If you’ve been reading along in this 30 Days to ETA series, you know that in the Day #25 post I shared that your ability to analyze reports, or the CIM will not be enough as an Entrepreneur Through Acquisition (ETA). You’re going to have to conduct interviews with key parties on the seller’s side of the equation successfully. The ETA Owner Interview needs to be done so that you gather all of the missing pieces of information you need to proceed — if justified (You can read the previous post by CLICKING HERE). Finding, researching, conducting preliminary due diligence — as well as interviews — are all precursor to what is considered by most to be the first step in the formal business sale, the Letter of Intent (LOI). So, in today’s 30 Days to ETA post, we’re going to explore The ETA Letter of Intent (LOI)… Enjoy!
The ETA Letter of Intent (LOI)
Sometimes called a Memorandum of Understanding or an LOI, the Letter of Intent alerts a business seller that a buyer “intends” to purchase their company. Usually, the LOI is non-binding, but many courts uphold its provisions as contractual and binding. Therefore, whenever you provide a Letter of Intent, make certain your attorney and your transition team have created/reviewed it respectively.
At Tip of the Spear Ventures, when we create an ETA Letter of Intent (LOI) we want to convey the purpose this potentially binding document serves In its most basic form, the ETA LOI is an agreement to agree or to reach an agreement. The ETA Letter of Intent (LOI) sets the stage for the business sale. It can effectively do one or more of the following things:
- Lay out the expectations and essential terms of the business sale.
- Serve as preliminary documentation for lenders or governmental boards.
- Put the public on notice that there will be a sales transaction.
- Determine which party or which team member will draft certain documents.
- Set a time frame for negotiations, periods of purchasing exclusivity, purchase agreements, and closings.
Elements of The ETA LOI
Whether the ETA Letter of Intent (LOI) shows a basic commitment between the buyer and seller or publicizes the trading of a company’s stock, it will inevitably contain a number of elements. While not exhaustive, here is a list of details typically contained therein:
- A list of the assets to be sold in the transaction.
- The purchase price for the business and all its stated assets
- A good faith, or earnest money, deposit
- Exclusivity period parameters
- Expected length of time for due-diligence to occur
- Signed Confidentiality Agreements
- Definitions of important terms that might be used during the transaction
- A target date for the execution of the Purchase Agreement (PA)
- Allocation of expenses for both parties
- Identification of sale’s jurisdiction and governing entities
- Any provisions intended to be binding
The ETA LOI Excitement Blunder
Since the ETA LOI signals the start of the formal business sales process, you must be more cautious than ever before. As the Buyer, you have the opportunity to make many demands which the Seller has the choice to accept or refuse. Adding restrictions or limits to your Buyer demands can protect you during the approaching due-diligence period. I can’t say this enough; lean on your ETA Professional Team. The ETA Professionals you’ve assembled have hopefully walked down this road before and will know how to advise you accordingly.
The ETA LOI Guidelines
The following are a few ETA LOI Guidelines that I have created/compiled from the Tip of the Spear Ventures Mergers & Acquisitions practice:
- Limit the exclusivity period to 90 days – If you’ve been properly preparing to acquire the business, you should have most of the data the seller will provide already. By limiting the time you give this particular exclusive right to buy the business, you prevent the seller from dragging out the process so long that the seller loses potential interest in selling to you.
- Request the delivery of a purchase agreement within 60 days – Dragging out the sales process could keep you from effectively managing the company, which could cause the value of the company to decrease over the short-term. The seller will inevitably check-out from leading the business the moment they decide to sell the business. Time is not your ally.
- Publicize other Letters of Intent received – If the seller receives other Letters of Intent (LOIs) during the due-diligence process, I’m a firm believe in wanting to know that they are receiving them. Therefore, they should be public record. It shows transparency, trust, and good faith to share this information. Any withholding of an LOI approach could/should be grounds for termination of LOI.
- Don’t take responsibility for any fees – Don’t give the seller everything they desire and the kitchen sink! Share that you will not be responsible for legal fees and professional fees incurred during this time.
- List everything that is not included in the sale – Just as you list everything that is included in the sale, be sure to list everything the seller should plan on taking with them. If they want to keep a piece of equipment or a plaque on the wall, list it. Don’t be afraid to keep things you will need for the business, but let them have those family heirloom items. Just be sure to clarify what you’re keeping versus what you’re having them take.
- Address what will happen to cash on hand and Accounts Receivable – Clarify whether the seller is buying any, some, or all rights to the cash on hand and accounts receivable. Have a plan in place to purchase the 30 day, 60 day, or 90 day + accounts. Maybe buy the current accounts at a dollar-for-dollar rate. Then, maybe acquire the outstanding 60 day+ accounts for 50 cents on the dollar and the 90 day+ accounts for 10 cents on the dollar. Spell out what will be done with those open accounts and excess cash. I’ve had sellers desire to not include any accounts receivable as a part of the sale. The reason why you are an ETA, and not a startup entrepreneur, is that there is a business in place with associated customers/revenue streams. Not having access to this revenue stream is startup-equivalent, and therefore should be avoided.
- Employ formula pricing – Also known as cap pricing, formula pricing places a set cap on the sales price. Formula pricing usually keeps a seller from negotiating a higher sales price as the buyer finds more value in the company.
- Don’t text or email without attorney approval – Since this is the beginning of a FORMAL business sale, any and all written communication can affect the terms of your Letter of Intent and subsequent Purchase Agreement. Don’t send out a “quick text” or an emotional email without consulting your ETA Professional Team because that “quick text” or emotional email could alter the course of your sale and your legal responsibility therein.
- Don’t offer IOU’s – If you agree to a promissory note for the cash on hand or the accounts receivable, the seller could receive it all, spend it all, and leave town without giving you a dime. Don’t trust them and don’t offer to write IOU’s.
In today’s ’30 Days to ETA’ post, we explored The ETA Letter of Intent (LOI). Finding, researching, conducting preliminary due diligence — as well as interviews — are all precursor to what is considered by most to be the first step in the formal business sale, the Letter of Intent (LOI). A sharp seller is going to try to get everything they can for their bsuiness (You will too when it comes time to sell the business!) So when you’re dealing with the ETA Letter of Intent (LOI) to buy your business, listen to your ETA Professional Team.