 Author: Scott J Lochner | WHY YOU, THE PROSPECTIVE SELLER OF A PRIVATELY-HELD BUSINESS, WANT AND NEED YOUR OWN HIGHLY CUSTOMIZED LETTER OF INTENT ("LOI") |
You, the prospective seller of a privately-held business ("You"), should benefit greatly by creating your own customized letter of intent (“LOI”) prior to entering into negotiations regarding the tentative sale of your business (the "Transaction"). By being proactive and presenting your ideal terms and conditions upfront, you substantially increase your ability to get your ideal outcome. This statement assumes You enter into an LOI with a potential buyer before You (i) enter into an exclusivity agreement, (ii) share the due diligence materials (other than the financials) regarding your business, or (iii) negotiate a definitive sales agreement, with the potential buyer.
Why follow this advice? Because when You consider the reasons for entering into an LOI first, as generally described below, it will be clear to You that You want and need your own customized LOI.
Why follow this advice? Because when You consider the reasons for entering into an LOI first, as generally described below, it will be clear to You that You want and need your own customized LOI.
1. You are Strongest, and Have the Most Negotiating Leverage, at the LOI Stage of the Transaction.
The LOI stage of the Transaction is early. As noted, it is before You enter into an exclusivity agreement, before You share due diligence materials regarding your business, and before You negotiate a definitive sales agreement, with a potential buyer.
If You immediately give a potential buyer contractual exclusivity (pursuant to which You will only be allowed to negotiate the sale of your business with that particular buyer), You will have given up a lot of your bargaining leverage. You will no longer be able to have potential buyers compete against one another, which competition can often drive-up the sales price for your business and improves other sales terms for You.
If You immediately provide a potential buyer with the due diligence materials related to your business You may irreparably harm yourself. Due diligence material disclosure (other than the disclosure of the financials of your business, which is typically shown to a potential buyer very early) usually occurs prior to or concurrently with negotiating the definitive sales agreement. Buyers often delay negotiations while they digest the due diligence materials, which materials the buyer will use to "beat You down" to obtain a low(er) sales price and better Transaction terms from You. You may not even understand how you have suffered in the Transaction, since virtually none of your Transaction terms will have been previously agreed upon.
If You immediately start negotiating a definitive sales agreement (which is usually prepared by the buyer), You will be reacting to what the buyer wants. You will have already set the stage for Transaction term compromises that will not benefit You. After You have spent a lot of time negotiating Transaction deal points, You could become overly invested -- both emotionally and financially -- in the Transaction. Your negotiating leverage might not be as strong as it earlier was. If you "walk away" (which typically will become harder and harder for You to do), You will give up all the emotional time and energy and all the money You spent negotiating the Transaction. You may feel somewhat trapped, and forced to accept Transaction terms that You do not want in order to simply move forward so as to not lose your investment of prior time and money.
How can You avoid all of these situations that will be harmful to You? Easy! You can avoid all of these bad situations by providing your potential buyer(s) early on with a front-loaded LOI that You have prepared which contains all of your preferred Transaction terms.
With a front-loaded LOI You can determine early, before you have selected and agreed to exclusivity with one potential buyer, whether the buyer(s) will give you acceptable Transaction terms. You can require multiple buyers to compete on both Transaction and financial terms. A buyer marking up your LOI does not have to know how many other potential buyers there are. Through an LOI You can "lock down" the terms of your Transaction as much as possible before You (i) select your preferred buyer and give away negotiating exclusivity, (ii) disclose your due diligence materials to your preferred buyer (which is especially important if that buyer is in the same industry and is a competitor), and (iii) negotiate your definitive sales agreement with your preferred buyer.
Remember, as a seller You are strongest, and have the most negotiating leverage, early on at the LOI stage of the Transaction. This is why the most experienced EXIT STRATEGISTS encourage their clients to create their own customized term sheet and include it in their LOI.
If You immediately give a potential buyer contractual exclusivity (pursuant to which You will only be allowed to negotiate the sale of your business with that particular buyer), You will have given up a lot of your bargaining leverage. You will no longer be able to have potential buyers compete against one another, which competition can often drive-up the sales price for your business and improves other sales terms for You.
If You immediately provide a potential buyer with the due diligence materials related to your business You may irreparably harm yourself. Due diligence material disclosure (other than the disclosure of the financials of your business, which is typically shown to a potential buyer very early) usually occurs prior to or concurrently with negotiating the definitive sales agreement. Buyers often delay negotiations while they digest the due diligence materials, which materials the buyer will use to "beat You down" to obtain a low(er) sales price and better Transaction terms from You. You may not even understand how you have suffered in the Transaction, since virtually none of your Transaction terms will have been previously agreed upon.
