Selling a Business Part 3: The LOI/Offer
29 May 2023: Selling a Business Part 3: The LOI/Offer
Last week’s post, the second in this 6-part series on selling a business, focused on the listing and what the owner of a business coming to market should look for. (Part 1 focused on the preparation or the business – and the owner – for the coming sale). This week we look at what to expect from a buyer’s letter of intent (LOI) or offer to purchase.
It has been our experience that offers to purchase are the initial acquisition document only when the business in question is very small; a laundromat, single unit car wash, small mom and pop restaurant and the like. Businesses that need very little, if any due diligence (which, incidentally, is the topic next week’s post, Part 4 of this series). Given that most of the businesses we focus on are larger and the initial acquisition document is almost always a letter of intent, the LOI is what this post is about.
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The usual purchase contract is a lengthy document containing copious amounts of boilerplate language – text that is necessary in most similar contracts and is used repeatedly by the talents that prepare such docs. This can represent 50% or more of the content of the document.
No matter the issue being addressed – the purchase of real estate, the settlement of a dispute, the acquisition of a business – few people will go through the time and expense of preparing a definitive purchase agreement until the salient points of such transaction are negotiated and agreed. A letter of intent, rarely longer than four pages or so, is the tool used in most cases.
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Therefore, this post focuses on what a seller and the seller’s broker are likely to see initially from a prospective buyer: the letter of intent.
The intent of the LOI is to open negotiations on the most important terms of the proposed deal. But remember, it’s from the buyer’s perspective. In few cases does the buyer expect the seller to accept the terms of the proffered LOI. Such terms are almost always the starting points of the negotiations and a seller should view them as such and realize that the potential buyer is “testing the waters”. He or she expects a counter; one with most, if not all proposed terms revised.
(The Brokers Roundtable℠, an online community created and hosted by Worldwide Business Brokers, has a live interview with Greg Brinson, of CapLinked Partners, California-based provider of Virtual Data Rooms (VDRs), scheduled for Thursday, 22 June. VDRs are essential in controlling the flow of information when confidentiality is important. At the conclusion of that discussion there will be a Q&A during which attendees can get their questions answered by a pro. But you’ve got to be a member to attend. You can sign up for The Brokers Roundtable℠ here.)
The hope is that the terms of the offered LOI will be “reasonable”, rather than “ridiculous”. But who’s to judge “reasonable” and “ridiculous?
A professional business broker or M&A specialist is the ideal person to fill this role. He or she, assuming an informed valuation has been done, knows how the market has treated businesses such as the one in question: what, as a percentage of these numbers, was paid for similar amounts of revenue and earnings; how long the due diligence should take; what warranties and representations should be expected; what should the financing structure look like; and many other aspects of a “reasonable” deal. With that knowledge and experience, a professional business broker is qualified to judge the reasonableness of the LOI and counsel the seller on how best to proceed. When selling a business, such talent is essential.
What to Expect
A buyer’s letter of intent will usually contain references to the following major terms of the proposed deal:
- The structure of the transaction (asset or stock purchase; the topic of a future post in this series),
- The purchase price
- Payment terms (will there be a seller note; anything held in escrow; an earn out; etc.?)
- Due diligence: The scope and duration of the study period
- Transition period: The scope and duration of the seller’s ongoing assistance.
- Confidentiality: A BIG deal.
- Exclusivity: Effectively taking the business off the market for a certain period of time.
- Target closing date.
- A list of contingencies to closing (permitting, environmental, financing., etc)
Again, if the terms offered are “reasonable”, the buyer and seller will negotiate until they are satisfied with the provisions of the LOI. The LOI is signed, and the parties enter a period of exclusivity where the buyer has the sole right to pursue a deal with the seller.
Caveat #1: The exclusivity period – the period during which the seller and broker must freeze all efforts to find additional buyers and often described as the “no-shop” clause – must have a clearly-stated ending. This is known as a “sunset” term. It might be 30 days, 90 days or any other timeline but whatever it is, there has to be a specific end date or the buyer can drag the deal out to the point that the seller will simply concede some issues unnecessarily just to get the deal done.
Caveat #2: The seller must remember that the purchase price is subject to change at least through the due diligence period. Brokers must caution our clients to not make specific plans for the purchase price before that date. And it’s not unusual for some unforeseen speed bump to arise after the due diligence period has ended and the deal’s closing is only days away that drives the buyer to request a change in price or a change in how that price will be paid.
Caveat #3: The closing date is never more than a guess on the part of the buyer and a hope on the part of the seller. It will almost always be different than stated in the LOI – and could even be different than stated in the eventual purchase agreement.
Caveat #4: We always want a statement in the LOI that “binds” the parties to work in good faith toward a purchase agreement within a certain period of time. This could be as short as 10 days or as long as the duration of the due diligence period but we want the onus to be on the buyer to submit a draft of a purchase agreement by a date certain. Our client, the seller, needs to know that negotiating the purchase agreement will take some time but we need to keep the deal on track. We do this by including, to the extent possible, specific timelines in our response to the buyer’s LOI.
The Bottom Line
A letter of intent, sometimes referred to as a “term sheet‘, is always a bit squishy. It’s non-binding so either party can take advantage of that “squishy-ness”. But when selling a business, sellers and brokers must realize that buyers are more prone to take such advantage, particularly since they, by reason of the exclusivity, have effective control of the business vis-á-vis the sale. Hence the need for a sunset date on the exclusivity period.
Some buyers will want the exclusivity period to run concurrent with the due diligence. This is not necessarily an unreasonable request. But if the business is complex and will require an extended due diligence, the scope of the due diligence, with milestones, should be clearly spelled out ahead of time. And upon certain milestones being reached, remove certain issues from negotiation within a certain period of time. Exclusivity can be tied to one of those milestones.
As brokers usually representing sellers, we want to incentivize a buyer to get on with the acquisition without unreasonable delay or bail out so we can get on to the next buyer.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at jo*@Wo*******************.com.
If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
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If any of you know of something that might fit, please let me know.
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 500 in the world. He can be reached at jo*@Wo*******************.com