You found the business you want to buy. Congrats!
There are many things that need to happen before a deal closes. One of the first steps you’ll need to take is to write, sign and negotiate a Letter of Intent (LOI) with the seller. An LOI is a non-binding document, meaning there is not a legal requirement for things to play out exactly as the document states.
This article will walk through an LOI for an asset-based (not stock) purchase of a private business. We will start by stating our assumptions about the context in which you are writing the LOI, explore the timing of an LOI, move to the components of the document and finish by pointing you to some other resources that may help you in this first step toward a closed deal.
There are two main assumptions guiding this article.
1. The sale process is non-auction.
Buying a business through an auction means the business is represented for sale by a broker or investment banker who is running a structured, timed process on the assumption that dozens of bidders will compete to purchase the business. In an auction, if you make it through all the gates, usually the highest price wins. The process explained here is based on a non-auction sale that assumes you have some access to the seller and you don’t have to follow strict timing requirements set by the investment banker.
2. A reasonable valuation exercise has been undertaken beforehand.
A valuation of the business you want to buy must precede the crafting of an LOI- an LOI always includes a purchase price. If you don’t have some idea of what you want to pay for the company (and how), you aren’t ready to issue the LOI.
Letter of Intent Timing
You can choose to bring an LOI into the buying process at a couple different points.
One method, common with most private equity groups, is to produce an LOI quickly and with relatively little information. The LOI will be riddled with caveats but at least the seller gets to see a number and feel like a deal is in reach. Significant negotiation and renegotiation almost always follows, so this is a risky strategy with an emotional seller.
The other option would be to have a slew of conversations with the seller to be sure that what you propose in the LOI aligns with their expectations. Here you run the risk of annoying the seller by asking too many questions before you really demonstrate commitment.
Neither method is right or wrong or better or worse. What you choose depends on your style, the dynamics of your relationship with the seller and what the seller would respond to best.
Components of a Letter of Intent
No matter when you bring an LOI into the buying process the contents of the LOI will follow the same general formula.
Let’s walk through the considerations that are usually included.
1. If necessary, include your working assumptions. There may be pieces of the business you don’t fully understand or that you haven’t been granted access to yet. This limited vision of the entire picture likely impacted the valuation and structure of the deal, so it is important to acknowledge assumptions to show the seller how you came up with the number that you did.
2. Purchase price must be included. This is also where you would explain the desired structure of the deal– the cash up front, escrow, and any subsequent payments such as requested seller financing. It should be clear what the buyer is purchasing- likely the assets of the company free of liens and encumbrances along with a combination of receivables, payables and debt.
3. There are certain expectations that the buyer has of the seller in this stage of the process that need to be made explicit. Below are examples of typical LOI language explaining the buyer’s expectations (along with a non-legalese translation). These examples are not comprehensive in what may be included in an LOI.
a. “Seller shall continue to maintain inventory and equipment in a manner consistent with historical business practices in order to prevent any adverse changes in the condition of the inventory or equipment.”
Translation: “Do things the way you normally do them from now until I own the company.”
b. “Seller shall enter into an individual employment or consulting agreement with Buyer at Closing.”
Translation: “You will still work at the company for a short time after I own it. I’ll need your help for a bit.”
c. “Seller, and any other key personnel, will also enter into an agreement not to solicit the employment of or employ any person who is then an employee or agent of the Company, and to maintain confidentiality with respect to proprietary information of the Company.”
Translation: “After closing, don’t try to take away the company’s employees and don’t tell other people important things you know about the business.”
d. “This offer constitutes an active effort by Buyer to purchase Company, and Seller agrees not to engage with any other party for the purpose of entering into a sale agreement until 90 days after the signing of the term sheet or until Buyer has withdrawn this active offer.”
Translation: “I’m trying to buy this business from you. Don’t ask other people to buy it, and DEFINITELY don’t go around using my offer to try to get a better deal out of someone else.”
e. “Seller and Buyer shall enter into individual Noncompetition Agreements, whereby Sellers shall agree not to compete with Buyer for a period after Closing.”
Translation: “Don’t go down the street and compete with me after I just paid you a lot of money for your company.”
4. You are obviously hoping to purchase the business but you want the seller to be aware of what needs to happen before you are confident that the business is a purchase you truly want to make. To do that you lay out your conditions to closing. This part of the LOI provides a path for next steps and makes it clear that each of the next steps must be taken in a satisfactory way for a close to happen. These conditions may include things like:
a. Completion of Due Diligence on terms satisfactory to Buyer
b. Agreement on a Transition Plan- with the seller and employees
c. Execution of a Definitive Purchase Agreement (containing customary representations and warranties)
d. Attainment of satisfactory financing at Buyer’s sole discretion
5. The document is formalized with a dated signature from both the buyer and seller.
You should always seek your attorney’s guidance in crafting this legal document. Although, here’s a pro tip for you: Don’t “lawyer up” too early. Get your business points agreed to with the seller first, then get your attorney involved.
Below are resources about LOIs from two websites dedicated to law education and from NYU’s School of Business.
The M&A Lawyer Blog: What You Need to Know about M&A Letters of Intent
Law 360: The Importance Of Letters Of Intent In M&A Negotiations
New York University: Sample Letter of Intent