If You immediately start negotiating a definitive sales agreement (which is usually prepared by the buyer), You will be reacting to what the buyer wants. You will have already set the stage for Transaction term compromises that will not benefit You. After You have spent a lot of time negotiating Transaction deal points, You could become overly invested -- both emotionally and financially -- in the Transaction. Your negotiating leverage might not be as strong as it earlier was. If you "walk away" (which typically will become harder and harder for You to do), You will give up all the emotional time and energy and all the money You spent negotiating the Transaction. You may feel somewhat trapped, and forced to accept Transaction terms that You do not want in order to simply move forward so as to not lose your investment of prior time and money.
How can You avoid all of these situations that will be harmful to You? Easy! You can avoid all of these bad situations by providing your potential buyer(s) early on with a front-loaded LOI that You have prepared which contains all of your preferred Transaction terms.
With a front-loaded LOI You can determine early, before you have selected and agreed to exclusivity with one potential buyer, whether the buyer(s) will give you acceptable Transaction terms. You can require multiple buyers to compete on both Transaction and financial terms. A buyer marking up your LOI does not have to know how many other potential buyers there are. Through an LOI You can "lock down" the terms of your Transaction as much as possible before You (i) select your preferred buyer and give away negotiating exclusivity, (ii) disclose your due diligence materials to your preferred buyer (which is especially important if that buyer is in the same industry and is a competitor), and (iii) negotiate your definitive sales agreement with your preferred buyer.
Remember, as a seller You are strongest, and have the most negotiating leverage, early on at the LOI stage of the Transaction. This is why the most experienced EXIT STRATEGISTS encourage their clients to create their own customized term sheet and include it in their LOI.
2. The Four (4) Keys Points to an Acceptable Transaction for You.
In your LOI You can "flesh-out" and determine if You will be able to get, to your satisfaction, the four (4) key points You need (and that any seller needs) to confidently move forward with your Transaction:
(i) Price. You need the offer of an acceptably high enough price/amount of consideration in order to justify the sale of your business.
(ii) CAP. A “CAP is a limit (absent fraud) on the percentage of the total purchase price that the buyer can potentially "claw back" in the event of a breach by You of any of your representations and warranties in the definitive sales agreement. Obviously the lower the CAP percentage, the better for You, although the actual CAP percentage You get varies in part based on your industry, the current market, your negotiating strength and other factors such as the experience, skill and tenacity of your EXIT STRATEGY team.
(iii) "Basket." The basket is the aggregate dollar amount of claims the buyer must have, based on alleged breaches by You of your representations and warranties in the definitive sales agreement, before the buyer can request indemnification from You for damages the buyer sustained (i.e., a "claw-back" of a portion of the purchase price you received). The higher the basket, the better for You, since in part the basket exists so You are not "nickeled and dimed" down on price. Also, you do not want your new “Financially Independent” life of your dreams disrupted by litigation.
(iv) Survival Period. This period is how long your representations and warranties in the definitive sales agreement last, after which time the buyer cannot make a claim against You for an alleged breach of those representations and warranties in an effort to potentially "claw-back" a portion of the purchase price You received (or that is technically yours, but pursuant to the definitive sales agreement delivery is being held back for an agreed period of time by the buyer or by a third-party escrow agent).
If You are satisfied with what the buyer agrees upon regarding the four (4) key points discussed above You are arguably done with seventy to eighty percent (70-80%) of your Transaction. The remainder of the Transaction will be “push-pull” items that for You are probably not very consequential to your perspective on the overall Transaction.
(i) Price. You need the offer of an acceptably high enough price/amount of consideration in order to justify the sale of your business.
(ii) CAP. A “CAP is a limit (absent fraud) on the percentage of the total purchase price that the buyer can potentially "claw back" in the event of a breach by You of any of your representations and warranties in the definitive sales agreement. Obviously the lower the CAP percentage, the better for You, although the actual CAP percentage You get varies in part based on your industry, the current market, your negotiating strength and other factors such as the experience, skill and tenacity of your EXIT STRATEGY team.
(iii) "Basket." The basket is the aggregate dollar amount of claims the buyer must have, based on alleged breaches by You of your representations and warranties in the definitive sales agreement, before the buyer can request indemnification from You for damages the buyer sustained (i.e., a "claw-back" of a portion of the purchase price you received). The higher the basket, the better for You, since in part the basket exists so You are not "nickeled and dimed" down on price. Also, you do not want your new “Financially Independent” life of your dreams disrupted by litigation.
