When the seller of a business and an acquirer verbally agree on a price for the purchase of that company, the acquirer’s solicitors will, in many cases, send a letter of intent (LOI) to the seller. The letter of intent, sometimes referred to as the memorandum of understanding or the heads of terms, is the effective roadmap for the transaction from here until completion.
The letter of intent can be considered as a proto-sale and purchase agreement (SPA). The SPA is the legally binding agreement covering the sale of your business to the acquirer. However, while the letter of intent does bear many similarities to the eventual SPA you and your acquirer sign, you should, as the buyer, expect the acquirer and their professional representatives to stray away from the content of the LOI to benefit their client.
In this article, we examine how you should interpret and evaluate a letter of intent regarding a proposed purchase of your company including:
● the identification of the buyer,
● the proposed type of transaction,
● how you will be paid and when,
● who settles the debt,
● how is the transaction being funded,
● preconditions set out in the LOI,
● the scope of the due diligence required for deal completion, and
● the proposed schedule to complete transaction.
WHO IS THE BUYER?
If the buyer is an individual or an operating company, these types of buyers are much easier to pursue legally for non-payment or underpayment of monies owed. If it is a holding company, you could chase them for non-payment or underpayment however the likelihood of your actually getting any money from a holding company are almost non-existent.
WHAT TYPE OF TRANSACTION DOES THE LETTER OF INTENT PROPOSE?
Will this be a deal to buy the shares of the company from you or to buy selected assets from your company? Each type of deal is very different from each other with very different tax outcomes – you’ll need to consult with your professional advisors on both.
HOW MUCH WILL YOU BE PAID AND WHEN?
Much to the chagrin of most sellers, receiving the full amount of money for your business in a one-off payment on the day of completion is unusual.
Even when consideration is paid to you over a number of stages, some acquirers will expect you to put money into an indemnification escrow account so that they can reclaim some or all or it on grounds that will be set out in the sale and purchase agreement.
While the conditions under which you would have to repay that money seem non-onerous in the LOI, expect them to be significantly tightened during the negotiation over what’s included in the final sale and purchase agreement.
If your consideration is paid in multiple stages, will the amount you receive in each tranche be affected by the financial performance of the company once you have surrendered your shares in it?
You will need to ensure that your accountants and solicitors protect you as much as possible so that the amount you receive in later tranches can not be manipulated by either the direction the new owners take the business in, the accounting methodologies they use, or both.
If part of your recompense is to retain shares in the company and/or be granted shares in the acquirer’s company, will those shares actually have any real world value? Will they be easily disposable? Will you be given enough decision-making power in either the company you’re selling or the acquirer’s company because, if you don’t, any actual value in shares granted will diminish if the new owners take your old company and/or their existing companies in the wrong direction.
On the subject of deferred consideration (where you receive an initial payment on the day of completion followed by further tranches at agreed points), what penalties are there if the acquirer makes late payment, pays less than the agreed amount, or fails to make payment?
As mentioned above, your ability to recover money owed will depend on the entity which is actually purchasing your business. You should battle on this point with the consequence of non-payment being freedom from any restrictive covenants on you (more on that later) and from any non-solicitation clauses preventing you from recruiting your old staff.
If the deal you’re offered appears too good to be true, this may be a ruse to persuade you to sign the letter of intent. The acquirer and their professional representatives’ real aim may be to wear you down throughout the entire due diligence process so that you accept a lower price on worse terms.
This is a surprisingly common tactic used on first time sellers – for the majority of business owners who build a second business which they take to market, they don’t fall for the same trick again.
WHO SETTLES THE DEBT?
Nearly all commercial finance and mortgage providers will not “novate” an existing agreement with your company over to its acquirer. This means that, if your company has an outstanding working capital loan or HP agreement on which you’re still making repayments, this debt will have to be settled in full on or shortly after completion day.
Your solicitors will need to ensure that the settling of all outstanding loans and finance facilities by the acquirer forms part of sale and purchase agreement. You should also take advice on what to do with any personal guarantees you’ve given to obtain finance in the past for your protection.
HOW IS THE DEAL BEING FUNDED?
If the acquirer is funding the deal from free cash, this is better than if they are using third-party financing to pay for ownership of your company. Third-party funding (especially if you’re one of the third parties offering seller notes) often complicates greatly the process of you being paid on time and in full.
You should seek reassurance and proof from an acquirer using third party funding that they have a finance facility in place for the entire amount and not just for the initial consideration payment – this is more common, unfortunately, than you might think.
Your prospective acquirer’s demand for exclusivity during the purchase process will mean that your business is off the market for an extended time if they’re busy pursuing and failing to secure acquisition finance. An experienced M&A advisor will stop these types of situations occurring.
WHAT PRECONDITIONS ARE BEING SET?
Your acquirer will always expect both an evaluation of the completion accounts and an independent fair market valuation of any capital assets (particularly those assets surplus to basic operating requirements) into the sale and purchase agreement. This is to protect them from overpaying for the company and its assets.
Your solicitor and accountant should ensure that the completion accounts and the valuations attached to company assets are as realistic as possible. Ideally, they should negotiate for an additional payment to be received by you if both are worth more than expressed in the supporting documents to the SPA.
Your acquirer may want sensitive information disclosed like customer names or supplier names – there is a risk in this and you should speak with your IBA Corporate M&A advisor on your options and the likely outcomes of each option for you and on the progression of the sale.
THE SCOPE OF DUE DILIGENCE POSED
Due diligence is the process by which acquirers and their professional representatives attempt to understand exactly what you are selling. The due diligence process may take months if your business operations and finances are complex however, when you engage IBA Corporate as your M&A advisor, we will help you prepare the documentation, paperwork, and statistics needed for due diligence right at the start.
In due diligence, acquirers and their professional representatives look for any reason possible to reduce the price paid and to make the terms of the SPA more favourable to them. If there are any particular issues with your business which would likely lead to an acquirer wanting to lower the amount of money they’re prepared to pay for the business, we advise you to disclose this during the negotiations.
This is because the discount you offer during a negotiation will certainly be less than the discount requested on discovery during due diligence.
SCHEDULE AND CLOSING
Motivated buyers and sellers will set a timeframe for completion in the LOI.
Both parties should aim for 45 to 60 days for:
● the receipt of due diligence documentation by the seller,
● the receipt of an SPA to review,
● employment and non-competition agreements for senior managers and key members of staff, and
● an actual target completion date.
Be prepared for timings to slip however even despite the best intentions – due diligence may take up to four or five months.
WORKING WITH AN M&A ADVISOR – IBA CORPORATE
Many potential acquirers will offer the most favourable price and terms on the deal in the LOI with no intention of following through on them.
This is a sound negotiating tactic by the acquirer’s purchasing team – they want you to reject all other offers made by potential acquirers leaving you with only one choice.
Please note that, although this situation is rare and unlikely to occur, you’re also at risk of the buyer walking away deep in the due diligence process if the acquirer is a competitor. They may have no intention of purchasing and they may treat this process as an opportunity to discover your company’s financial and operational strengths and weaknesses.
You should consider the acceptance of an LOI as the end of the beginning of the sale of your company – the harder part is yet to come.
Your business is worth what someone will actually pay you for it and not what they say they’ll pay you in an LOI. Your IBA Corporate M&A advisor team has decades of combined experience in deciphering the actual intent hidden between the lines in letters of intent and they make sure that your best interests are always protected.
We look forward to the opportunity to work with you on the sale of your company providing you with insight, opinion, feedback, and advice at every stage of the process.
To start the conversation with us, please contact us by email, by phone, or by using the contact form on the site.