Negotiating the Letter of Intent

An LOI or letter of intent is an offer for the purchase of a business establishing the buyer, deal structure, price, and terms as well as certain other high-level details about the transaction. It represents a good faith agreement to move to the next step in the sale, namely, due diligence and the negotiation of the definitive purchase agreement.  LOIs vary as far as how much detail is presented, however, the purpose of the letter is to have a general agreement as to structure, price and terms. It may also include the buyer’s desire for continued employment of the seller and management team, conditions to closing, and timing of the transaction. The LOI is the first step of formally engaging a buyer to purchase or recapitalize your business. The best results are achieved through a conciliatory approach to the negotiation process.

The LOI agreement is generally non-binding and subject to the buyer completing a comprehensive due diligence process to verify the financial and operational information and to make sure the company is compliant in all legal and regulatory procedures. Although the agreement is considered to be non-binding there are typically three items that are binding. First, the standstill or no-shop clause requires the seller to stop marketing the business and not entertain other offers for a stated period. Second, the confidentiality of the transaction is also binding to prevent either party from disclosing the transaction and its terms, except on a need-to-know basis. Finally, both parties agree to pay their own expenses such as their accounting and attorney fees as they work through the deal.

Even though the deal terms are non-binding, the agreement should not be entered into with the thought of negotiating a higher price or better terms during the selling process.  Buyers become leery if something is agreed to and then back tracked and could see it as bad faith. It’s important not to dwell too much on granular details in the LOI as these details will be negotiated in the definitive purchase agreement that solidifies the sale. However, anything that is imperative for you to complete the sale should be noted. For instance, if the owner wants to exit the business within ninety days, it should be discussed during the negotiation of the LOI. Any assets that the seller wants excluded from the sale such as working capital or company cars should be noted in the LOI. Also, if there is anything material that could affect the value or marketability of the business, it should be disclosed prior to signing the LOI. An example might be if the company is being sued or an audit is ongoing.

Negotiating an LOI differs from other types of negotiations in that it represents the first step to many more negotiations to come. It’s important not to get bogged down with too many details. Too much negotiation at this early stage can be exhausting and may suggest a difficult road ahead. The best-case scenario is to have multiple offers on the table so you can leverage them. When deciding on who you want to acquire and operate your company, consider the buyer’s ability to get to closing. Do they have cash or established bank financing? How experienced are they in your industry? Have they purchased companies before? By asking these questions up front, you can avoid running down a rabbit hole and wasting time. It’s not uncommon that the highest offer comes from an inexperienced buyer incapable of securing the funds.

Enter the negotiation with a clear idea of what is important to you and what you are trying to accomplish. Try to be flexible where you can. Keep in mind that selling a business is more like a marriage than a divorce and one should enter the agreement with a high level of trust and respect for the other party.

All elements of the LOI should be considered as a whole since each term may affect the other elements of the agreement. There is a saying in dealmaking, “your price, my terms” or “my price, your terms”.  In most cases, buyers will only pay what the market will bear but could be persuaded to pay more if the seller offers a favorable financing arrangement. For buyers using bank financing, the buyer is constrained by what the bank will allow. Other than hitting a specific price target, there may be other things that are important to you. Keep in mind, once the business is sold you will no longer have control so placing post-sale operational requirements on the buyer may not be practical. Approach the negotiations with a willingness to make it work. Trust and confidence in the acquiring company’s leadership and some degree of flexibility will go a long way to achieving your goals in a transaction. The best crafted deals require give and take from both buyer and seller.

Beth DaSilva is the President of Fleetridge Pacific and M&A Transaction Advisor with over 20 years of experience helping business owners sell their companies.