After 27 years in the business of selling companies, we have seen almost every odd-ball twist to a transaction that you might imagine. A client of ours recently told me that I should use our newsletter to tell some of the more interesting/ unusual twists we have seen in purchase agreements, to teach sellers about how to protect, and what to do to position optimally for sale.
In an effort to do this, we will start with the earliest agreements that a seller company will have to respond to from the buyer.
As soon as a buyer learns enough to know that he wants the acquisition, he’s likely to submit to the seller his “letter of intent”.
The initial letter of intent typically states an expected purchase price (or, in some cases, a range of possible purchase price) and asks for the seller’s acceptance of the offer, with their signature. We tend to discount the offer that provides for a range in pricing. Sellers can generally know that such range will finalize at its lowest level, so the range stipulation is generally not meaningful.
The LOI will commonly ask for the seller’s acceptance of an “exclusivity” commitment, with signing. The buyer expects the seller to allow them to do further investigation, enabling them to really decide if they want to close the purchase or not. And the buyer will spend real time and money in that endeavor, so they don’t want it to be wasted effort if the seller is still chasing alternative suitors.
Acceptance of an LOI with an exclusivity commitment is a big deal. It means the seller must drive all alternative buyers away, and cease talking with them. In our practice, we normally ask for a nonrefundable deposit (usually $250k), to remain in place until closing (defined to be necessary within anywhere from 30 to 90 days out). We commonly get such deposits in place, before we recommend acceptance by our client. Of the 135 company sales we’ve closed, probably 50 of them had such deposits in place. Each of those transactions except one, ended in closing. (One changed their mind, and forfeited deposit.)
If the buyer is unwilling to put up such deposit, the “next best” thing is to ask the seller to continue with due diligence, without an exclusivity provision in effect. We’ve done this for probably another third of the deals we’ve managed. You may provide that when the buyer becomes “certain” of his intent, and is comfortable making a deposit, exclusivity will be triggered.
In some cases, no buyer may be willing to firm up their decision in advance of further due diligence. In those cases, a seller may be forced to accept an exclusive commitment with no assurance that the deal will consummate.
The time period proposed for a due diligence period is also very important. We commonly go to 60 days. In some cases the really organized buyer may be faster, and in some cases, they may fight hard for a longer period.
We worked with a client a couple of years ago, who asked us to propose on representing them in sale. However, they wanted to exclude one possible buyer from potential fees to us, because they had already been talking to that potential buyer for several months. They felt that this buyer was likely to be very real and able to pay, but they were curious about whether we might generate higher offers. We declined to propose, explaining that the work to get company information accurately prepared, and to get other suitors to the table to propose was just too much, given their likely interest in the already established one buyer.
We said no harm/ no foul, and they could feel free to continue with their buyer and contact us if it didn’t work out. They then entered into a signed a letter of intent with that buyer, and we did not hear from them for some time.
About six months later they came to us and wanted to talk again. It seems the seller had signed a letter of intent with the buyer, which allowed the buyer 120 days to close. Near the end of that 120 days, the buyer came back to ask for an extension of another 60 days. The buyer loved the company, and remained enthused, but their financing had not yet been secured.
Our client declined to extend beyond this now six-month mark, and came to hire us, with no exclusions. We worked quickly, and within about two more months, began receiving offers.
At that point the original failed buyer came back to us. They said, “We love this company, and have done LOTS of work to do this deal! We still want to be their buyer!”
Since hired, we had learned that the original buyer had proposed 20% down, and 80% of their deal in a note. We told that buyer that we were happy to update info for them, and to court any proposals they would like to make. However, we assured them that we would have absolutely zero interest in anything except an all-cash at close deal.
The buyer made us an all-cash offer, and at an increased price. We said great, but we would need a very substantial deposit from them to take the company off the market. They entered into a letter of intent the next week and paid a nonrefundable deposit of $500k to secure the deal. It closed happily about 30 days later.
Other issues well worth working through in advance of the signed LOI might include issues regarding confidentiality during due diligence. Fairly often the buyer may want to contact major customers in the course of their due diligence. Risks are tremendous to the seller, if the deal subsequently fails to close. We have often outlined rules for making such contacts, to allow investigation, while still keeping the potential for sale very secret. For example, in some cases we have permitted buyers to interview customers as if doing a customer satisfaction survey. We will ask that we too join in such calls and listen to the discussion, to ensure safe adherence to the rules of the game. It generally can work very well.
In one scenario, for a company which had a major customer concentration with Polaris, the buyer’s management person who was expected to lead the company post acquisition, joined the management team for an annual Polaris conference, and was introduced as a new member of the selling company’s sales team. During that trip, Polaris took the entire client troop (including their would-be new sales guy) on a snowmobile venture in the woods, at 20 below, wind chill 40 below. (Rough outing, but he said it was worth it!)
Generally, issues that relate to the letter of intent, that we always try to look for, include:
- The purchase price should be detailed without a range – with a set amount. Additionally expected payment terms also need to be specified. (The seller has no real ability to evaluate the value of the offer, without those details.)
- Expected confidentiality during the due diligence process should be outlined. If buyers won’t be allowed to interview staff, that should be agreed. If buyers want to interview key customers, restrictions should be outlined ahead of signing an LOI. If buyers need external CPAs, appraisers, or other consultants to have access to information or to staff, details of related terms should be stipulated ahead of time.
- If all of the assets of the seller are not to be sold, that needs to be delineated. The LOI also needs to specify if this is a stock format or an asset format deal.
- If ongoing post close employment by owners is to be required, that needs to be stipulated, along with ongoing salary expectations. Expectations for duties and title of owners staying in place should be delineated. Future exit possibilities should be provided for.
- If owners will be required to reinvest a portion of proceeds in continued ownership, percentage requirements and pricing should be stipulated. If owners might be required to take a second class of stock, that should be spoken to. (Dangerous!) Timing and pricing for later buy-out should be agreed upon, as it may materially impact total outcome for selling shareholders.
There are probably another dozen items that can or may arise in the LOI discussion process. We realize that this may be “painful” to hash through so far in advance of closing, but early resolution of such issues markedly simplifies later documentation for the final Definitive Purchase Agreement, and reduces likelihood of later disagreement over items not previously considered. It’s worth the time and effort!
by Deb Douglas