Lets Talk Letters of Intent • Part II
Questions to Consider before the LOI is Signed
The issues posed may be based on the perspective of a buyer in the examples, but the concerns are the same for sellers. Some big picture questions that need to be answered before an LOI is executed:
Will the deal be structured as an “asset purchase” agreement or a stock sale? There are significant differences in the structure, particularly when it comes to the liabilities that will be sold and those that will be retained by the seller.
Does Seller plan on extracting all the cash from the business at the close of the sale?
What’s happening with the accounts receivable?
Does the Seller have much work in progress and, if so, what are his or her expectations for the revenue post-close?
Does the business rely on one or only a handful of key customers? How much of their revenue is derived from the top customers and how are those relationships?
How much of the inventory is slow-moving or obsolete and therefore of little value?
What’s the track record for warranty repairs and will the seller assume covering any existing warrantied products or services for a period of time?
Will (or should?) Seller commit to staying on as a consultant or employee for a period of time while the transition of management takes place? Either way, will they execute a non-compete agreement?
How will the purchase price be paid? All cash? Will Buyer have an opportunity to apportion a certain amount of the purchase price in an “earn-out” provision? Is there a note and, if so, can it be secured? Are there other creditors that will make the security pointless?
How will the purchase price be allocated? Goodwill, inventory, customer list, etc.
Will Seller refrain from entertaining other inquiries from other Buyers during the time period that you are conducting your own due diligence? Negotiating with a second buyer in the background may be counterproductive to your current negotiations.
Both parties need to be represented by an attorney at these early stages. We often encounter clients that didn’t want to retain us at an early stage to help reduce costs and prior to confirming the transaction can go through after their diligence is complete. That error can cost much more than our services, as the material terms in an LOI will be written in stone. Parties can be forced to honor the terms of the “harmless” LOI when those same terms are the non-negotiable substance of the purchase agreement itself. This effectively removes the room for much negotiation as the terms of the LOI will govern.
It’s never too early to involve counsel on your side, especially when you could unknowingly be locked into some less than favorable terms at such an early stage. The LOI, despite whatever soft language regarding the intent is drafted, is a legally binding document. Don’t let the descriptive title fool you – it’s a contract that creates rights and obligations.