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Punching Out! Getting to a Signed Letter of Intent

The letter of intent (LOI) is an important milestone in the sale of a business. It shows that both the buyer and seller have agreed in general to the valuation, terms, and conditions of a deal and that closing should take place in 60–90 days or so if due diligence, financing, final negotiations, and other items are successful.

Before the LOI stage, the parties have likely been introduced, signed an NDA, exchanged information, and met or talked several times. If an advisor represents the seller, the seller may have interacted with several buyers. Often, buyers are asked to submit a simpler indication of interest (IOI) before reaching certain milestones, such as a visit to the seller’s location. An IOI is typically very simple, around 1–2 pages long, listing the basics, such as valuation, terms (cash at closing, deferred compensation, other aspects of compensation), and any essential conditions. IOIs usually have no binding terms. Sellers and buyers often prefer to exchange an IOI before going too deep in the process to make sure both parties are in basic agreement on most key points.

The LOI serves as a roadmap for the buyer’s attorney to begin drafting the purchase agreement, so it is important that there are enough details in the agreement. Any major terms that are important to the parties should be included. Generally, the LOI includes the following:

• Introduction: A brief summary of the buyer, their experience in the industry, and the reason for their interest in acquiring the seller
• Valuation: The price that the buyer is offering, usually with some justification (for example, six times the average adjusted EBITDA for the previous and current year)
• Terms: Cash at closing, escrow, deferred compensation (earnout, seller note, other items). If a seller’s note is included, the buyer typically lists the terms of the note, such as interest rate, principal and interest payment terms, and any other conditions. If there is an earnout, a basic formula is usually included. Some buyers wish for the owner and/or management to have a continued ownership stake in the company after closing. In that case, the amount of ownership, terms, and buyout conditions should be included
• Assets/liabilities: Especially for an asset sale, it is important to list what assets and liabilities will be included in the deal, such as accounts receivable, inventory, accounts payable, etc. Almost all deals have a balance sheet adjustment clause to account for any changes in working capital during due diligence
• Cash/debt free: For many asset sales, the seller keeps any cash in the business but pays off any debt. If there are any operating leases, equipment leases, building leases, etc., these should be spelled out
• Legal structure: Asset or stock sale (this could be very important for tax purposes, especially if the seller is a C corporation). Many buyers prefer an asset purchase to help avoid past undisclosed liabilities of the seller, such as legal, environmental, employee, and other issues
• Financing: The buyer should indicate how they will afford the deal, such as using cash on hand and/or current borrowing capacity, or if they will need to raise debt or equity. Sellers should be careful of buyers who have a financing contingency, as it may take the buyer 60–90 days (or more) to secure financing. A seller may end up having to renegotiate later with the buyer’s lenders or investors after already spending a lot of time negotiating the LOI
• Exclusivity period: This is typically one of the few binding conditions of an LOI. The seller is pledging to not negotiate with other buyers during the due diligence period, which is often 60–90 days. The buyer is spending significant time and money on due diligence, and both parties are spending a lot of money on attorneys, accountants, and other advisors. If a seller is well-prepared, the buyer is well-financed, and nothing major comes up in due diligence, deals can close within 60 days or quicker
• Ownership/management transition: How long will the owner(s) stay, their compensation, and roles. Some buyers want employment agreements for key employees
• Building/lease: If the seller owns the building, this is a significant component of the deal. Many buyers do not want to commit to a real estate purchase. If the business is difficult to move, such as a PCB shop, buyers typically will want a long-term lease. If the building is leased from an unrelated third party, a buyer will want to confirm that the building owner will approve the new tenant and not change the terms of the lease
• Going concern or consolidation: Especially for smaller deals, buyers may wish to move the seller’s business into the buyer’s facility (consolidation) while buyers for larger deals usually want to keep the seller’s facility as a going concern. It is important to make it clear, especially if the buyer wishes to do a consolidation
• Environmental: Whether buying the building or not, for both PCB and PCBA deals, buyers often want to complete a Phase 2 environmental report. Since these reports can take 30–60 days to complete and review, it is usually best if the seller has this completed before going to market
• Breakup fees: While common in larger deals, most smaller deals do not have a breakup fee, or the fee is fairly small. Often, the parties commit to a certain breakup fee figure, or to cover legal/accounting expenses of the other party, up to a certain amount under certain conditions. Both buyers and sellers are concerned that the other party will drop out for no good reason, such as simply changing their mind. Buyers are also concerned that due diligence will reveal that the seller’s financials are substantially incorrect, or that other undisclosed issues will arise
• Reps, warranties, and insurance: Some LOIs get into more details, such as the general terms for the seller’s representation and warranties. For deals currently around $25 million or more, many parties consider rep and warranty insurance to cover large post-closing issues. Premiums for this type of insurance are coming down, so it may become more common for smaller deals as well
• Others: The list of terms can go on for a while, but some common terms are state of jurisdiction, good faith clauses, normal conduct of business, indemnification, disclaimers, any shareholder or other needed approvals, closing conditions, confidentiality (if an NDA has not already been signed), a clause that each party is responsible for their own expenses, and others

An important decision can be whether to under-negotiate or to over-negotiate. LOI negotiations take a while to complete, typically 1–2 weeks. If both parties are motivated to complete a deal and were already generally on the same page, these negotiations can be smooth. If LOI negotiations drag on, it can be an indicator that due diligence and the purchase agreement negotiations are going to take forever.

There is a trade-off between negotiating everything in the LOI or leaving it for the purchase agreement. A typical LOI is 5–6 pages, but for larger, complex deals, they can be over 20 pages. Each deal is different, but if things are tough-going during the initial dating period (LOI), just think what the wedding planning (purchase agreement) and marriage (post-closing) will be like.

If your deal gets to a signed LOI, congratulations—the hard work has just started! Hopefully, the seller has already prepared the materials for a data room (or can produce those quickly), the buyer will move according to schedule, nothing will come up in due diligence, and the deal will move quickly to closing. Good luck!

Tom Kastner is the president of GP Ventures, an M&A advisory services firm focused on the tech and electronics industries. He is a registered representative of StillPoint Capital, LLC—a Tampa, Florida member of FINRA and SIPC—and securities transactions are conducted through it. StillPoint Capital is not affiliated with GP Ventures.