Term sheets and letters of intent are non-binding except often for confidentiality clauses and lock-ups. This means the buyer can walk away – for any reason. Remember this and plan accordingly.
In a venture capital situation, it is important to understand if you are receiving an early diligence term sheet or a late diligence term sheet. By the way – it should be pretty clear. Have you met the full partnership? Have the investors called customers? Have you done a deep dive of the financial statements or financial model? Has there been deep technology diligence? Has the fund introduced you to other of its CEOs so that you can do your own diligence on the fund? If the answer is “no” to most of these questions, then you are pretty early. If you haven’t met the full partnership and the investment committee hasn’t blessed the term sheet, then you could be on shaky ground and you are relying on the gravitas of the person leading the deal. If customer and technical diligence hasn’t been conducted, then again, there is some way to go. Some firms will honor 99% of term sheets issued as long as you haven’t stretched the truth on key facts. For other firms, it can be less than 50%. As an entrepreneur, when you sign that term sheet, you want to have a sense of where the investor is in their process, what still needs to be done on diligence, and what are the likely odds of closing. If you are stopping discussions with other investors in order to sign a term sheet, you want to make sure that the firm you are signing exclusivity with for the next 60 days has not simply lobbed in the term sheet to lock in what may or may not be a deal they want to do.
In an M&A situation, it can be even worse. You may have the deal signed, you may have the blessing of the CEO of the buyer. The business unit, corporate development, and legal may all be on board yet sometimes that isn’t enough. CEOs get fired, quarters get missed, boards of directors say no. Suddenly what looked like a smart deal is put on hold. If you are a strong company, going like gang-busters, lots of cash, and plenty of options – then this is an annoyance. If cash is short, things are being held together with band-aids, you have been holding off cutting costs because “the buyer wants the team”, and your investors are done – then having a buyer walk away can bring on corporate cardiac arrest. And when it’s not because of what you have done but because the buyer’s own house isn’t in order, there is nothing more frustrating.
When I was running Verticalnet, we got left on the altar. Press releases were written, post-acquisition employment agreements were done. The deal was supposed to close on Wednesday, but at the Monday board meeting, the buyer’s board said “no”, because the team had failed to meet integration targets on several past acquisitions. We were stretched at Verticalnet. We had racked up hundreds of thousands of legal and accounting expenses. We made it through, but it wasn’t pretty. Fifteen months later we found a better home with a better buyer and the story for the buyer and seller and for the Verticalnet team and customers has been a good one. But we were lucky.
When we went through the process the second time, we made sure the board of directors of the acquirer was bought in. We understood their process and their intent and we also had a better understanding of why we were the perfect fit. Much of this was uncertain with the first buyer.
Bottom line: There are things you can do to increase the odds of a deal closing – in raising venture capital and in selling your business. But you can’t get the odds to 100%. Even if you do everything right – different buyers behave differently.