Selling a business? Tips for evaluating a buyer’s letter of intent

October 24, 2018|Brock Childers

It can be difficult to decide how much sensitive information to share with a buyer up front when selling your business. A buyer’s letter of intent can offer some clues—or perhaps, some red flags.

Once you have made the decision to sell your business and have gone through a proper mergers and acquisitions (M&A) process, the next step is to evaluate letters of intent (LOI) from potential buyers.

An LOI is a nonbinding written document from a potential buyer that outlines the intentions of the buyer and the seller to establish basic terms of the business purchase.

So, once the seller signs an LOI, the deal is done…right?

Unfortunately, signing an LOI does not mean the deal is closed. In reality, it has only just begun. Typically, signing the LOI means the buyer and seller have agreed on the key terms of the intended transaction and have also agreed on a period of exclusivity while the buyer evaluates more intimate details of your business and final terms are determined. Typically the seller is prohibited from talking with other interested buyers during the period of exclusivity.

Shortly after the LOI is signed, a process of increased due diligence begins. The due diligence process usually grants the buyer with access to more private information of the company, including:

  • Detailed financial information
  • Customer information
  • Pricing
  • Sales pipeline and backlog
  • Contracts
  • Employee information
  • Other confidential information

Seller beware

As a seller, it is important to understand that a buyer can still walk away from the deal even after they have reviewed the sensitive information that was provided in due diligence. If this happens, it can have unintended consequences for the seller, especially when the buyer is a direct competitor. That is why it is important for you to evaluate all offers and determine if the buyer has the ability and true willingness to close the transaction before signing an LOI. Below are some important items you should consider when selecting a buyer.

Is the deal too good to be true?

A great offer may sometimes be nothing more than a great offer. If the offer seems unrealistic, this can result in different terms than were originally laid out in the LOI, or even worse, a failed transaction.

How will the seller be compensated for the business?

Will you receive the full purchase price in the form of cash at closing? As the seller, will you have to place any proceeds in an indemnification escrow? Is there an earn-out portion that is dependent on the business meeting certain criteria in the future? Will you receive any rollover equity of your company or any stock of the buyer?

How will the buyer finance the transaction?

Will they pay cash for the company or finance with bank debt? Or, do they want you to help with the financing via a seller note or other instrument? If the financing seems unrealistic, this may decrease the probability of getting the deal done.

Does the transaction include a working capital adjustment?

If yes, how is the basis for normal working capital determined? If value was based on a stream of cash flows, the expectation is that a normal level of working capital will be delivered at close.

Will the buyer—especially one that is active in your industry or market—determine through due diligence that investing the same money in their existing business will be easier than paying a premium by buying a company?

Will the buyer try to use this as negotiating leverage to lower the proposed purchase price?

Is the offer a stock or asset deal?

If the deal is an asset deal, what assets and liabilities will the buyer be assuming? Keep in mind that a stock and an asset deal with an identical purchase price may have different tax implications for you as the seller.

Who is responsible for paying off the long-term debt?

Most deals are done on a cash-free, debt-free basis, which often means the seller is responsible.

What sensitive information will you have to provide during due diligence?

As the seller, consider whether you could potentially provide more sensitive information—such as customer names—after a purchase agreement is executed, or at a minimum, when it is reviewed.

What involvement will you have in the business after the transaction is closed?

Will you be able to walk away shortly after closing, or will you be required to be involved with the business for a longer period of time? If the seller is required to be involved, what will your involvement and compensation look like post-closing?

Will you be required to sign a noncompete agreement with the buyer?

What does this agreement limit you from doing in the future? Most transactions will require a noncompete between two and five years.

Total deal value is always a key concern, but it is important to understand that there are so many other factors that need to be considered before agreeing to a letter of intent. Working with an experienced team of investment bankers, attorneys and accountants can help navigate and negotiate the best deal possible for you as a seller and can also increase the probability of successfully closing the deal.

Contact us with questions or for help creating a team who can advise and evaluate offers during the sales process.