What Are Exclusivity Periods And How Should They Be Negotiated?
Exclusivity periods are often used to protect the buyer in an M&A deal who is seeking to purchase a target company from its seller(s).
Where a buyer is contemplating acquiring a target company it will carry out a detailed investigation of that target’s affairs (i.e. conducts its due diligence) which costs the buyer time, money and resources (including use of personnel). The buyer will usually want a certain degree of comfort that during this due diligence period the seller(s) won’t enter into negotiations with, and agree to sell to, a third party instead.
A buyer should always seek a binding exclusivity provision within the heads of terms that are signed at the outset of a transaction, before the buyer’s main due diligence investigation commences. Such an exclusivity period is usually two or three months long and the seller(s) will often require the buyer to pay a non-refundable deposit to cover the seller’s expenses if the buyer does not go ahead.
The exclusivity provision will sometimes require the buyer to put the pre-agreed non-refundable deposit (otherwise called an ‘exclusivity fee’) into an escrow account where it will be held to the seller’s order. Then, depending on whether a deal is signed by the buyer or not, the money held in that escrow account will either be retained by the seller or put towards the purchase price of the target in the buyer’s favour.
It will be up to the parties to negotiate both the length of the exclusivity period and the amount of the exclusivity fee (if there is to be one). The buyer will want the exclusivity period to be as long as possible, with the seller wanting the opposite. The seller will want the exclusivity fee to be as high as possible, with the buyer wanting the opposite.
The size of the exclusivity fee will depend on the bargaining positions of each party, although it is typically set at around 1% of the purchase price for the target company.
Below is typical wording that could be used to integrate an exclusivity provision into heads of terms (or to include within a standalone exclusivity agreement):
In consideration of the Buyer paying to the seller the sum of [enter exclusivity fee amount], receipt of which is hereby acknowledged and incurring fees, expenses and other costs in connection with, and committing management time and resources to, its due diligence investigations in relation the Target and negotiating the Proposed Transaction, the Seller undertakes to the Buyer that for the duration of the Exclusivity Period it will not (and will procure that no other member of its Group nor any of their respective officers, employees, agents or advisers will), directly or indirectly:
- continue, re-start, enter into, initiate or participate in any Third Party Negotiations;
- invite, induce, encourage, solicit or respond to any approach that might lead to Third Party Negotiations;
- invite, induce, encourage or solicit any offer or expression of interest from a Third Party in relation to a Restricted Transaction;
- enter into any agreement, arrangement or understanding (whether or not legally binding) with a Third Party in connection with a Restricted Transaction; [or]
- withdraw from negotiations with the Buyer in relation to the Proposed Transaction; [or]
- supply, disclose, or otherwise make available to a Third Party any information concerning the Target (or any other member of its group) for the purpose of enabling it to evaluate, or decide whether to make an offer in connection with or otherwise pursue, a Restricted Transaction.
Note that the above does not deal with the payment of a (non-refundable) deposit. Deposits are generally not advisable for small transactions because of the additional time and effort involved in their negotiation. In such cases the parties may instead agree to an indemnity in favour of the buyer for an amount equal to its costs, fees, disbursements and expenses which have been incurred in respect of the proposed transaction should the seller breach its exclusivity obligations. If the seller accepts the principle of providing an indemnity in respect of the buyer’s costs, it should try to limit the indemnity to the buyer’s reasonable costs, and impose a cap on the amount payable under the indemnity.
Careful consideration should be given to exclusivity deposits as there may be undesirable tax implications and additional drafting will be required to deal with a) any set-off of the deposit against any deposit payable on an exchange of contracts and b) when the seller is required to return the deposit if the sale does not go ahead.