An LOI is a critical document when selling your business. It outlines the key terms and conditions that the buyer is proposing for the acquisition.
While not legally binding, the LOI sets the groundwork for the definitive purchase agreement to come.
As a seller, you can't afford to skim over the details in an LOI. Every word matters and can have major implications down the road. Here are some key areas to scrutinize closely:
1) Purchase price:
The stated purchase price is obviously important, but understand how it is defined. Is it the enterprise value or equity value?
Are there any contingencies, earn-outs or holdbacks that could reduce the amount you actually receive at closing?
2) Asset vs. Equity purchase:
An asset purchase means the buyer is cherry-picking the specific assets they want and leaving behind any unwanted liabilities. This is more common for asset-light businesses. If your business has material liabilities, you’ll be responsible for resolving those in an asset deal.
An equity purchase means they are buying the entire company, including all assets and liabilities
3) Employee matters
Does the LOI require you to terminate any employees prior to closing?
Are there any provisions about compensating or retaining your key employees long-term? Understand the implications for your workforce.
4) Escrows and holdbacks
Buyers often try to hold back a portion of the purchase price for a period of time after closing to ensure no issues arise.
Negotiate the amount, duration and release conditions.
5) Non-competes
The LOI will likely include non-compete and non-solicitation provisions restricting your ability to start a competing business or hire away employees/customers.
Understand and negotiate the scope and duration.
6) Due diligence:
The scope of diligence requested by the buyer can be a heavy lift. Try to limit this to just critical areas and negotiate a reasonable timeline.
Watch for overly broad areas of diligence listed (which the buyer had the opportunity to do pre-LOI) which means the buyer really hasn’t done their homework yet and is likely to back out more easily
7) Exclusivity period:
The seller cannot solicit offers from other buyers during this time. Ensure that this period is not unreasonably long.
If the exclusivity period is too long and the buyer fails to come back with a final offer after the process, the seller generally have to go back to the other buyers from the pre-LOI stage and the deal loses traction.
The LOI is just the first step, but getting it right can pave the way for a smooth sale process where you maximize value. Read every detail carefully and negotiate accordingly.