Thursday, February 23, 2006

Understanding the Letter of Intent (LOI) in the Sale of a Business

The letter of intent is an essential step in facilitating the sale of a business. The purpose is to establish the economic framework for buyer and business seller to move to the due diligence phase. It basically says that with all the available information I have thus far seen and if that all stands the scrutiny of due diligence, I am willing to buy your business for X dollars under Y payment terms. It is however, non- binding pending the execution of mutually acceptable purchase agreements.
If I am a seller, I am going to insist that I have this letter establishing the economics of the deal before I agree to allow my company to be turned inside out with buyer staff and advisors. If, as the seller, I want $5 million and the LOI specifies $4.5 million, I am going to attempt to negotiate up before I counter sign this letter. If I am still short on price and terms, I continue to sell the company to other interested buyers.
If I am the buyer, I want the seller to commit to my economic parameters before I spend thousands going through due diligence. The other important element of the LOI from the buyer’s perspective is exclusivity. The buyer will lock up this company for a period of from 30 days to 90 days to complete their due diligence and execute mutually agreeable definitive purchase agreements. That means that in return for the time, effort and expense of due diligence, the seller and his business broker or merger and acquisition advisor are not allowed to actively market the business to other interested parties.
If you are the seller and you get your LOI, don’t celebrate yet. Make sure the financials that the buyer is analyzing to come up with his offer are professionally done using GAAP. Normally a measuring point is established in the LOI with those financials for net working capital. There will be an adjustment made to the transaction value (post closing adjustments) depending on the new net working capital balance post close.
If the buyer is looking at sales forecasts prior to submitting his LOI, make sure they are conservative and accurate. If you have some major sales losses or the pipeline moves to the right (they always do) some buyers may attempt to call that a material adverse change and look for an adjustment in purchase price.
Finally, the LOI is normally a three to seven page document without a lot of legal boilerplate. The purchase agreements that follow will take care of that. So expect 30 pages or more. Focus your efforts on the economic parameters and conserve your legal budget. You will need your attorney most for his help with the purchase agreements.

Dave Kauppi is president of Mid Market Capital, Inc. MMC is a business broker firm focused on middle market corporate clients. We provide complete M&A services. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123 or
Dave Kauppi is a business broker and President of MidMarket Capital. We help business owners with all aspects of Mergers and Acquisitions. Dave a licensed business broker and a member of IBBA and the MBBI. Contact (630) 325-0123

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