I want to start this blog post by defining what a Letter of Intent (“LOI”) is and as importantly, what it isn’t.
An LOI is an agreement between two parties that outlines the broad strokes of a transaction. Its primarily non-binding, which means that either party can walk away from the deal for any reason “while under LOI” with no future obligations (apart from usually some sort of confidentiality provision). LOI’s are also referred to as term sheets, the primarily difference being that LOI’s are usually written in letter form whereas a term sheet is usually done in bullet form.
Everyone has their own preferred format and structure of an LOI. Some parties prefer to keep them to one simple page with only the very high level details outlined. At Redcap&Truss, we prefer a more detailed LOI for a few reasons.
First, its usually more advantageous to the seller to negotiate the key value items early and upfront in a deal due the increased tension in a process and before the deal goes “exclusive” to the buyer. Exclusivity is often a key term in an LOI and it means that once the parties sign the LOI, while the sale is non-binding until the definitive documentation is signed, the parties are agreeing to work together for a period of time (usually 60-90 days) to negotiate the definitive documents and complete due diligence, and during that time the seller won’t entertain offers or discussions about the business during that time. This is an important concept to buyers as they don’t want to spend time and money working to complete a deal only to have the buyer tell them near closing that they found a better deal with another party.
Second, we prefer detailed LOIs as it provides a roadmap for the other advisors (particularly the Lawyers involved who are drafting the definitive documentation) the guideposts for a deal. We work with some really knowledgeable and great lawyers, but when real value items are not properly contemplated in the LOI, they become harder points to negotiate in the definitive documentation (and frankly, can take up a lot of lawyer billing time). The more detailed up front we can be on what the business terms are, the more focus the lawyers can put to the legal aspects of the deal.
Finally, the act of negotiating a more detailed LOI in and of itself gives the opportunity for both sides to really get a sense of each others business style. Selling a business, especially one where the seller is expected to stay on for a period of time is a bit like dating, so the more discussions that can be had early, often helps develop a sense of trust between parties (or expose fractures that we’d like to know about sooner rather than later).
So what are the key terms in an LOI? When we send out our instructions letters to interested parties, we will generally ask for the following information:
- Purchase Price – What is the enterprise value the buyer is putting on the business, assuming a debt free and working capital free basis. By looking at an offer on a debt free, working capital free basis, we can compare different proposals on a more apples to apples basis and ignore any capital structure consideration at this time. Some sophisticated (and arguably unscrupulous buyers) will try to hide their ultimate value by outlining certain assumptions about working capital levels and assumed debt. A strong advisor can guide a seller through this, but a transparent buyer will understand this nuance from the outset and provide a clear value proposal upfront.
- Transaction Structure – outline whether the buyer is proposing an asset or share sale (we will cover the differences in future posts) and here is where we would request any details about required working capital levels, the assumption of debt or operating leases, and any other tax or other structuring items a buyer is contemplating like earn-outs or shares given as consideration. Ideally, this is the section that is heavy on details as this forms the basis of the definitive documentation.
- Acquiring Entity – a legal and operating description of who is actually acquiring the business. Buyers will often outline here their history, other completed acquisitions they have done and their plans for the business going forward.
- Due Diligence Requirements – what other diligence activities would a buyer like to complete.
- Financing Requirements – does the buyer have sufficient capital on hand to complete the transaction or will the buyer need to work with its bankers to raise additional third party capital. This somewhat speaks to the speed upon which a deal can be completed and the risks to the seller if a buyer isn’t able to raise the necessary capital to complete the deal.
- Role of Existing Management, Owner and Employees – Sellers, especially in people intensive businesses want to understand whether they will be requested to stay to run the business for a period of time. They will also want to understand what is going to happen to their employees, both due to an obligation to their staff, but also a legal obligation related to severance and other HR matters if the staff aren’t remaining with the business.
- Timetable – We ask for an understanding of how long a buyer may need to complete the transaction. Buyers who have long timetables often are not serious about a transaction, but want the “option” on the deal. Exclusivity may also be outlined here or in its own section.
- Real-Estate Plans – If its contemplated that any associated real-estate will also be part of a deal, the high level terms of this acquisition or alternatively, so discussion about the assumption of leases or the potential of moving the business to another location (often a shop/yard/office already in control of the buyer near by.
- Approvals – Does the signatory to the LOI have the authority to bind the buyer to the transaction, or are there internal executive or Board of Directors approvals that still need to take place (which can cause risk to a deal if the Board is not aware/not supportive of ultimately pursing a transaction). In some industries due to environmental or size considerations, there may also be government approvals that are required.
- Key Contacts and Advisors – we want to know who is going to be the point person driving this deal from the buyers perspective and have they engaged outside help. Having outside legal or financial advisors already engaged is a strong indicator that the buyer is serious about transaction (indicated by spending a bit of time and money already through the engagement process).
Receiving an LOI is often the first time a seller gets a true sense of what their business is worth and as such, its important that they are detailed and comprehensive enough to allow a seller to make an informed decision as to how they want to move forward.
We would love to hear your story – please feel free to contact us anytime (we are good with evenings and weekend chats).