Selling your business is a big deal – for many, it is the culmination of a lifetime of work, and the final hurdle before retirement. Preparing for a sale takes effort, a lot of effort. With so much to do, it can be tempting to give less than your full attention to negotiating a letter of intent (LOI). After all, the LOI is non-binding, right? Though technically true, it would be a huge mistake to conflate “non-binding” with “inconsequential.” If you are selling your business, you can’t afford to miss on the LOI.
The LOI is a preliminary agreement between the parties outlining at a high level the basic terms for a potential sale. Until this point, interactions between you and the potential buyer have been akin to an open courtship, with each of you getting to know the other while possibly exploring other opportunities at the same time. Negotiating the LOI is the pivotal moment in which you define the relationship. It is a non-binding commitment in the sense that you are not obligated to go through with the sale – you are not married to the buyer yet – but you are sufficiently aligned on key points like transaction structure and price that you are willing to move forward on an exclusive basis, meaning that while the LOI is in effect, you agree not to explore offers from other potential buyers.
- Exclusivity and Leverage. Exclusivity is a key provision in nearly all LOIs. A buyer typically will not be willing to expend the necessary time and resources to pursue a transaction with you while there are still other potential buyers in the picture. To retain leverage (and motivate the buyer to work efficiently), you should insist on limiting exclusivity to a defined period, usually around ninety days, which can be extended as long as both parties continue working in good faith towards closing. Buyers often want to hurry through the process of negotiating the LOI, leaving as many details as possible for future negotiations when they have more leverage. Be careful not to move too quickly at this stage. Experienced counsel can help ensure that you secure the best possible terms while your leverage is at its peak.
- Binding vs Non-Binding Terms. Some provisions of the LOI, like exclusivity, are actually binding obligations, meaning there are real legal consequences for violating them. Most LOIs will also include binding confidentiality and non-solicitation provisions. The rest of the terms, though not legally binding, establish a clear path forward, one which the buyer will expect you to follow. In this sense, it is more accurate to say that the LOI is not a binding obligation to sell your business to the buyer, but as you move further in the sale process with the buyer, straying from the path established in the LOI will require you to traverse rough terrain. There may be valid reasons to do so as you and the buyer obtain more information, but a unilateral decision by either party to renegotiate terms already agreed to in the LOI will feel like a bait-and-switch to the other.
- Payment Mechanics. For most sellers, the most important point is the total purchase price, but, as is often the case in M&A transactions, the devil is in the details. Of course, you want to get the highest possible price for your business, but you also need to consider when, how, and by whom you are paid. Because you lose leverage after signing the LOI, it is in your best interests to address these points sooner rather than later. If you expect the purchase price to be paid in full at closing, you should ensure that is included in the LOI. The majority of transactions include some form of escrow or holdback on which the buyer can draw to cover indemnified losses or shortfalls in working capital. The size, duration, and accessibility of such funds are all up for negotiation.
- Transaction Structure. The sale itself can take many different forms. Your business can transfer its assets to the buyer, you can sell the equity interests of your business to the buyer, or you can merge your business into the buyer’s business. There are significant tax and practical implications at work here, the details of which are beyond the scope of this article, but it is imperative that you consult with an experienced advisor to create a structure that protects your interests.
- Post-Closing Relationship. Last, but not least, consider what kind of relationship you will have with the buyer after the sale of your business is complete. For example, you might be a creditor of the buyer if some or all of the purchase price will be paid to you over time under a note, or the buyer may wish to hire you as a consultant to assist with the integration of your business. True “walk-away” deals – where you shake hands with the buyer at closing and never see or hear from them again – are rare. Odds are that your paths will be intertwined to some extent for at least some period of time after the sale is complete. Either way, the LOI should address whether and to what extent you will remain involved with the buyer going forward.
The topics covered here are just the tip of the iceberg. These are complex transactions and no two are exactly alike. Assembling the right team around you early in the process is the best way to reach a successful outcome. To learn more about Fluet’s Corporate + Transactional team capabilities, click here.