First-time sellers often feel pressure to rush into signing a letter of intent, or LOI, submitted by a potential buyer, but the LOI is much more than a box to be checked on the journey to selling your company.
At the LOI stage in a deal, you and your buyer have limited information about each other. You are still getting to know one another, due diligence is just commencing, and the optimal deal structure for both sides has yet to be determined. How then can the buyer be expected to present you with a detailed letter of intent? On the other hand, can you as a seller commit to a deal based on purchase price, with little additional information? In general, a buyer will prefer a short, high-level LOI, while sellers should push for a more in-depth, negotiated LOI.
Although the LOI or term sheet, as it is also referred to, is not legally binding, it documents both parties’ intent to close a deal based on specified terms. It reflects both the buyer’s and seller’s crucial requirements for the deal and provides a blueprint for the definitive agreements. Many deal professionals believe that a deal is either won or lost during the LOI stage of the process, and that it’s essential to outline all the key points in the deal. We’ve written in the past about what belongs in a thoughtfully negotiated and comprehensive LOI. In this article, we’ll expand on three reasons why you should think about your LOI as an important, or perhaps the most important, step in the deal process – the “why” behind your LOI.
As a seller, your leverage peaks during the LOI negotiations when buyers are competing to acquire your company and begins to diminish after one is signed. An LOI typically calls for an exclusivity period during which the seller is prohibited from discussing the sale of the company with other potential buyers, while the buyer will conduct due diligence and write the definitive agreements. A sophisticated buyer won’t proceed into costly, time-consuming due diligence without an exclusivity period and the assurance that the seller is committed to pursuing a deal with them; however, a seller should grant it very judiciously.
As a seller, you lose not only the leverage provided by the threat of another buyer offering a higher price or better terms. Due diligence means that buyers will have access to sensitive information, vendors, customers and key employees, and word of an impending sale can dissuade them from making commitments to your company. And should the buyer – for whatever reason – not proceed, the implication to the market is that they discovered a fatal flaw during their due diligence. In short, your negotiating position is weakened, making you more likely to agree to unfavorable terms to close the deal.
Takeaway: negotiate the key deal points while your leverage is at its highest point.
Deal expenses can be significant and start to ratchet up during the due diligence phase. For the buyer, there is travel to meet the management team or conduct plant tours. A buyer will commit significant time and, often, an outlay of cash; for example, accounting, regulatory, or industry specialists may be hired to provide analyses. And the buyer’s attorney will produce a lengthy, detailed first draft of the definitive agreements.
For the seller, much of the cost comes in the form of upheaval within your company. Your management team will populate a data room and respond to due diligence requests. Countless meetings – both internal and with your team of deal professionals – will require significant time commitments. There may also be requests for your company to engage outside specialists to produce environmental, quality of earnings or other reports. And, of course, you and your deal professionals will be heavily involved in reading, re-writing and negotiating the definitive agreements.
Takeaway: before these costly, time-consuming steps are taken, work through the difficult conversations and document key deal points in the LOI.
Likelihood of a Close
Deal negotiations can be drawn out, costly and even adversarial. However, when buyer and seller have these often difficult discussions about key deal points early on, critical deal terms and structure are agreed upon at a high level and outlined in the LOI. Once both parties have aired their must-haves and deal-breakers, surprises during the lengthier, more detailed negotiation of the definitive agreements should be few and of lesser importance. Conversely, in the absence of such discussions, it can be an uphill battle for the seller to gain ground on requests not previously outlined in the LOI.
Takeaway: a thorough, negotiated LOI both decreases the time required to produce the definitive agreements and increases the likelihood of a closing.
The Ideal Scenario
When considering an LOI from a potential buyer, the ideal process involves in-depth discussions so that both buyer and seller agree from the outset that a deal can be reached. Potential deal breakers are brought to light and resolved. Having negotiated and documented the terms of the transaction that are important to both parties, the process of writing, negotiating and finalizing the lengthy, detailed definitive agreements moves quickly and smoothly. An understanding has already been reached, and the process is collaborative as both parties work actively towards that deal.
As a seller, you are putting your deal at risk by neglecting critical deal points in a brief, high-level LOI. It is advisable to rely heavily on your team of deal professionals to help you walk the fence between a thorough, thoughtful LOI and the needless breakdown of negotiations in the early stage of a deal. Work towards a deal with a good likelihood of closing by agreeing on a thorough, thoughtful LOI while you have a strong negotiating position.
At Linden Law Partners, we specialize in quarterbacking all aspects of M&A deals, and we have represented buyers and sellers in hundreds of M&A transactions. While there are many common threads among the most successful transactions, we recognize the uniqueness and personal attention required for each deal. Contact us to discuss how we can help.
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