10 Things Sellers Must Do BEFORE Signing Letter of Intent
My Love/Hate Relationship With The Letter of Intent
I admit it. I used to hate the Letter of Intent. I know many other business sales professionals who still do.
I spent many years in commercial real estate doing office and retail leasing, institutional investment sales and ground-up development deals. Some investors seem to enjoy sending LOI’s out by the dozens, hoping to grab the eyeballs of attention-starved sellers and their brokers. It’s common to receive LOI’s from prospective buyers who’ve never seen the property and couldn’t tell you where it is.
These agreements are almost always non-binding, allowing buyers to back out for any reason. It usually obligates the seller to negotiate with the buyer on an exclusive basis going forward, removing the listing from the marketplace. The buyer enters into a due diligence period with the supposed comfort that other prospects won’t make an end run and steal their deal.
Once a business owner signs an LOI, the balance of power shifts dramatically in the buyer’s favor. Once you’re in bed with the buyer, you’ve got to be careful who sleeps where, and when. If not handled properly, with enforceable timeframes and earnest money deposits, buyers are capable of dragging out due diligence for months and manufacturing reasons for better terms and a lower price.
LOI’s work better in business sales than in commercial real estate transactions. They allow business buyers and sellers to warm up to each other without the pressure of a binding contract.
Here are 10 steps every seller should take BEFORE signing an LOI.
- Making sure your buyer is “real.” An earnest money deposit should always be part of the LOI submission. In smaller deals, the EMD will be refundable. On larger deals, portions or all may be non-refundable. It your buyer balks at submitting a deposit, move on. For individual purchasers, get a personal financial statement, credit report, bank statements, more than just a standard proof of funds.
- Negotiate down the due diligence terms. Most acquirers will ask for a period of 60-90 days. You may be able to negotiate this down to 45 days, maybe 30 with financial buyers. Make sure the LOI has clearly stated timeframes and consequences. The buyer should always know you’re not about to let due diligence drag out. Make it clear there are others at the table, though you’re still honoring the “no-shop” clause.
- Considering auditing your financials. When numbers don’t make sense, buyers balk. There’s nothing more credible than handing audited statements from a recognized accounting firm to a buyer. Faulty financials are among the leading causes of broken deals.
- Make sure you understand ALL deal points. Is this a stock or asset sale? Will funds be held by an attorney or escrow? Will you get 100% of the proceeds at closing? Know how the holdbacks, carveouts or seller carry notes will work. What are the contingencies? Do you pay off any longterm debts or does the buyer? One of the biggest mistakes you can make as a business seller is not understanding every element of the proposed transaction.
- Have detailed discussions with your accountant and financial professionals. I can’t stress this enough. Understand what you will walk away with. How much Uncle Sam gets. How to reduce your tax hit. What all closing costs will be. What are the tax implications of your receivables? Many business owners are dissatisfied upon closing because they didn’t walk away with as much as they expected. You need to know how the numbers will play out.
- Make sure your supplier and customer contracts have “successor clauses.” Whenever possible, have your contracts include a clause stating the agreement will survive any change of ownership. The presence of this language gives buyers much comfort.
- Disclose risks and flags to the buyer. All companies have risk factors. The more you disclose at the outset, the easier it will be to build the necessary trust. Heed to adage – “Problems don’t kill deals. Surprises kill deals.”
- Fully understand and negotiate the non-compete agreement. These can get tricky in the online and ecommerce space, where there are no geographic boundaries to your business. How does it limit your future business activities? Are you being adequately compensated? Is there an enforcement mechanism? Can your buyer live without one?
- Nurture and prepare your references. Acquirers may want to speak to customers, suppliers, employees, attorneys, accountants. Contact a few key “reference-able” folks so they’ll be ready without necessarily indicating the business is for sale. Tell them they’re getting contacted because you’re applying for a business loan.
- Understand all aspects of the transition. Make sure your role in the post-sale company is clearly defined. Many of these details will not likely be spelled out in writing so a good deal of conversation may be in order before signing the LOI.
Analyzing competing offers is not always easy. Deals often get hung up on issues having little to do with price. Your chances improve tremendously when you truly understand the elements of the LOI and you have a genuine sense of the buyer’s motivations.