Don’t Let the Thrill of a Letter of Intent to Buy Your Business Cost You – Post #28

You have finally reached the stage where the actual selling of your business begins. One of my attorney friends actually calls this stage “the first of many battles” in the “war we’re going to wage.” Your potential buyers become intentional buyers. Once they see the value of your business, buyers will issue a Letter of Intent to purchase your company. Negotiations begin. If buyer and seller teams reach agreements beneficial to both parties, you win the first battle in the formal business sale. As I’ve done before, let me implore you to listen to your legal counsel. Rely on your transition team to guide you through the landmines. This is an exciting time! However, don’t let the thrill of a Letter of Intent to buy your business cost you. Take this first step in the formal business sale cautiously.

Podcast Time Index for “Letter of Intent, the First Step in a Formal Business Sale”

00:44 – The Letter of Intent, the first step in a formal Business sale
02:45 – What is a Letter of Intent?
04:49 – What is included in the LOI?
08:46 – A LOI is not really a binding agreement
09:01 – Why have an LOI?
10:42 – Conditions to look out for
15:08 – State what is not for sale
17:26 – Other Ts&Cs to be aware of
20:27 – Conclusion

Butterflies in My Stomach

I can remember it well… way back in elementary school, like any kid, my friends and I had childhood crushes. We chased girls on the playground. Inevitably, some of my friends even handed the girls a “Do you like me?” letter. You know the one I’m talking about – the one that asks you to check “Yes” or “No.”

I’ve only experienced that same type of feeling during one other circumstance in my life – the day I received my first Letter of Intent to buy my first business. Years after those silly elementary school days and after I met the woman of my dreams, I decided to relocate to Tennessee. I knew that I couldn’t take my landscaping company with me. Since I had a business partner, I went to him and proposed that he buy out my half of the company. After talking with his wife, he came back and gave me a Letter of Intent to buy my part of the business. I’ll never forget it. It was awesome, just like that feeling I had back in grade school when I asked a girl to go out with me!

The Purpose of the Letter of Intent

Sometimes called a Memorandum of Understanding or an LOI, the Letter of Intent alerts a business seller that a buyer “intends” to purchase his company. Usually, the LOI is non-binding, but many courts across our nation and around the world uphold its provisions as contractual and binding. Therefore, whenever you receive a Letter of Intent, contact your attorney and your transition team. Let them review the document and guide your next steps.

So what purpose does this potentially binding document serve? In its most basic form, the LOI is an agreement to agree or to reach an agreement. Just like a first date sets the stage for a relationship, the Letter of Intent sets the stage for your business sale. It can effectively do one or more of the following things:

1. Lay out the expectations and essential terms of the business sale.
2. Serve as preliminary documentation for lenders or governmental boards.
3. Put the public on notice that there will be a sales transaction.
4. Determine which party or which team member will draft certain documents.
5. Set a time frame for negotiations, periods of purchasing exclusivity, purchase agreements, and closings.

Elements of a Letter of Intent to Buy Your Business

Whether the Letter of Intent shows a basic commitment between the buyer and seller or publicizes the trading of a company’s stock, it will inevitably contain a number of elements. While not exhaustive, I’ve compiled a list of details attorneys I work with and I have seen throughout our careers.

A Letter of Intent will include some or all of the following:

1. A list of the assets to be sold in the transaction
2. The purchase price for the business and all its stated assets
3. A good faith, or earnest money, deposit
4. Exclusivity period parameters
5. Expected length of time for due-diligence to occur
6. Signed Confidentiality Agreements
7. Definitions of important terms that might be used during the transaction
8. A target date for the execution of the Purchase Agreement
9. Allocation of expenses for both parties
10. Identification of sale’s jurisdiction and governing entities
11. Any provisions intended to be binding

Don’t Let the Excitement Blind You

Since the Letter of Intent signals the start of the formal business sales process, you must be more cautious than ever before. Buyers will make many demands, and you have the choice to accept them or refuse them. Adding restrictions or limits to buyer demands can protect your business during this due-diligence period. I can’t say this enough; lean on your team. The professionals you’ve assembled have walked down this road before and will know how to advise you.

Nonetheless, I want to share with you the guidelines I tend to follow when I receive a Letter of Intent on behalf of my clients or when I’ve sold my own businesses:

Guidelines to Follow When Receiving the Letter of Intent

1. Limit the exclusivity period to 90 days. – If you’ve been properly preparing to sell your business, you should have most of the data the buyer will request ready. By limiting the time you give this particular buyer exclusive rights to buy your business, you prevent the buyer from dragging out the process so long that other buyers lose interest in case this one dissolves.
2. Request the delivery of a purchase agreement within 60 days. – Dragging out the sales process could keep you from effectively managing your company which could cause the value of your company to decrease over time. The buyer could then leverage that to lower his purchase price.
3. Keep other Letters of Intent you receive private. – If you receive other Letters of Intent during the due-diligence process with the first buyer, keep them to yourself, especially if the offers are lower than the one you are working to finalize. You don’t want the buyer to lower his purchase price to match other ones.
4. Don’t take responsibility for all fees. – Don’t give the buyer everything and the kitchen sink! Share responsibility for legal fees and professional fees incurred during this time.
5. List everything that is not included in the sale. – Just as you list everything that is included in the sale, be sure to list everything you are taking with you, what’s not included in the sale. If you want to keep a piece of equipment or a plaque on the wall, list it. Don’t be afraid to keep things you need to live your life after the sale. Just be sure to clarify what you’re keeping versus what you’re selling.
6. Address what will happen to cash on hand and Accounts Receivable. – Clarify whether the seller is buying any, some, or all rights to your cash on hand and your accounts receivable. Have a plan in place for the buyer to purchase the 30 day, 60 day, or 90 day + accounts. Maybe have them buy the current accounts at a dollar-for-dollar rate. Then, maybe sell the outstanding 60 day+ accounts for 50 cents on the dollar and the 90 day+ accounts for 10 cents on the dollar. You don’t have to include any of this in the sale, but you need to spell out what will be done with those open accounts and excess cash.
7. Be wary of formula pricing. – Also known as cap pricing, formula pricing places a set cap on the sales price. While this may work if a buyer has offered you top dollar for your company, it usually keeps a seller from negotiating a higher sales price as the seller finds more value in the company.
8. Don’t text or email without attorney approval. – Since this is the beginning of a FORMAL business sale, any and all written communication can affect the terms of your Letter of Intent. Don’t send out a “quick text” or a raging email without consulting your team because that “quick text” or that rampaging email could alter the course of your sale.
9. Refuse to accept IOU’s. – If you agree to a promissory note for the cash on hand or the accounts receivable, the seller could receive it all, spend it all, and leave town without giving you a dime. Don’t trust someone you don’t know with millions of dollars. Work those accounts into your deal so that the seller won’t owe you money AFTER you sell.

Get Excited But Be Wise

A sharp buyer is going to try to get everything he can. So when you’re dealing with the Letter of Intent to buy your business, listen to your legal and professional counsel. While this process is probably new to you, they have dealt with this before. Be excited, but be wise. Seek and follow advice.

Friends, the Letter of Intent is a major event. You’re going to feel butterflies of excitement and fear in your chest. It’s almost like hitting the business lottery. Now is when your business deal is going to make it or break it. If you can make it through to the end, though, the pay-out is totally worth it… the subject of our next article.