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Why Letters of Intent Matter

By Generational Equity

01/02/2017

Over the years of publishing these M&A pieces, we have discussed how important key documentation is for business owners seeking to complete an M&A event, especially if they are not using the advice of a professional M&A firm like The Generational Group. Some of the key documents we have discussed include:

Today we are going to cover a document that you may not even be aware of unless you have gone through an M&A transaction. The letter of intent (LOI) is vital to completing a transaction. Our friends with Axial (a leading online resource that combines capital providers with business owners) have produced a comprehensive piece on LOIs. This is how they describe the importance of this document:

LOIs set procedures for due diligence … An LOI can be used to set expectations around deal structure, scheduling, and other big picture deal points. Material terms that are essentially deal-breakers can be resolved early.

It is this last sentence that demonstrates the importance of an LOI. Resolving key items via the LOI can prevent deals from collapsing later when unforeseen issues arise. So, your logical next question is: What are material items and how can I determine them in advance? Ah, now you see that is a huge challenge to the uninitiated and a good reason to hire an M&A professional to represent you.

Until you close a few dozen deals and have literally seen nearly every possible “material term,” you will have a hard time anticipating them. Furthermore, if you are negotiating with a savvy, professional, experienced buyer, he/she will most likely craft an LOI that protects their interest more than yours. Is this wrong? No, it is simply a reality. Buyers are going to pay attention to details that impact them, so you need to do the same in the LOI, ensuring that your interests are covered as well.

Security for All

In essence, an LOI can be used like Switzerland is for banking: a neutral document that can protect both parties. Again, Axial describes it this way:

LOIs help protect all parties in the deal. In order to prevent a bidding war, or to allow the buyer an exclusivity period in which to conduct its due diligence, an LOI can include a “no-shop” clause that prohibits either or both sides from approaching third parties for a limited period of time. Likewise, in order to protect a seller from wasting time, money and effort, an LOI may include a break-up fee that is paid if the buyer cancels the transaction for an unpermitted reason.

You may be tempted to balk at the notion of any sort of fee to be paid if you back out a transaction. However, the key word above is “unpermitted.” Again, if you have never completed a transaction, you are most likely completely unaware of what some of these reasons may be. This is another reason to spend some money in advance and hire an M&A advisor.

There are certainly valid reasons for sellers to cancel a transaction. However, savvy buyers know that these reasons can be limited and strict in detail. You need to be sure that you are very comfortable with the terminology and verbiage used in your LOI relating to break up fees.

Momentum is Key

Finally, a well-executed LOI can not only protect both parties, it can also, in the long run, speed the velocity of a deal up:

LOIs are considered formal legal documents. It is important to differentiate between what parts of an LOI are intended to be enforceable, and what parts aren’t. Examples of enforceable sections include clauses around confidentiality, no-shop, or break-up fees. Although price and terms typically wouldn’t be included among the enforceable provisions, they set an expectation that is difficult to change absent a good reason.   If the circumstances of the deal warrant, an LOI can be a valuable tool to save time and money.

There is an old saying in deal making that goes something like this: The longer a deal takes to close, the more the odds go up of something unforeseen happening to scuttle it. So, having a well-thought-out LOI can help both parties close a transaction faster than not having one at all. Again, if you hire an experienced deal maker, the odds are good that he or she will be able to help you anticipate material issues that might arise in advance and thus save a transaction from failing if something does come up out of the blue at the 11th hour.

A good analogy for this is that you see your family physician annually for a physical and you go to a specialist to treat any condition outside of your GP’s practice. The same is true for the eventual sale of your largest asset. Don’t go cheap and try to do it yourself because you will encounter key documents that you have no experience with (such as an LOI) and that may lead to not only you leaving chips on the negotiating table, but it also could lead you to agree to the terms of an LOI that are not in your favor.

My suggestion, if you are considering entering the market on your own, is to first attend a Generational Group exit planning seminar. We hold these no obligation, educational meetings throughout North America for business owners who are interested in learning how and when to exit for maximum profit. Follow these links to learn more:

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

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