When you’re selling your business, an important step in the process is receiving a letter of intent (LOI) from a qualified buyer. The terms of an LOI can still be negotiated, but once signed by both parties, it’s a little bit like getting engaged; both parties pretty much commit to each other that they will forsake all others and work diligently to get this deal closed. Here are the typical elements of an LOI.
- Identifies the Buyer. Typically, the buyer may be an operating company or a new holding company incorporated for the purpose of completing the transaction. When assessing the buyer, business owners need to ensure that the buyer making an offer has the financial backing and capabilities to complete the transaction.
- Defines the Type of Transaction. The LOI will typically state whether the transaction is being completed as a stock sale or an asset sale. Each has different due diligence and tax implications for both the seller and the buyer. The LOI will also typically identify what assets and operations are being purchased and if there are any assets,
- Defines the Purchase Price /Consideration. Most sellers would prefer to get all cash at closing, but the larger the deal, the more likely the buyer will not be willing to do this. Typically, the consideration may include some cash at closing, possibly some non-cash consideration such as equity in the acquiring company, and possibly some future payments based in part on the continued success of the business, such as an earn-out and/or a sellers note. It’s important for the seller to assess the likelihood of receiving each element of the consideration, as well as the after tax consequences.
- Sets the Buyer’s Conditions Precedent. A buyer will likely have a number of conditions in the LOI that need to be satisfied before closing. A smart buyer will include the required net working capital and FMV of capital assets that are to be included as part of the deal in the LOI, as well as a “dollar for dollar” reduction in the purchase price if working capital or capital assets don’t match the values pegged. A smart seller will ensure that this clause also allows for an upward revision dollar for dollar if a higher value of working capital or capital assets is delivered.
- Defines Required Due Diligence. There are three objectives to due diligence: a) to vet valuation assumptions, b) to identify the cost savings or revenue-increasing opportunities of the combined entity, and c) to identify any “hair” your company may have that may reduce the purchase price.
- Specifies Timing and Closing Steps. A quick close is always better than a slow close. Experienced and motivated buyers are able to close a transaction in 45 to 60 days after the LOI is signed, but a more typical time line is 90 to 120 days.
Accepting an LOI is an important milestone which marks the beginning of an intensive and time-critical process where the seller needs to be as involved as the buyer. Remember that signing LOI is not a contractual obligation, but still a big step that should not be taken lightly. You are essentially committing to see the purchase and sale process through, so backing out without a good reason will send a message to all potential buyers that you’re not ready to sell.
As ever, if you know of a business owner who’s thinking of selling or buying a business and who might benefit from a free, confidential, consultation with us, have them contact me directly.
By: Mike Ertel, Transworld M&A Advisors