How to Negotiate the Letter of Intent
One key stage of any M&A process is the successful negotiation of the Letter of Intent (LOI). The LOI serves as an initial agreement between the buyer and seller. An LOI should clearly define all of the key commercial terms, and outline key assumptions made by both the buyer and seller. Having an LOI in place allows both parties to calibrate their expectations during the M&A process, and save time, money and effort during the ladder stages.
Here are the top 8 considerations every business owner should make when negotiating the LOI:
What is being purchased?
This is important as the tax implications of an asset vs a share deal are very different depending on the seller’s jurisdiction and business structure.
How will the Purchase Price be Paid?
- Is the buyer purchasing the business in cash, shares, or a combination? Often times if the purchaser is paying all or a portion of the purchase price in shares, they will restrict you from selling those shares for a number of years post-acquisition. As a result, you will need to do some reverse valuation work on the purchaser to make sure the shares are fairly valued.
- Is there a contingent component to the purchase price (i.e. an earnout)? If so, what is it based on and what operational and tax implications does it have on your business post-acquisition? Ideally, contingent payments are simple to calculate and based on mutually beneficial outcomes.
- What portion of the purchase price is paid up front versus held in escrow? What are the triggers to release the funds held in escrow?
Where are the Funds Coming From?
Some buyers will require financing in order to execute a transaction. If this is the case, you will need to assess the likelihood of the buyer obtaining financing as it could potentially kill the deal if the buyer doesn't obtain proper financing. Also, be sure to understand what operational implications this has for the business going forward. Things like meeting interest payments and other covenants can be crippling to a business.
What are the Key Legal Terms?
What are the key representations and warranties you are making and to what extent are you willing to indemnify these? Agreeing on the legal framework for a transaction at this stage helps put a box around the potential legal risks stemming from the transaction. Doing so will help streamline both the drafting of the final purchase agreement as well as the due diligence process.
What are the Conditions to Closing?
Common conditions include Purchaser Board of Director approval, successful financing, and the seller's business achieving certain operational or financial milestones.
What are the Principal Assumptions Both Parties are Agreeing to?
Unlike legal terms, these assumptions are forward looking and will not be captured by any reps and warrants. Rather, these are the key financial and business forecast assumptions the purchaser is making in order to support the offer on the table. Should the purchaser feel any Principal Assumptions are not attainable over the course of Due Diligence, they will request to restructure the transaction. Therefore, it is important for you to carefully review these assumptions and be able to defend them over the course of diligence.
This is typically the only binding part of the LOI. In the vast majority of cases, buyers want to be exclusive with a seller before dedicating the necessary resources to Due Diligence and legals.