Exclusivity Period

What is an exclusivity period?

Exclusivity period (German: Exklusivitätsphase, Exklusivitätszeitraum) denotes the contractually agreed period during which a company or its shareholders may negotiate a planned transaction only with a particular investor or buyer. Talks with other interested parties are suspended for this time. The provision itself is called the exclusivity clause.

Exclusivity is agreed in the term sheet of a funding round, in the LOI of a company sale or in a separate exclusivity agreement. It is one of the few binding parts of these otherwise largely non-binding documents and, as a rule, begins with their signing. Outside transactions, the English term has other meanings. In US insolvency law, it denotes the period in which only the debtor may submit a reorganisation plan; in pharmaceutical law, the data protection for new active substances (data exclusivity).

Purpose and interests

The investor or buyer incurs considerable costs with the due diligence for law firms, auditors and its own team. It accepts these costs only if it does not have to expect that the company will conclude with another interested party in parallel. Exclusivity secures it the time for review and contract negotiation.

For the company and the sellers, competition among the interested parties ends with it. The negotiating position shifts to the favoured party. If that party uses the phase to worsen price or terms after the review (retrading), the immediate alternative is missing. Exclusivity is therefore, as a rule, granted only once the key terms are settled.

Length of the exclusivity period, extension and end

The length depends on the scope of the due diligence and the complexity of the contracts. In funding rounds, 30 to 60 days are common; in company sales, often 6 to 12 weeks. For the company, a fixed end date matters more than the exact length.

Extensions are usually agreed only in writing and by mutual consent. Automatic extensions should be tied to conditions, such as a completed due diligence without material findings and agreed contract drafts. Early termination is also common: exclusivity ends automatically if the interested party changes the valuation or key terms to the company's disadvantage or declares that it will not pursue the transaction.

Regularly, exclusivity ends on expiry of the period or on signing of the final contracts. For the time between signing and closing, the rules of the purchase agreement then apply.

Content of the exclusivity clause and no-shop clause

The exclusivity period determines the time frame, the no-shop clause the content of the obligation. It generally prohibits approaching other interested parties, negotiating with them and giving them information or access to the data room. Stricter versions prohibit any opening of talks, even if a third party approaches of its own accord. Three points above all are negotiated:

• Exceptions: term sheets of a funding round often exclude talks with existing investors, that is, investors already involved who wish to participate in the round. Applications for grants and debt financing are also often excluded, to the extent they do not replace the round.
• Unsolicited approaches: many clauses oblige the company to inform the favoured interested party of incoming approaches. From the company's perspective, notice that an approach exists is sufficient, without the name and terms of the third party.
• Ongoing talks: existing negotiations are ended or suspended when exclusivity begins. It must be clarified whether contacts that do not concern the transaction may be continued.

In the sale of a GmbH (German limited liability company), the shareholders themselves decide to whom they sell their shares. An exception in favour of a better offer (fiduciary out), as is known above all from takeovers of listed companies, is therefore rarely agreed here.

Consequences of a breach

If the company breaches exclusivity, claims for an injunction and for damages may come into consideration. In practice, what is recoverable above all is the due diligence expense that the interested party incurred because of the promised exclusivity. It must prove the loss and its causation by the breach.

A flat-rate reimbursement of costs or a fixed payment in the event of a breach (break-up fee) is owed by the company only if expressly agreed. If such a payment in the sale of GmbH shares is so high that it in effect forces the sale, the agreement may require notarisation. Economically, a consequence outside the law often weighs more heavily: an interested party that learns of parallel talks often withdraws, and the company's conduct is also noticed by other investors.

Practical example: exclusivity in the term sheet of a funding round

A software company is negotiating a funding round of EUR 15 million and has received three term sheets. It chooses the investor with the highest valuation: EUR 60 million before the round (pre-money). With that investor it agrees:

• exclusivity for 45 days from signing of the term sheet,
• an extension by at most 15 days, only if the due diligence has been completed without material findings and agreed contract drafts are available,
• an immediate end to exclusivity if the investor lowers the valuation,
• exceptions for the participation of existing investors in the round and for ongoing talks on debt financing.

The longest possible exclusivity is thus 45 + 15 = 60 days. On day 38, after a finding on revenue quality, the investor proposes a valuation 10% lower, that is, 60 × 0.9 = EUR 54 million. For EUR 15 million it would then receive 15 / (54 + 15) = 21.7% instead of 15 / (60 + 15) = 20.0% of the shares. Exclusivity ends automatically through the proposal.

The company resumes talks with the second-placed investor and continues to negotiate with the original one, now again in competition. Without the termination clause, it would have had to negotiate the lower valuation with this investor alone until the 45 days expired, that is, for another seven days.

Distinctions: exclusivity period, no-shop, go-shop and drop-dead date

• No-shop clause: describes what is prohibited during exclusivity. The exclusivity period determines how long this prohibition applies.
• Go-shop provision: the counterpart. After signing, it allows the seller for a limited time to actively look for better offers.
• Drop-dead date: the deadline by which a signed contract must be completed. Exclusivity, by contrast, as a rule already ends at signing.

Common mistakes

• Exclusive too early. Anyone who grants exclusivity before valuation and the most important terms are negotiated gives up competition in exchange for a non-binding offer.
• No fixed end date. An exclusivity that is to run until conclusion or until talks are broken off has in effect no limit.
• Extension without conditions. An automatic extension takes effect precisely when the negotiation stalls and the company needs alternatives.
• Data room not ready. If documents are missing in the data room when exclusivity begins, the search uses up the scarce period and forces an extension.
• Exceptions forgotten. Without an express exception, talks about debt capital or with existing investors can fall under the prohibition.
• Comprehensive notification duty. If the company must disclose the name and terms of every approach, the interested party obtains information that strengthens its negotiating position.

Frequently asked questions

Is exclusivity required in every process?

No. In auction processes it is often granted only shortly before signing or not at all, so that competition is preserved until the end. Investors and buyers who finance an extensive review, by contrast, regularly demand it.

Who is bound by exclusivity?

Only those who sign or are effectively covered by the agreement. In a company sale, all selling shareholders must therefore be bound; in funding rounds, alongside the company usually the founders.

Can exclusivity also be agreed without a term sheet or LOI?

Yes. It can be concluded as a separate agreement, for example if an interested party demands an in-depth review before submitting an offer. The same considerations on length, exceptions and termination apply.

What applies after exclusivity expires without a deal?

The company is free to negotiate with other interested parties. Continuing obligations exist only to the extent agreed, such as confidentiality or a time-limited non-solicitation clause. Companies as a rule reject a continuing effect of exclusivity itself.

The Roemer Capital view

For clients, we grant exclusivity only once valuation, structure and the economically most important terms are negotiated, and always with a fixed end date. Until then we keep several interested parties in the process, because competition has the strongest influence on the outcome in this phase.

So that the period can stay short, the data room is completely ready when exclusivity begins and can be released within 24 hours. We tie extensions to milestones reached, and in the event of a reduction in valuation we provide for exclusivity to end automatically. The legal drafting of the clause lies with the client's law firm.