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The Letter of Intent – The Importance of M&A Documentation

By DealForce

04/14/2019

The critical role that documentation plays in a successful M&A transaction cannot be overemphasized. Indeed, if you want to have a “clean” transaction, one where you, the seller, is protected, documentation that dots the Is and crosses the Ts is critical. 

One of the most important documents that many novice business sellers have no experience with is the Letter of Intent (LOI). So, what exactly is the LOI?

“The LOI is an important step because it lays out the basics of the final deal: the purchase price and terms, closing date, length of exclusivity, approvals, and much, much more. However, the LOI isn’t necessarily the final deal. Rather, it’s the framework or roadmap for that final deal. Based on what each side discovers during due diligence, and/or whether the profits of the company decline, the deal may change.”

Letters of Intent: A Framework for Moving Forward

Essentially the Letter of Intent is a framework for the deal, but what it does most importantly is commit both parties to move forward with the deal exclusively.

As such, the LOI provides the seller with the confidence that the proposed buyer is serious, and likewise the buyer gains the knowledge that the seller is committed to working on closing the deal (assuming all the following steps in the transaction pan out).

It is an important document in the process of selling a business, one that you, as a seller, should require of any and all serious buyers.

Elements of a Good Letter of Intent

Therefore, getting the Letter of Intent right is vital. But to the novice, what is important in the LOI? Here are some general guidelines.

First, although they’re similar in many ways, an LOI is different from an indication of interest (IOI). Both documents are part of the process of buying or selling a company; however, the LOI lays out more specific terms. So, don’t confuse the two. 

An IOI is like asking for a date, while an LOI is a marriage proposal. Although some sophisticated buyers often include significant details in their IOI, it is still incumbent upon the seller to get a formal LOI from the buyer. 

Secondly, exclusivity is a key consideration. An LOI usually includes a lock-up period where the seller is out of the market — that is, unable to speak with other buyers about doing a deal. Sellers should grant exclusivity very carefully and should do everything possible to limit the amount of time they’re prevented from speaking to other buyers. 

This is a key issue to consider when selling a business. Your lockout period means that you will be unable to market your business to anyone else. This can be detrimental given that even a 90-120 day lockout means that any other interested parties will most likely move onto other opportunities during this time frame. 

In addition, once it becomes known that the seller has entered into a Letter of Intent (even if the terms are confidential), if the transaction does not close, the perception may arise that the buyer found something wrong and walked away.

True or not, such perceptions can have an adverse impact on the ability of the seller to find a replacement buyer at the same price. So, be sure that your buyer is truly interested before countersigning any LOI.

Professional Guidance for Your Letter of Intent is Key!

This points out what we have said several times in these postings: Hire an M&A advisor to guide you through the complicated process that any exit can (and will) be.

Most likely you will only exit one business in your professional career. Learning “on the job” regarding how to effectively do this can have a huge negative impact on you, your family, and your financial legacy. 

Most buyers that you want to be in negotiations with are what we call “professional buyers,” the kind that make several acquisitions annually and are very experienced and knowledgeable about how to buy companies to their benefit (ROI), not yours.

Before you sign a proposed Letter of Intent, have your M&A advisor and M&A attorney review it closely so that it is detailed enough to protect you and your interests. Since most LOIs are drafted by the buyer, this is critical. 

This is how our friends at Smith, Gambrell, & Russell LLC put it in a recent article:

“For a seller, the letter of intent often provides the point of maximum negotiating leverage to insert a few phrases or sentences that can make a material difference in the overall transaction. Experienced professional advisers have a highly useful role to perform, and a wise seller will take full advantage of this important opportunity to maximize its strategic transaction position and thereby put more dollars in its pocket.”

As you approach your exit and consider all the documents you will need to create/approve/sign, be sure that any LOI you sign is crafted with protections for you as the seller. Since you will be effectively taking your company off the market for a period time, given the risks and ramifications, be sure the LOI you countersign has safeguards protecting you.

Bottom-line: The M&A process is extremely complex. The LOI is just one example of something you need to know about how to exit your company for maximum profit. 

The good news is that we offer a way to learn more. Our complimentary exit planning conferences are led by seasoned, experienced M&A professionals, many of whom have successfully sold multiple companies during their careers. I would advise any business owner who is contemplating an exit in the next 1-5 years to attend one of our conferences to learn how to prepare for the complexities associated with your eventual exit.

Interested in learning more? Use the following links to discover how you can use our services to prepare you for what you need to know about a successful exit (and the documentation critical to this process):

By Carl Doerksen, Director of Corporate Development at Generational Equity.

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