This is the fourth in a series of posts discussing the sale of a business from the seller’s perspective. In the first three posts, we provided an introduction to this series and discussed asset versus stock sales, seller financing, and earn-outs. In this fourth post, we’re moving away from deal structure issues and into the deal process itself, starting with letters of intent, or “LOIs” (also known as “term sheets”).
We’ve previously written about LOIs from the point of view a buyer of a business and recommended that a lawyer be engaged at the LOI stage. However, in this post we want to discuss some of the important points from the perspective of a seller of a business. Here are four tips for sellers in negotiating the LOI followed by a list of items sellers might consider including in the LOI.
Point 1 – Get the Maximum Benefit of Your LOI – From the seller’s perspective, negotiating power is often highest at the LOI stage. However, many sellers fail to take advantage of their relative negotiating strength at this point in the deal process, instead viewing the LOI as non-binding and thus not as important as it really is. From a practical standpoint, after a seller has signed the LOI and started the deal process, the seller has often formed a mental and emotional commitment to the sale (and the cash) and it can be very difficult to negotiate with an experienced buyer concerning items that haven’t been previously “agreed on.” Often, a sophisticated buyer simply says “no” to what may be important and reasonable requests because they weren’t included in the LOI, leaving you, as the seller, with the nearly impossible position of risking the deal or giving in. So, point one is to maximize your leverage at the LOI/term sheet stage by broadening the scope of your LOI to include not only business points but significant legal points too.
Point 2 – Be Clear as To What’s Binding and What’s Not – As I’ve previously discussed, it’s imperative to be clear as to which portions of the LOI/term sheet are binding and which are not.
Point 3 – Be Aware of Expectation Setting – Often, the LOI will be the first negotiations between buyer and seller and, thus, the first chance for the parties and their counsel to “size each other up.” If you treat the LOI lightly and try to sign too quickly without giving it your full consideration, you might be giving the buyer the impression that you’re too anxious or want the deal “too much,” thereby giving the buyer more confidence in its negotiating power. I’ve seen many sellers rush to sign something, thinking it’s non-binding and can be changed which, in my view, only leads to problems down the road. Instead, treat the LOI stage as a critical step in the deal process and be tough, yet reasonable in negotiations.
Point 4 – Strike a Balance – Despite what I’ve just said, don’t overdo it. The LOI is, after all, an expression of intent for the most part, so don’t try to negotiate the entire deal at this stage. There’s a reasonable balance that needs to be maintained – negotiate towards a clean, crisp LOI that covers the salient deal points (business and legal) but don’t get into the minutia at this stage.
Potential Items to Consider – With this backdrop in mind, here’s a list of items sellers should consider including in the LOI, some obvious and some you might not think of:
- In an asset deal, include a generic list of assets being sold and list any significant excluded assets; on the flip side, do the same with liabilities to be assumed by the buyer or excluded.
- Clearly state the purchase price and payment terms; include basic terms of any seller financing or earn-outs, if applicable.
- Clearly describe any working capital adjustments and associated assumptions.
- Provide a general framework for how the diligence process will proceed and note any items you will retain pending execution of a definitive deal document (e.g., sensitive customer information).
- Consider stating who will be required to give representations and warranties from the seller’s side (will it be the selling entity only, or the individual owners as well?).
- Note any significant closing conditions – e.g., whether the deal is contingent on the buyer obtaining its own financing.
- List the basic indemnification terms (who will provide the indemnities; what will the baskets, caps, and survival periods be) and consider noting any special terms that might apply in your deal.
- Consider listing the basic terms of any employment or consulting agreements for the principals of the sellers post-closing (how long you will work post-closing and what your title and compensation will be after closing).
- List the basic non-competition terms that will be applied to the sellers post-closing (e.g., sellers won’t compete for three years after closing).
- List the buyer’s intent with respect to seller’s employees (will they all continue with the buyer post-closing?) and note whether buyer will be able to discuss the deal with employees prior to a definitive deal document being signed.
- Note the anticipated closing date and any special terms that might apply (e.g., the deal must close on or before X).
- Be sure confidentiality and non-disclosure provisions protect your information – often, there’s a separate confidentiality/nondisclosure agreement. If there’s not, be sure to include these provisions in the LOI and make sure they are binding. If there is a separate agreement, make sure the LOI does not supersede the confidentiality/nondisclosure agreement.
- Be sure your LOI disclaims reliance by the buyer on information it may review during the due diligence process. If you don’t get to a definitive deal document, you don’t want to be on the hook for claims by the would-be buyer if it claims reliance on preliminary discussions or diligence information.
- Consider an exclusivity clause. You most often see these clauses in the buyer’s favor, which is usually reasonable, but you might consider whether it’s reasonable to restrict the buyer from talking to your competitors while you’re negotiating with the buyer. You don’t want the buyer pulling out because it finds a better deal in your industry while you’re negotiating in good faith and providing the buyer with sensitive information.
- Be clear on who pays deal expenses in the event the deal doesn’t close. You’ll generally want to make sure the buyer is paying its own costs.
- Include normal contract “boilerplate” provisions, such as those dealing with governing law, jurisdiction for disputes, etc. Again, if the deal doesn’t close, you’ll want to be sure these items are covered.
- Clearly list the binding provisions.
- Add anything that’s unique and material to your deal. At a minimum, you want to make sure you and the buyer are on the same page to avoid surprises.
In the next post, we’ll discuss the due diligence process.
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.