12 May Quick Tips for Negotiating a Great Letter of Intent
Negotiate a Great Letter of Intent
A business seller’s negotiating strength is greatest prior to signing the Letter of Intent (LOI). This is because the buyer is at an informational disadvantage. The bad news hasn’t been revealed, and the seller typically has little invested in the project. Following agreement on an LOI, and as due diligence progresses, the power begins to shift to the buyer. As more people learn about the proposed transaction, the seller’s desire to close intensifies.
If you’re the seller:
- Your communications should convey that you might be willing to sell, but you don’t need to. They will need to be willing to make it very attractive to you.
- Take the initiative in drafting the initial LOI, if possible, and make sure all material deal terms are in it. Review other well-written LOIs and purchase agreements, to alert you to important terms.
- Provide that the purchase price is to be paid at closing, to forestall later buy-side arguments that a portion should be held back in escrow.
- If a promissory note is to be used as part of the purchase price, consider interest rates, default provisions, personal guarantees and security, and whether offset rights will be permitted (and under what circumstances). Further, consider acceptable subordination provisions to the extent a primary lender is contemplated.
- Include how the due diligence review will proceed. Provide that buyer not communicate with employees, vendors, lenders, etc. until later in the process. Include exactly who will be contacted, and when, and what will be asked and said.
- Typically, it’s best to conduct due diligence before drafting the definitive agreement. Lawyers are expensive for both sides. The buyer bears the brunt of the expense for due diligence. If the buyer says he is satisfied after due diligence, the sell side legal fees might be worth the investment.
- Provide for binding confidentiality and non-solicitation agreements that survive the termination or expiration of the LOI.
- Fully delineate the indemnification mechanism. Provide for an indemnification basket and cap, and that such will be the sole and exclusive remedy for breaches.
- If the buyer intends to establish an acquisition sub, be sure to obtain the signatures of both the parent and sub for purposes of enforcing the binding provisions of the LOI.
- If an earnout is to be used, include the precise language to be used in the calculation and payment of the earnout. A peg to revenue is best. Gross profit is second best. Net income or other forms of “profit” should be avoided because of the many ways expenses can be manipulated.
- Nail down the exact mechanism for pegging “normal” working capital, and how the closing price will be adjusted for working capital deviations.
- If possible, retain the right to shop the deal with other buyers through conclusion of due diligence. Avoid a long unconditional standstill provision.
- Consider seller’s appetite for litigation and consider providing, as appropriate, for arbitration. Most commonly, lawsuits arise from non-payment of a deferred portion of the purchase price or breach of representations by the Seller. Sellers generally like speedy justice when it comes to getting paid, but resist the notion when it relates to purported breaches of representations. Determine which is more likely.
- Stipulate, of course, what assets and liabilities will be included – and not included – in the transaction.
- How long will seller’s warranties and representations survive? They need to terminate in, say, 3 years after the date of closing.
- Specify, if possible, all of the material conditions to buyer’s obligation to close. Resist, if possible, open-ended due diligence and financing outs, and other conditions largely within the control of buyer.
- Insist on a detailed timeline. Seller should add key dates such as:
- Date of first draft of definitive purchase agreement
- Dates for employee, vendor and customer interviews
- Dates by which buyer must have financing
- Include, as appropriate, provisions such as the right to terminate the LOI if buyer should (1) try to renegotiate essential terms, (2) delays the process or (3) otherwise fails to live up to seller’s reasonable expectations.
- Preclude press releases and publicity announcements and postings of any kind without the prior written consent of Seller. Generally, you don’t want any announcement prior to closing. There is no benefit to the seller.
From the Buyer’s Perspective
Buyers gain tactical advantage from avoiding specificity of deal terms in the LOI. However, the buyer will want to be sure the seller is clear on exactly what is expected of him and how the transaction will move to closing, especially if the buyer is inexperienced, and have binding terms the protect the buyer from getting his time and money wasted.
- You want a tight (binding) “no-shop” or exclusivity agreement from the seller before spending the considerable amount of time and money necessary to conduct due diligence and draft documents.
- If you are unsure whether you will acquire the stock or assets, leave flexibility. Buyer will “acquire the business of the Company” or “acquire the assets or capital securities of the Company.”
- With few exceptions, leave yourself the flexibility and time necessary to complete due diligence review prior to agreeing to specific terms.
- Sellers typically resist a holdback or escrow, but it can be deal making or breaking for the buyer. If you want it, get it in at the LOI stage.
- If the buyer is aware of certain areas of potential liability, broach them at the LOI stage. Specify how such may affect the purchase price, the escrow amount, or structure of the transaction.
- Consider whether and to what extent the shareholders or management will be asked to personally make representations, and enter into employment and non-compete agreements. To the extent they will, get them in the LOI.
- Include the seller’s obligation to cooperate in due diligence as needed by buyer, as well as an obligation to negotiate in good faith. These obligations, which essentially prohibit the seller from unilaterally terminating or taking an unreasonable position to squash the deal.
- Bind the seller to managing the business “in the ordinary course” from LOI to closing. Consider as well a provision that the buyer cannot incur liabilities or purchase assets over a certain dollar amount.
Business purchase and sale transactions are complex. Success requires skilled communication, negotiation, and the savvy that comes with experience. The reward for “getting it right” can be considerable. Lack of experience and haste will lead to waste. If you’re new to it, gain the help of an experienced dealmaker. Not an attorney or an accountant, but a transaction broker or advisor. Lawyers and accountants are essential, but they are not dealmakers, and their overuse, in appropriate use, can result in a failure to close but success in spending a lot on professional fees.