Selling a Business - Why the Letter of Intent is So Important

A Letter Of Intent, or LOI, is an "intermediate" document drafted and submitted to you by the buyer.

I say intermediate, because it is not the final contract. But it spells out the major elements of the sale the buyer and seller have agreed to so far. Typically, you will accept a Letter Of Intent and then enter into a period of exclusive negotiations with just one buyer.

The Elements Of The Letter Of Intent

Selling Price & Terms - Amount of cash down, interest rate and term as well as description of the security the buyer is providing the seller.

Structure - Is it an asset or stock sale? How is the sale price allocated among different elements of the sale such as non-compete clause and goodwill (this is important for tax reasons and is discussed in the next section).

Deadlines - How much time is the buyer requesting to complete the due diligence process and what is the proposed closing date? The buyer may also place a time limit (usually a week) on the seller to accept or decline the LOI itself.

Contingencies - The buyer's offer is contingent upon certain keys facts being confirmed. One example may be confirming that the current lease is transferable to the new owner. Also, their willingness to buy is contingent upon the due diligence period confirming that everything you have stated about the business is true.

Some Facts to Keep in Mind About The Letter Of Intent

1.) Don't accept an LOI that grants the buyer exclusive negotiation rights unless the Due Diligence period is short. 10-20 days of DD is sufficient for most small businesses. Some buyers will ask for exclusivity and a 2 month DD period. Your other prospects will eventually lose interest, leaving you with just one buyer. Then your one buyer will start asking for all sorts of concessions from you.

2.) Some buyers will want to skip the LOI and instead submit a full purchase contract. They figure, why should they pay their lawyer to draw up both documents. But a purchase contract requires a significant amount of time and attorneys fees to draft. Once the buyer has made this big investment in legal fees, it puts a lot of pressure on them that is detrimental to the negotiating process.

Better to encourage them from the start to go the LOI route.

3.) Hopefully, by this point you have developed more than one prospect. If you receive LOI s from more than one prospect don't just accept the one with the highest price. Be sure to take into account all the details of the offer as well as the qualifications and background of the buyer. This is especially true if you are financing part of the sale - getting a slightly higher price from a weaker buyer who runs the business into the ground and then doesn't pay you is of no benefit.

4.) It is perfectly all right to negotiate the contents of the LOI with the buyer before you have accepted it

If your most qualified prospect submits a Letter Of Intent that includes a lower price and more generous terms than you had wanted or a less qualified buyer has submitted a more attractive LOI, then now is the time to negotiate with the stronger prospect.

It's almost impossible to improve the deal once you have accepted (by signing) the Letter Of Intent. However, the buyer may find reasons to re-negotiate a lower price during the due diligence phase.

The Letter Of Intent you accept will be the best deal you will ever get.

Your selling memorandum, your recast financial statements, all your follow up communications with buyer and your tour of the facilities should all serve to justify your asking price. If the buyer has any objections or concerns about your asking price you want them to express them now rather than later.

Never be afraid to hear negative feedback or objections from the buyer - it means you will always know where you stand and gives you a chance to deal head on with their objections. And as far as disagreements over price go, the time to deal with them is before you accept the Letter Of Intent.

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Selling Your Company - Finding the Right Buyers

We are in the middle of a merger and acquisition engagement representing a Human Resources Consulting company. We had contacted several industry players and had gotten some good initial interest. Several buyers dropped out because their entire management team was comprised of family members. We asked our client to take their company off the market and to bring in at least one non family executive that had the authority and the ability to run the company. They successfully implemented this change and asked us to take them back out to market.

Because their business is counter cyclical and actually grew during the economic downturn they posted some pretty impressive growth and profit numbers. It was difficult to determine how much of the improvement was due to the addition of the new senior manager.

As we re-launched our marketing efforts, we identified several interested buyers. One buyer was particularly interested and after signing the confidentiality agreement and reviewing the memorandum, contacted us almost daily with additional detailed information requests. Before long he started to grill us about selling price expectations. As we usually do, we deflected his requests and asked him to put together his letter of intent based on the value of the business to his company.

He started giving us a lecture about valuing services companies whose assets (meaning people) walked out the door every evening. He pointed out that their revenues were based on new sales each year and not "contractually recurring revenue". We had our client put together for us a chart that showed the "historically recurring revenue" generated from their top 20 clients over the past five years. This was our way to demonstrate some consistency and predictability of revenues.

As we conversed further, my radar started buzzing loudly. This guy was getting ready to provide a low ball offer and was trying to sell me on all the reasons why I should go back to our client and pitch his offer. I politely listened to his well practiced approach for a little while longer. Then he came up with the statement that I just could not let go. He said that last year's revenues were an unusual upward spike and "I am just going to use 2008's revenues as my basis for my offer. Well, I just could not let that one go. I asked him how he would have made an offer if last year was unusually bad, but the prior five years were strong. He would not respond, but of course, the answer was that he would have made his offer based on the new trend.

There are thousands of business buyers out there that are just like this guy. There is a famous residential real estate investor that has written a book and gives classes to help individuals become real estate moguls. I could sum up his book and his class in one sentence. Find 100 people with their homes for sale. Approach them aggressively and make a low ball offer and one of them will take it.

When I reviewed where our buyer had originated, I traced it back to a posting we had made on our business broker's association Web Site. As I think about it, these Business-for-Sale Web Sites actually give these buyers a powerful tool to actively and aggressively contact their 100 potential sellers. As I thought about this, sure enough, I have seen this behavior repeated multiple times and the source was always a Business-for-Sale Web Site.

So we are always preaching to our prospective clients to get multiple buyers involved in the process. If they post their business on one of the Business-for-Sale websites, they may get multiple buyers interested, but they are those buyers that are contacting 100 sellers very efficiently through the power of the Internet in order to make their low ball offers.

But I digress. Let's get back to our client. The good news is that we had 6 other industry buyers that we had contacted and they were looking for acquisitions that were based on acquiring new customers or adding another product offering, or leveraging their sales force or install base. In other words, their buyer motivation was not to buy a company with a low-ball offer.

The only way we can encourage buyers to make fair offers is to conduct an outbound marketing campaign to industry buyers that have strategic reasons for making acquisitions. If we can get several involved, then the buyer that comes in and says that he is going to base his offer on 2008 performance, is easily eliminated from consideration. If a business seller is only going to attract these inbound, bargain seeker buyers from Web Sites, he/she will only be getting low ball offers and wasting a lot of time.

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