After a potential acquirer has built a serious level of interest in the business, and is ready to attempt to get a deal done, they will provide a letter of intent (LOI) outlining the characteristics of the proposed deal as a starting point for negotiations. LOIs are like being almost pregnant — it really doesn’t mean much. It is an understanding of the deal two parties are working towards, much like a term sheet, but slightly more detailed and involved.
Here are a few notes when thinking through the letter of intent:
- Standard due diligence and no shop periods should be of reasonable length (e.g. 30 – 45 days) to promote focused work by both parties (if things are going well, and more time is needed, it’s easy to ask for an extension)
- Financial considerations around the cash and stock mix, if applicable, are very important, especially if there’s a lock up on the stock where it can’t be sold for a period of time (in this current market of uncertainty, cash is much more desirable)
- Net working capital adjustments (e.g. the price goes up or down based on current assets) are always present, and should be considered carefully, especially if there’s serious deferred revenue (it’s a liability! — also note that debt will reduce the purchase price)
- Escrow funds (the amount set aside in the event of an issue) as a percentage of the deal and how long they are held should be aggressively negotiated (e.g. 7% of the deal held for 12 months might be normal depending on the industry)
- Other important, but less commonly discussed, items include things like indemnification where you agreed to defend the potential acquirer against future lawsuits for a period of time related to aspects of the business they are acquiring
A letter of intent is a major milestone in the process to sell a business. Once signed, both parties should work hard to get a deal done. The key is to not rush into signing the LOI, rather take your time and get the terms right up front, resulting in a much smoother process going forward.
What else? What are some other thoughts on the letter of intent process in the sale of a business?