(iv) Survival Period. This period is how long your representations and warranties in the definitive sales agreement last, after which time the buyer cannot make a claim against You for an alleged breach of those representations and warranties in an effort to potentially "claw-back" a portion of the purchase price You received (or that is technically yours, but pursuant to the definitive sales agreement delivery is being held back for an agreed period of time by the buyer or by a third-party escrow agent).
If You are satisfied with what the buyer agrees upon regarding the four (4) key points discussed above You are arguably done with seventy to eighty percent (70-80%) of your Transaction. The remainder of the Transaction will be “push-pull” items that for You are probably not very consequential to your perspective on the overall Transaction.
3. Front-Loading your Preferred Transaction Terms into the LOI.
In the LOI you can "front load" the four (4) key points described above and as many of the other deal terms as You want (e.g., indemnification provisions, purchase price holdback amounts and periods or escrow amounts and periods, employment or consulting agreement terms, etc.) so You (i) can compare one potential buyer against another potential buyer (i.e., You can have multiple potential buyers mark up your preferred LOI at the same time (competing as to which one will get to be your preferred buyer who will receive exclusivity), (ii) are not surprised by deal terms later, when You have less negotiating leverage, and (iii) can reduce the amount of negotiating later when You negotiate the terms of the definitive sales agreement (which will save You time and money).
Quality of life factors post-Transaction are critical to You. This is why having a highly experienced EXIT STRATEGY team is important. The best advisors will be constantly helping You balance the price You want with the terms which specifically affect your quality of life. For example, if You don’t want to be obligated to do things that will diminish your quality of life (such as frequent long distance travel in coach class), your term sheet can specifically limit the amount of distance and frequency of travel. Your term sheet could also lock in first class transportation or even the use of private jets and limousines, etc. The amount of time You are obligated to work post-Transaction is important. Whether or not You are willing to relocate your personal residence can have a major impact on your quality of life and therefore your wants should be described in your term sheet.
Quality of life factors post-Transaction are critical to You. This is why having a highly experienced EXIT STRATEGY team is important. The best advisors will be constantly helping You balance the price You want with the terms which specifically affect your quality of life. For example, if You don’t want to be obligated to do things that will diminish your quality of life (such as frequent long distance travel in coach class), your term sheet can specifically limit the amount of distance and frequency of travel. Your term sheet could also lock in first class transportation or even the use of private jets and limousines, etc. The amount of time You are obligated to work post-Transaction is important. Whether or not You are willing to relocate your personal residence can have a major impact on your quality of life and therefore your wants should be described in your term sheet.
4. Tying the Buyer's Exclusivity Period to the Buyer's Due Diligence Review Period in the LOI.
In the LOI You can tie the length of the buyer's exclusivity (i.e., the time during which You can negotiate only with that potential buyer for the sale of your business) to the length of the buyer's due diligence review of your business, thereby limiting the due diligence review period.
Why is limiting the buyer's exclusivity period and the due diligence review period important to You? Because:
(i) You Can Sign and Close Sooner. As the seller, once You have signed an LOI the sooner You can sign and close the Transaction the better for You. You will never do better than You have done in the LOI stage, and You want to hold on to all You can and sign and close as quickly as possible. Closing becomes, or should become for You, a race against time, whether it be a concern that something unforeseen may happen to your business, a sudden downturn in the buyer's business, or a general market downturn (e.g., a "9/11 event") which may scare the buyer away.
(ii) You Incentivize the Buyer to Sign and Close Sooner. You want to incentivize the buyer to quickly sign the definitive sales agreement and close before the buyer's exclusivity period expires. If the buyer does not sign and close by then, You have the potential ability to shop the deal to other potential buyers (which puts intense pressure on the buyer to sign and close, because much like You the buyer has spent time and resources on your Transaction).
(iii) You Get Better Transaction Terms; You Hold Down Transaction Expenses. An extremely long or unlimited due diligence period provides the buyer with more time to find flaws with your business to "beat You down" and attempt to obtain better buyer Transaction terms. Placing a reasonable deadline on the due diligence review period makes the Transaction go faster, which holds down Transaction expenses for You.
Why is limiting the buyer's exclusivity period and the due diligence review period important to You? Because:
(i) You Can Sign and Close Sooner. As the seller, once You have signed an LOI the sooner You can sign and close the Transaction the better for You. You will never do better than You have done in the LOI stage, and You want to hold on to all You can and sign and close as quickly as possible. Closing becomes, or should become for You, a race against time, whether it be a concern that something unforeseen may happen to your business, a sudden downturn in the buyer's business, or a general market downturn (e.g., a "9/11 event") which may scare the buyer away.
