(originally shared with my email list)
Introduction to LOIs
“LOI” is a commonly used term in the M&A space, as well as others, so you might already know it stands for ‘Letter of Intent’. This document serves as the actual offer a seller receives from a buyer and outlines the major parts of the deal including the sale price and terms, no-compete language, anticipated closing date, and other miscellaneous terms, all which could be specific to the deal or the buyer’s preferences.
LOIs can be countered and traded back and forth multiple times with the buyer before agreeing upon a final deal, typically taking around two weeks. At this time you become exclusive with one buyer, who now performs due diligence without the concern of us shopping the deal behind his back, also with a mandate to close the transaction in 90-120 days from the date the LOI is signed.
Binding Nature of an LOI
It’s also important for you to know that LOIs are non-legally binding, except for 2-3 sections pertaining to confidentiality and exclusivity. Think of it as a formal handshake where the deal is agreed upon at a high level. Although you’re not legally bound to it, proper etiquette here is that commitment to its terms remain intact all the way through to the closing. To agree upon an LOI and later attempt to change its terms without justification is called “retrading,” a highly frowned upon activity.
Because the LOI is the mechanism that transforms your business sale process from being on the open market to becoming exclusive with one buyer, it’s imperative that coming to an agreed upon LOI is handled with diligence and care.
Here’s three different ways I approach LOIs to ensure they set us up for a successful due diligence process and closing.
1. Must be a healthy length. Generally, you want an LOI that’s 2-3 pages long for a $3m or less deal. For a deal over $3m, you’re looking for an LOI that’s 4-7 pages long. Obviously page length isn’t in and of itself the guideline, but the LOI’s length, as determined by the scope of detail, should scale with the size and complexity of the deal. A two-page LOI on a $15m deal is likely a red flag that the buyer is either incompetent or acting in haste. On the other hand, a six-page LOI on a $1m deal could be overbearing and prematurely burden the seller with topics the attorney should be reviewing at a later time (attorney involvement should be minimized as much as possible in the LOI phase).
2. Be mindful of verbiage. “The sale price will include a normalized level of working capital. The Target Working Capital amount will be determined after financial due diligence has been completed.” What does this mean for your cash, receivables, and inventory at closing? Anything the buyer wants it to mean! If terms such as “normalized” and “working capital” aren’t defined, you’re giving the buyer an open door to dramatically change the face of the deal, even if the sale price remains the same on paper.
In one “LOI,” the buyer wrote in the Purchase Price section, “The asking purchase price of the company is $5,700,000 subject to…” Instead of outlining an offer price, it simply re-stated our asking price. Although the document was titled “Letter of Intent,” it wasn’t one at all. It even requested us to sign and agree. Agree to what!? Whatever the buyer wanted…
3. LOIs are sacred. Although non-legally binding, a good LOI sets the tone for a successful due diligence and closing process. Buyers who give an LOI without visiting your facility or asking tough questions are not quality buyers. And yes, these kinds do exist. They’re M.O.is to lure you with an enticing offer, get you under exclusivity so you can’t talk with other buyers, and wear you out to succumb to their eventual lowball price. A good buyer doesn’t want to change the terms of their offer and will therefore put a lot of effort in understanding your business so they can create a durable LOI. If you’re dealing with an active buyer, a good question to ask them is what percentage of their LOIs close at the same offered price. The good buyers will be happy to answer this question.
Summary of Key Concepts
- LOIs are non-legally binding, but should still require the utmost care as it is crucial to the success of a deal.
- It’s scope of detail should scale with the size and complexity of the deal.
- Words matter, and in the M&A world their definitions can take on unfamiliar meanings. It’s important to understand what terms of the LOI actually mean, not only before agreeing to it, but even before countering it.
