What Comes First? Term Sheets or Due Diligence?

There’s a common debate that arises between vendors and purchasers in business sales: vendors typically want to receive an offer (in other words, a term sheet) to purchase their business early in discussions with potential buyers, yet buyers often want to undertake significant diligence investigations before putting an offer forward. 

At Groves & Partners, we spend time acting for clients on either side of the hypothetical vendor/purchaser fence, hence we think we’re well placed to put forward our view on how this debate should be resolved.

The Position of the Vendor

Vendors are often very uneasy about releasing information as part of the sale of the business. They’re typically concerned (often rightly) that purchasers may be sniffing around to find out about their business, with little to no intention of proceeding with an acquisition. Window shopping if you will.

Vendors deal with purchasers for one reason: to complete a sale of their business. In this sense, they care about little more than what the purchaser’s offer will be and whether it is consistent with something they can accept.

It’s because of these reasons that vendors are typically very eager to push a purchaser toward making an offer to acquire their business very early during discussions, before the purchaser has had the opportunity to undertake significant due diligence investigations.

The Position of the Purchaser

Purchasers on the other hand typically approach potential acquisitions with a view to managing their risk exposure, ensuring they avoid a potential bad business deal, and making sure they don’t overpay.

It’s because of this that many purchasers can be quite reluctant to show their hand in the form of an offer before conducting quite a bit of due diligence.

How Can this be Resolved?

In our experience, a pathway exists which can provide both purchaser and vendor with an optimal result. There are a few steps in this pathway, specifically:

1. Vendor’s must be comfortable to disclose to qualified purchaser’s a reasonable level of business information to enable the purchaser to formulate a non-binding offer. It does not need to be enough information to enable the purchaser to decide to complete the purchase – simply enough to enable the purchaser to prepare a term sheet.

2. Based on the initial disclosures by the vendors, the purchasers should prepare a non-binding term sheet, with this then negotiated between vendor and purchaser to see if an in-principal agreement can be formed.

3. If an in-principal and non-binding agreement is formed, the vendor can then open up their books to enable the purchaser to undertake additional due diligence to satisfy themselves that the nature and risks of the business they believed they were making an offer on is consistent with that of the business that they are actually buying.

4. If the purchaser’s final due diligence is satisfactory then the deal can proceed to completion.

Why Does This Work for Both Parties?

This approach is, in our experience in the best interest of vendors and purchasers. It meets the vendor’s needs with respect to limiting the disclosure of business information and gaining an understanding of the purchaser’s transaction terms early on. At the same time, it allows a purchaser to invest minimal time (and hence, cost) in due diligence investigations prior to gaining an understanding whether any offer that they make will even be consistent with the expectations of the vendor.

Find Out More

What are your thoughts on this matter? You are welcome to contact us to share your ideas.Further, if you are interested in completing the sale or acquisition of a medium-sized business, we are available to help. Contact us at info@groves.com.au or call 1300 892 717 (+61 2 7208 7970) to find out more or provide feedback.