For a business owner, the sale of the company is the final act in the life cycle of the company (TargetCo). It represents the business owner’s opportunity to cash out on and be rewarded for his or her vision, ingenuity, years of hard work, sacrifice and risk-taking.
Typically, after some confidential discussions and limited sharing of a TargetCo’s financial and non-financial information, a critical, next step in the sale process is negotiating and entering into a letter of intent (LOI) with the prospective buyer (buyer).
With that said, let’s put some context on what the LOI is, and what a seller’s and buyer’s competing goals are. Simply put, the LOI is a roadmap for the transaction structure and material transaction terms. For example, the LOI accounts for whether the buyer will buy all of the outstanding stock or all or substantially all of the assets of TargetCo; what will the purchase price be and how it will be paid, either by all cash, promissory note, an earn-out or other contingent payments.
A buyer’s goal is to lock up a seller into exclusive negotiations with the buyer and have access to TargetCo’s financial and non-financial information, without the buyer itself being too locked in or committed on other transaction terms. To the contrary, the seller’s goal is to lock in clear and detailed transaction terms, including the financial terms, and get as a firm of a commitment from the buyer as possible.
Without careful negotiation and drafting, the LOI can become a bit of a trap for the unsuspecting seller. Let’s look at the following hypothetical scenario: A business owner is approached by a buyer. After some detailed confidential discussions and sharing of TargetCo’s information, the buyer tells the business owner it’d be prepared to pay $X million for TargetCo.
The business owner, being so excited about the $X million purchase price, quickly moves forward and signs the LOI, without careful consideration of any other terms. In this scenario, those other terms include (1) a 90-day buyer exclusive look at TargetCo where the business owner cannot talk to any other parties about a possible sale, (2) buyer’s unqualified rights of access to TargetCo’s information, employees, suppliers and customers, and (3) buyer being under no obligation to deliver a draft purchase agreement to the business owner by any specified date. And, that’s where the LOI can go from being the business owner’s friend to the business owner’s foe.
The LOI contains the typical reasonable qualifier that the buyer’s offer is “subject to buyer’s confirmatory due diligence on TargetCo” (translation: buyer’s right to reduce the purchase price or kill the transaction entirely if buyer uncovers something it doesn’t like).
The business owner wants to keep the possibility of the sale of TargetCo under wraps, especially from employees, suppliers and customers. More specifically, the business owner would prefer to control and defer buyer’s access to TargetCo’s employees, suppliers and customers until the business owner is confident the sale of TargetCo will happen.
Unfortunately, the LOI the does not include any such conditions on buyer’s access, nor does the LOI impose any obligation on buyer to deliver a first draft of a purchase agreement to the business owner by a certain date. So, the business owner is stuck in the disadvantageous position of having to comply with the buyer’s requests—without any sense or promise of a draft of the purchase agreement in sight—which risks premature disruption of TargetCo’s business and operations and potential leaking of rumors of sale of TargetCo to TargetCo’s competitors. If the business owner fails to comply with the buyer’s requests, the buyer could claim the business owner is in breach of the LOI or walk away from the transaction.
This is one example of unintended consequences that could trip up an unwary business owner in a sale process, if the business owner fails to plan carefully and move forward considering all of the important factors at play in selling TargetCo.