You have made the difficult decision to sell your business and have initiated a process to market it to a group of strategic and financial buyers. One of these potential buyers has now submitted a letter of intent (or “LOI”), which is an offer that summarizes the main points of the proposed deal. While “congratulations” are in order, LOI’s are meant to be preliminary, non-binding commitments between the buyer and seller. Yes, they signify a serious commitment, but lots of additional work and effort is required to get to an acceptable, binding deal.
While the price offered is undoubtedly a key concern, there are many other issues that could impact your total return, and should be addressed in the LOI, including:
- First of all, ensure your LOI is specified as “non-binding”.
- Assuming the price is acceptable, you need to have faith that the buyer will be able to close the deal. You should request proof that they have the capital and resources to close the transaction – often this is in the form of a “soft” letter of commitment from their banker – and you should be provided with this before signing the LOI.
- Is the transaction structured as a sale of shares or assets? You will need to consult with your accounting and tax advisors so that you understand the tax implications of the proposed offer.
- Is the consideration being paid structured as cash-at-close, or does it include some portion of a vendor-take-back (whereby you are being asked to finance a portion of the sale) or an earn-out (where a portion of the payout is contingent on future results of the business?) While these are common in the sale of private businesses, they each have their own issues and risk factors that need to be understood and managed.
- What expectations does the buyer have for the seller once the deal closes? There is generally some form of management contract that is negotiated, usually later in the process, which allows for the orderly transition of the business.
- What is the proposed timing for closing the sale? We typically find that two – four months are required to fully close most transactions.
- How does the sale deal with the working capital of the business? This can be one of the more contentious issues in any sale, and should be addressed at the LOI stage.
- If your company has debt, how is it treated in the transaction – is it paid out by the seller, assumed by the buyer, or something else?
- Does the LOI discuss expectations for the representations, warranties and indemnities that will form part of the formal purchase and sales agreement? Better to get these on the table early rather than have surprises when you are much further into the process.
Most LOI’s, once signed, includes a lock-up period which prohibits you from talking with other potential buyers. This results in a power shift to the buyer’s favor, and while this is a standard part of the process, you need to be aware of it.
Once the LOI has been signed, you will next move into the formal due diligence stage of the process. Due diligence provides the buyer with intimate details of your business – including financial, customers, staff, processes and contracts – and is often conducted in phases, so as to protect the seller in case the offer is pulled or the deal does not close.
Even though LOI’s are non-binding, we strongly encourage the business owner to speak with their business advisory team before prematurely popping the cork!
This article was written by David Laycraft P.Ag., MBA, CMC, CBV, CF, CDFA. David has over twenty years of diversified experience working with privately-held businesses, and regularly assists clients in identifying, measuring, growing and realizing business value. You can reach him at (403) 750-7685 or firstname.lastname@example.org