If I saw a transaction get done and the only thing I knew was the number of days of exclusivity that was granted on that deal, I would have a high degree of ability to.
- [16:24]
B
Estimate how it priced directly correlated. We actually have a slide in our pitch deck. We give to clients where we'll show these deals that happened, the valuations and how correlated it is to the days of exclusivity like they were directly related if you're running the process the right way and taking advantage of your leverage. Today's episode we talked a little bit about why buyers push for exclusivity, the risks that can come with it, and how you can manage it on your terms to kind of leverage it and get the best outcome. Jeff, thanks so much for joining us.
- [16:52]
C
Yep, it was fun.
- [16:54]
A
VistaPoint Advisors is a founder focused investment bank that advises software and Internet founders through M and A and Capital Raised transactions. We are a fully unconflicted investment bank who only works for founders on the sell side, so you know that we're always representing your best interests. Security is offered through VistaPoint Advisors member Finra Sipic. This has been provided for informational purposes only. It is not intended to address all circumstances that might arise. Testimonials from past clients may not be representative of the experience of other clients and there is no guarantee of future performance or success. Clients are not compensated for their comments. If you have any questions about the process of selling your business or raising capital, reach out to a member of our Team team or check out the four Founders section of our site by visiting four Founders Guide.