A term sheet outlines the rights and obligations of parties involved in private equity transactions. Generally speaking, most term sheets being provided by venture capital firms or potential acquirers are non-binding, with only two provisions considered to be binding upon the transacting parties – confidentiality and no-shop (also referred to as “exclusivity”).
There are important provisions in the term sheet, and one such provision is no-shop provision. In this article we will discuss the same in detail.
The no-shop clause is included in the term sheet to restrict the company from soliciting offers or initiating any other investment or acquisition procedure by a party other than the fund or acquirer initially presenting the term sheet.
In other words, it prevents the company from using the term sheet to “shop” for better offers.
The provision restricts the company to solicit or initiate investment proposals in relation to the sale or issuance, of any of the capital stock of the Company (or the acquisition, sale, lease, license or other disposition of the Company or any material part of the stock or assets of the Company). The no-shop provision usually also creates an obligation on the company to notify the fund or acquirer presenting the term sheet of any inquiries by any third parties in regards to any such offer. This provision is effective for a specified period of time as agreed by the parties, usually, it is between 30 to 60 days.
The intent behind this provision is to safeguard the interest of the investors by restricting the company from not using the term sheet to look out for better investment deals.
This allows the investor to conclude its due diligence process, and present and negotiate the transaction documents with the company, at ease.
Occasionally, and more often in mergers and acquisitions, the no-shop provision clause can also include an additional obligation, usually referred to as “break-up fee.” The “break-up fee” clause imposes an additional obligation on the company to pay an agreed penalty for breaching the no-shop provision, if effectively terminating the negotiations. Depending on the company’s attractiveness, companies can demand a “break-up fee” clause to be mutual, so that if the fund or acquirer presenting the term sheet has resolved to withdraw its offer, for reasons of convenience and not for breach by the company, they have to pay the “break-up fee”.
Back to the no-shop provision. The no-shop restriction provides leverage to the investors and that is why it becomes pertinent for the founders to understand the consequences of this provision. If a company is in financial distress, then committing to a no-shop clause could be tricky as the investment or acquisition are not imminent, and investors or acquirers could use that to try and change the commercial terms initially proposed by the term sheet.
What can founders and companies do?
One example would be to negotiate shorter periods of restriction. An excessive long time period could be detrimental to the interest of the company because if the investor did not close the deal then the company was unnecessarily kept off the market for the entire duration. Another example would be to break down the entire restriction period into a few, based on milestones. Adequate milestones could be – the completion of due diligence until a certain date, or within a certain number of days, presenting the transaction documents within a certain timeline, etc.
This will prevent the fund or acquirer from obtaining blanket protection by using this provision, and not taking adequate actions to close the deal fast. As such if there is no progress then no shop provisions will fall away prior to the specified time period.
From the above discussion, it is evident that this is an important provision for investors and founders and this provision has the capability to facilitate the private equity transaction for both parties. The time limit is the key issue in this provision and must be negotiated properly.
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