Buyers are quick to offer a Letter Of Intent, stating either a purchase price or a range for a purchase price, and offering to proceed with due diligence toward close, in exchange for the Seller’s commitment to deal with them exclusively. Frankly, this agreement doesn’t do much of benefit to the Seller. The Buyer almost always has free license to back away from the transaction for any reason. The Seller really has nothing firm after signing the Letter Of Intent, except a firm prohibition against courting alternative suitors.
In spite of all of these negatives to the LOI, the Buyer in some cases will not be willing to proceed (to begin to spend real time and money) without this commitment. In the past decade, probably half of the transactions we have closed have proceeded without an LOI – directly to the Definitive Purchase Agreement. However, in recent years, this has become harder to accomplish. (Buyers naturally prefer to get rid of the competition.) However, if the competition is steep, and Buyers really want the deal, they still may be willing to proceed without an LOI.
If I have a choice between two substantially equal Buyers, and one will continue to move forward without the “stop-shop” required of an LOI, I would almost always chose that Buyer.
If, however, that is not an option, and buyers all refuse to continue without the LOI, consider the following before accepting that Letter Of Intent:
Look for a firm and clearly defined purchase price
Buyers will often try to obtain a Letter Of Intent with a “range” of prospective purchase price, instead of a fixed and defined amount. If there is a range of pricing stipulated, be assured that the Buyer will always try later to move the definitive purchase amount to the absolute minimum within that range. If that minimum level is not tolerable as a final purchase price, do not sign the LOI. Press for the true minimum you would require, or don’t waste your time or the Buyer’s time.
Build a firm and narrow time table to completion.
Buyers will seek an LOI, which restricts the Seller from courting alternatives for 90 to 120 days if they can. After signing such an instrument, the Buyer may not do anything whatsoever for all or nearly all of that time. Meanwhile the Seller is turning away and putting off alternative suitors.
If we must sign an LOI, we typically advise clients to put in requirements for specific steps of progress, in order to keep the “stop-shop” in effect.
Within 30 days we would expect to see a draft of the Definitive Purchase Agreement, and drafts of any critical ancillary agreements to be required also. These might include Employment Agreements, Lease Agreements, and Non-Compete Agreements, for example. We would provide in the LOI that it is void if these timetables are not met. Other data we might require could include:
A. Completion of financial due diligence by CPA’s (typically within 30 to 60 days)
B. Agreement upon final terms of the Definitive Purchase Agreement (to be signed within perhaps 60 days)
C. Completion of any environmental review to be required by Buyers (30 to 60 days should be sufficient)
D. Interviews with any customers or employees to be held only after other due diligence – usually within the last 7 days prior to closing. (Such interviews are dangerous to the Seller, and should be done only after all else has proven to be satisfactory, and closing of the transaction is expected soon afterward.)
The LOI should also provide satisfactory restrictions regarding preservation of confidentiality during the due diligence process. For example, during financial due diligence, how will the process be conducted to ensure secrecy about the possible pending transaction? Financial Due Diligence may be undertaken off site, with auditors working from a remote location, where critical records are delivered to them. Or, Auditors may be identified to staff as conducting an audit for a bank, or for other outsiders, without mention of a possible purchase. In almost every case the company’s internal CFO will need to be “in-the-know”, and will need to assist the Buyer’s agents. However, others will not need to know.
In hundreds of transactions within our range of experience, we have never seen a Seller end with regret for having preserved secrecy about a possible pending transaction. We have, however, often seen a Seller regret when he has told employees or customers in advance. Everyone becomes nervous about a potential change in ownership. The best employees always have options to move. When change in their ultimate employer or “boss” is likely, they think about their alternatives, and give new consideration to the options presented to them by competing would-be employers. Customers too view change with fear. They begin to look around to ensure alternative supply sources “just in case.”
Sellers are prudent not to announce to employees or to customers until they can stand shoulder to shoulder with the new owners, and reassure employees and customers of a joint commitment to no adverse change. If there is no time lapse between the announcement date and the closing, most employees and customers will at least give the new relationship a chance, before seriously considering change. It’s a better process for all involved. The Buyer is more likely to keep customers and employees, and the Seller doesn’t run the risk of losing key relationships for a transaction that may or may not, in the end, close.
If there are other key terms to the necessary Purchase Agreement, which are unresolved, it is also prudent for the Seller to resolve these items in advance of signing the LOI. The LOI can then stipulate details about these points. The following are some of the most critical such items that we would typically seek agreement on between Seller and Buyer before signing the LOI:
1. Is there to be a lease of Seller-owned property to the ongoing entity? If so, what is the pricing, how long will the lease continue post sale, and what other key terms will prevail? (For example, detail any purchase options, what costs will be born by the Lessee, what rent escalations will be effective for future periods, etc.)
2. If there are to be Employment Agreements, who will be required to enter into such agreements, and what base salary and/or bonus elements will be in effect? What will benefit packages look like? If the employee is not a party to the sale directly, will he be required to sign Employment Agreements anyway prior to closing, and what will the specific terms of such agreements be? What will the timing of presentation of such terms to employees be, relative to the proposed closing date? (Outside employees to be required to sign new Employment Agreements or Non-Competes will, in effect, have “veto” power over your transaction. Sellers need to move slowly and cautiously before acquiescing to such requirements.
3. What indemnifications will the Seller are required to make in connection with the reps and warranties to be required in the Definitive Purchase Agreement. Typically, we would require some “cap” on total Seller exposure to such indemnifications. These caps usually would be at a maximum of 10 – 20 percent of the purchase price. We would also seek some minimum fixed dollar threshold for any such claims to avoid the potential for large numbers of trivial small items – which can be costly to the Seller. Also, discuss and outline in the LOI what the time limits will be for reps and warranties post sale. (Until these have expired, the Seller will worry about and have exposure to post sale claims. Reasonably short post sale exposure is fair and reasonable and Seller and Buyer will agree to this much more peaceably if they do so before signing the LOI.) All of these details are key to the successful completion of your sale transaction and are wisely negotiated before entering into and LOI with any Buyer.
4. Consider requiring a nonrefundable deposit. When we enter into an LOI, we almost always require a nonrefundable deposit – usually of $250,000 or more. Buyers don’t like the notion of such deposit, but sometimes, if they know this is the ONLY way they may gain exclusivity, it happens. The deposit is typically not refundable for any change of opinion by the buyer. However, we will make it refundable in the event of a) material inaccuracies given to the buyer by the sell side (which, of course, we can be sure never to let happen), or b) there is a material adverse event impacting the company’s operation (like perhaps, loss of a very material customer, or a fire at the main plant). In 22 years in this business, we have never once had a letter of intent accompanied by a significant deposit, which did not result in a closed sale. If the buyer has truly made the decision, he has no risk in making the deposit.
When you enter into an LOI, which restricts your ability to negotiate with outsiders, you will have to tell others that you have chosen a winning suitor, and thus that you must discontinue discussions. We know, from hard experience, that the vast majority of suitors who you leave behind at signing of an LOI will NOT return with good intent, if the transaction with the LOI buyer then terminates. The older Buyers resent not having been chosen initially, and they fear not knowing what failed in the pending transaction. Their enthusiasm is markedly dampened, and they almost never re-continue with the same velocity and gusto.
Know that if the LOI fails to come to closure, you as a Seller will likely “start over” with new Buyers to get to close.
It pays to get these matters clarified in the LOI before you sign. Your chances for closure go up markedly, and you are far less likely to be surprised late in the process by an unreasonable buyer demand.
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