Selling Your Business Part 2 - Letter of Intent
Last month, we shared the steps needed to prepare your business for a successful exit – a.k.a. sale. This month, we review what happens when a prospective buyer likes what they see.
If you are using a business broker or investment banker, they will most likely prepare the materials (like a one-sheeter, blind profile, a book, or prospectus) that will be used to shop the business. At this point, you have done all the work needed to clean up your books and prep the business for sale including securing a professional valuation. You should also have a good understanding of what you will and won’t do (from a numbers and structure perspective) as you begin to work through prospects.
So what happens when you get a fish on the line?
Protect and Qualify.
Be prepared to sit down for an initial meeting. If you are moving beyond the blind profile and providing any additional information, obtain a Confidentiality or Non-Disclosure Agreement (NDA) signed first. You want to get to know your buyer but not at the expense of potentially leaking valuable competitive information into the marketplace. An NDA is even more critical if the “buyer” is a bigger player in your field or a competitor. Trust but verify that they are serious by making them sign an NDA and QUALIFY them. You must ask them for information about their business history, their experience and education, and how much money they have for a down payment. Do they pass the lifeboat test (if you are stuck in a lifeboat with them for 24 hours would you survive or would you hurl yourself overboard)? Do they have all their financing in place? Do they understand the business and are they asking good questions to prove that? Listen and tune in. I can’t tell you how many times after a deal blows up one or both of the parties knew it from the get-go. If something feels off it is much easier to walk away at the beginning of a prospective deal then at the end.
Term Sheet or Letter of Intent.
Prior to the next step is usually the point where the client picks up the phone and says “Juliet, I’ve found my buyer, we’ve talked about the deal points, and we are ready to move on.” I say “congrats” and then dive into mapping out the Letter of Intent or LOI. An LOI is a pre-purchase contract that lays out the key terms for the purchase of the business. It gives each side comfort that they won’t be wasting time or money undertaking due diligence without a meeting of the minds on the most crucial issues. Typically, LOIs are non-binding. Why? Because there are many unknowns at this point. The part that typically is binding, however, is the “exclusivity” or “no shop” clause. This means that during the negotiation and due diligence process neither the buyer nor seller will be dancing with any other suitors. I steer clients clear of any buyers or sellers who aren’t willing to grant this exclusivity. It’s a red flag.
Letters of intent can be simple or complex, it really depends on the deal and the parties. They also can be negotiated directly between the parties themselves or handed over to counsel to manage. Here are a few things that are typically covered:
- Purchase Price and Deal Structure: Is it a stock or asset purchase? Is there an earn-out?A carry back note? SBA financing?
- Allocation of the Purchase Price: How much is going to goodwill?Assets?
- Adjustments to the Purchase Price: Is there a working capital calculation? What about A/R received after the deal closes but billed before?
- What is the expected close date?
- Is there an escrow? For how long?
- Are there special conditions like a lease or key employees or key contracts which may need to be renegotiated prior to a closing?
- How long will due diligence take?
- Who will be preparing the sale agreement (definitive agreement) and when is the first draft expected?
- Confidentiality obligations
- Termination of the LOI
- What about the disposition of employees?
- Is the owner or key staff required to stay on and if so for how long?
- What are the terms for non-competes and non-solicits?
- What is the general framework of representations and warranties and how long will they survive?
- What indemnification requirements are expected of each party?
- How will disputes be handled?
The biggest misconception that business folks have is that once the LOI is signed the negotiations are over. Nothing could be further from the truth. In fact, an LOI is just the beginning of negotiations that often run right up to the eve of close. Why am I telling you this? If you know this ahead of time, the process will be a lot less frustrating.
Once the LOI is completed and signed, it is time to move on to the fun stuff, due diligence and drafting the definitive agreement. We will pick it up there next month.