Whether you are a master negotiator or think negotiation is a necessary evil, one thing holds constant–if you don’t understand the basic components of an offer to buy a business, you’ll be at a disadvantage.
To effectively negotiate an offer, owners and buyers must first understand the various types of offer documents, standard topics covered, and methods that offers are presented. It’s not just about the purchase price.
The most common methods for presenting and documenting a proposed deal is by using a letter of intent, indication of interest letter, or a term sheet. Here, we will focus on the letter of intent, commonly referred to simply as LOI.
A letter of intent is the document often used to present an offer from the buyer to the selling company, and is the basis for negotiating the final contracts to purchase the business, usually referred to as the “definitive agreements.”
There will be many things that are not covered in the LOI and negotiated later in the process, but what follows are the nine major sections of a good letter of intent.
1. Purchase Price and Equity Participation
This section should include not only a purchase price, but the structure of the purchase price. Is it all cash? Is the seller going to hold a note? Is a portion contingent on future events (an earnout)? Will there be a holdback? Will existing owners get stock in the buying company?
2. Closing Adjustments
This section should outline all known adjustments expected to be made at closing. There will certainly be other things that come up in due diligence, but a reasonable outline of how to treat items that fluctuate, such as inventory, liabilities, pre-payments, accounts receivable, and so forth, should be covered.
3. Stock, Assets, and Liabilities Being Transferred
The opening paragraph will most often state whether the transaction is proposed to be the purchase of stock, membership interests, or assets. However, a section should be dedicated to exactly what is being purchased and specifically note any excluded assets or liabilities.
4. Consulting or Employment of Owners
In most transactions, even an exiting owner will stay on board for a short period of time, whether as a consultant or employee. The details are sometimes better left to negotiate after the letter of intent is signed; however at least a high-level scope should be described in the LOI to ensure the deal does not fall apart because of misaligned expectations.
5. Restrictive Covenants, Reps, and Warranties
Many pages will be dedicated to topics like non-compete, non-disclosure, and representations and warranties in the definitive agreements.
The letter of intent should clarify any exceptions from generally accepted norms. A framework should be included to make sure, for example, that the buyer isn’t thinking of a five-year non-compete when the seller is thinking one year.
6. Conditions and Due Diligence Provisions
Since the letter of intent is a framework from which to negotiate, it should contain detailed provisions for due diligence, conditions that affect the LOI, and any known conditions to close the final transaction.
The due diligence provision should set forth the items to be reviewed by the buyer, the time frame, and any special provisions, such as if, and when, contact with key employees and customers will occur. Likewise, any known contingencies–such as the buyer obtaining financing–should be stated.
7. Closing Details and Costs
Closing dates are like pregnancy due dates: They happen early and late, but rarely on the date planned.
However, it’s still important to select a target time frame in the letter of intent and outline any known provisions, such as: whether it will happen over time (a progressive close), whether there will be an escrow period, or if everything is expected to happen on a single day (a sign and close).
In addition, the LOI should clearly set forth who pays what costs associated with due diligence, closing, and so forth. Usually, each party bears their own expenses.
8. Exclusive Negotiations
Often, a buyer will require that once a LOI is signed, the seller negotiates exclusively with them and no other buyer. These provisions should be spelled out clearly, including the point at which exclusivity no longer applies.
9. Binding and Non-Binding Sections
In most transactions, a letter of intent is a non-binding document, which means it outlines the understanding to enter into more formal negotiations, due diligence, and ultimately the definitive agreements. It does not usually force the parties to move forward with the transaction.
Some sections, however, such as due diligence provisions, confidentiality, and exclusive negotiations may be binding, while others such as purchase price may not. The LOI must state which sections are binding and which are non-binding.
With an understanding of all the components of a good offer, now you’re ready to negotiate.
The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.