The first step in selling a business or firm is often a letter of intent (LOI).
Many sellers see this as a document of no significance that should be signed right away because the ‘real’ transaction will be negotiated later.
This isn’t correct.
Instead, the LOI sets the key terms and conditions for the transaction and trying to renegotiate or add important terms later will, in the absence of some compelling reason, be seen as acting in bad faith.
Therefore, it’s important to get the LOI “right” – fully describing the key deal terms.
These include:
- Purchase Price. The total price and how it will be paid.
- Buyer Loan Terms. If the buyer is financing the purchase with a loan, set guardrails for the loan terms and amount.
- Seller Note Terms. Be sure any note to be held by the seller is described as being secured by the assets of the business and guaranteed by an owner, and fully describes the payment terms and interest arrangements (including interest during any standby term).
Remember, if the buyer is a newly formed entity with limited assets, the seller won’t have any real protection without an asset lien and owner guarantee.
- Earnouts. If the price includes an earnout, be sure the financial terms that it’s based upon are specifically defined and the accounting methods used by the seller will be the same used by the buyer to calculate the earnout. It is always best to tie any earnout to gross figures (e.g., gross revenue or gross profit), rather than net profit which is subject to the buyer’s discretion on expenses.
Remember that, even if the seller is employed by the buyer after the sale, the buyer is in full control of the business and can do whatever he wants with the expenses.
- Binding Terms. Although most of the LOI should be non-binding, they often provide for certain terms to be binding, such as:
- An “exclusive dealing” provision preventing the seller from entertaining competing offers. As the seller, its important to:
(1) set the exclusivity term to a limited period that gives the buyer enough time to complete a due diligence review while not unduly delaying a sale should the buyer decide not to buy, and
(2) require the buyer to work diligently during that time.
- A non-disclosure or confidentiality provision requiring the buyer to keep the seller’s information confidential and use it only to evaluate the deal.
Be careful using a broker provided NDA. If it’s between the broker and the buyer, the seller won’t have a right to enforce it. Sometimes, the NDA has a limited term of two or three years. And many broker NDAs don’t adequately protect the seller.
Selling a business is an exciting and potentially life-changing event. Getting to the finish line starts with getting the deal terms agreed to by the parties in the letter of intent.
If you’re wondering about a letter of intent you received for your business, call me. I’m here to help.