(ii) You Incentivize the Buyer to Sign and Close Sooner. You want to incentivize the buyer to quickly sign the definitive sales agreement and close before the buyer's exclusivity period expires. If the buyer does not sign and close by then, You have the potential ability to shop the deal to other potential buyers (which puts intense pressure on the buyer to sign and close, because much like You the buyer has spent time and resources on your Transaction).
(iii) You Get Better Transaction Terms; You Hold Down Transaction Expenses. An extremely long or unlimited due diligence period provides the buyer with more time to find flaws with your business to "beat You down" and attempt to obtain better buyer Transaction terms. Placing a reasonable deadline on the due diligence review period makes the Transaction go faster, which holds down Transaction expenses for You.
CONCLUSION
As described above, You have many excellent reasons to enter into an LOI. Entering into an LOI is about more than just money. It is also about quality of life and your peace of mind. As my Exit Strategist colleague Bruce Raymond Wright teaches every client:
This is about securing for yourself the best life you dare to imagine. A thoughtfully customized LOI expertly crafted and tenaciously negotiated could make all the difference for you. Knowing what you want empowers you and your team to structure a deal that gets you more of what is really important to you as you enter the next phase of your life.
Be sure You are otherwise ready to proceed with a potential Transaction, and prepare your ideal most preferred terms and LOI.
Having your own highly customized term sheet/LOI can save You and your team a lot of time and expense. It can help you identify a buyer that is most suitable for You and your employees. It can save everyone involved a lot of money. And it can make a big impact on whether or not your deal actually closes.
Applying everything described in this article will get You more prepared for success. Somehow, all throughout history, success has favored those who were the most prepared and focused on what they wanted. Let this describe You.
***
The views in this article express the personal views of the author and do not represent the views of any other person or entity and do not constitute legal advice.
***
Scott J. Lochner is a very experienced and pragmatic business lawyer who has helped his clients for over 30 years to cost-effectively achieve their goals. Scott has specialized in providing legal assistance in buying and selling businesses in individual transaction value from several million to several billion dollars. He also has extensive experience in intellectual property ("IP") matters, helping clients to develop, protect and commercialize their IP and brands, both in consumer products and high technology. He is known for being entrepreneurial and thinking like a business person as well as a seasoned business lawyer. In addition to practicing law, Scott is an inventor who has successfully monetized two U.S. patents he owns related to computer wireless technology, and has a score of license agreements with prominent name-brand domestic and foreign multi-billion dollar companies related thereto. Scott writes and speaks frequently on business law matters, and has been involved in improving state business law to create a better business environment to benefit everyone.
Contact: Scott J. Lochner
Phone: (626) 773-6061
E-mail: [email protected]
© 2014 Scott J. Lochner
This is about securing for yourself the best life you dare to imagine. A thoughtfully customized LOI expertly crafted and tenaciously negotiated could make all the difference for you. Knowing what you want empowers you and your team to structure a deal that gets you more of what is really important to you as you enter the next phase of your life.
Be sure You are otherwise ready to proceed with a potential Transaction, and prepare your ideal most preferred terms and LOI.
Having your own highly customized term sheet/LOI can save You and your team a lot of time and expense. It can help you identify a buyer that is most suitable for You and your employees. It can save everyone involved a lot of money. And it can make a big impact on whether or not your deal actually closes.
Applying everything described in this article will get You more prepared for success. Somehow, all throughout history, success has favored those who were the most prepared and focused on what they wanted. Let this describe You.
***
The views in this article express the personal views of the author and do not represent the views of any other person or entity and do not constitute legal advice.
***
Scott J. Lochner is a very experienced and pragmatic business lawyer who has helped his clients for over 30 years to cost-effectively achieve their goals. Scott has specialized in providing legal assistance in buying and selling businesses in individual transaction value from several million to several billion dollars. He also has extensive experience in intellectual property ("IP") matters, helping clients to develop, protect and commercialize their IP and brands, both in consumer products and high technology. He is known for being entrepreneurial and thinking like a business person as well as a seasoned business lawyer. In addition to practicing law, Scott is an inventor who has successfully monetized two U.S. patents he owns related to computer wireless technology, and has a score of license agreements with prominent name-brand domestic and foreign multi-billion dollar companies related thereto. Scott writes and speaks frequently on business law matters, and has been involved in improving state business law to create a better business environment to benefit everyone.
Contact: Scott J. Lochner
Phone: (626) 773-6061
E-mail: [email protected]
© 2014 Scott J. Lochner
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