Structuring the LOI

I. Introduction

?? A. The letter of intent (LOI) is a non-binding document in which you’ll attempt to understand all of the material terms of the transaction with the seller before spending additional time and money on negotiating full transaction documents and conducting a comprehensive due diligence review.

Deal points often covered in an LOI include the following:

·??????? Purchase Price and Terms — how much you’ll pay when you pay it, and in what form—e.g., cash, SBA, commercial financing, the promissory note (seller financing), or some combination of all the above.

·??????? Consulting Services — how much transition support will the seller provide after closing?

·??????? Non-Compete — how long will the seller be barred from competing with the buyer?

·??????? Exclusivity — how long will the buyer have the exclusive right to negotiate the business without the threat that an alternative buyer will swoop in and steal the transaction?

·??????? Statement of interest in purchasing the business - Affirmation of the buyer's seriousness and commitment to the transaction. This should have reference to any prior discussions or negotiations between the parties.

Entering the LOI is typically considered a significant milestone and signals that the seller and buyer are ready to go from “dating” to “engaged.”

Note that, except for a few key provisions (e.g., confidentiality) of the LOI, the LOI should be non-binding. This means neither the buyer nor the seller can sue the other to try and enforce the terms of the LOI. It’s simply a starting point for the transaction.

II. Parties Involved

?? A. Clear identification of the buyer and seller

????? 1. Full legal names of the entities involved

????? 2. Inclusion of official business addresses and contact information

?? B. Inclusion of any relevant subsidiaries or affiliated entities

????? 1. Listing of any subsidiaries or affiliated companies included in the transaction

????? 2. Explanation of how these entities relate to the central business being acquired

C.????? Include other parties to the transaction (as relevant):

1.????? Brokers, Lenders, Investment Bankers, Lawyers, Accounting Firms, etc.

III. Transaction Overview

1.????? Description of the proposed transaction:

a.????? Stock Sale -?the seller(s) sell(s) their equity to the buyer.

b.????? Asset Sale -?the target company sells its assets to the buyer, and the seller(s) receive the sale consideration as a distribution from the target company.

c.????? Merger -?the seller(s) approve(s) a transaction to merge the target company into a buyer entity, then receives merger consideration at closing.?Note that this is rare in small-medium businesses

?? B. Statement of intent to negotiate in good faith

????? 1. Express commitment to fair and transparent negotiations

????? 2. Emphasis on the collaborative nature of the transaction

IV. Purchase Price and Payment Terms

This may be as simple as a sentence saying the total purchase price will be paid in cash at the closing. More likely than not, though, it will include some combination of two or more of the following:

1.????? Cash

2.????? Seller promissory note

3.????? Assumption of debt

4.????? Transfer of in-kind property (i.e., tangible property like equipment)

5.????? Equity interests in the buyer entity (or holding company of the buyer entity)

6.????? Escrows and holdbacks

7.????? Future, performance-based earn-out payments (which in turn can be paid in one or more of the preceding methods)

When describing any of the above, a balance must be struck. You want to provide enough detail that it avoids future disagreement over fundamental terms. Still, you don’t want to give so much detail that you engage in protracted negotiations with the seller at the LOI phase.

For example, suppose you intend to include seller financing. In that case, you may state the size of the note, the amortization period and maturity date, the interest rate, and whether it will be secured or unsecured and guaranteed by the buyer principals. As an example, a sample purchase price provision could look like the following:?

The purchase price for the Company (the “Purchase Price”) would be $___________, [and would be paid in cash at the Closing] [payable in the following manner: [describe if holdback, escrow or earnout or if noncash consideration is being used]].

In most cases, you should include some agreed level of working capital in your transaction. If so, at least you’ll want to mention it in the LOI.

V. Due Diligence

Due diligence provides the buyer with the necessary information regarding the business, legal, and financial affairs of the target company to determine whether to buy the target company and, if so, on what terms.

There are three critical areas of due diligence, which should be examined in this order:

1.?????????????? Financial?— examining the financial affairs of the target company (typically handled by the buyer, sometimes with the assistance of 3rd party business valuation or a Quality-of-Earnings (QofE) provider

2.?????????????? Business?— examining the operational components of the target company (again typically handled by the buyer) and

3.?????????????? Legal?- examining the target business for potential legal issues.

VI. Conditions Precedent

?? A. Identification of critical conditions that must be met before the transaction proceeds

????? 1. Examples include regulatory approvals, third-party consents, or financial milestones

????? 2. Clarity on the responsibilities of each party to fulfill the conditions

?? B. Clear timeframe for the fulfillment of conditions

????? 1. Specification of deadlines for meeting each condition

????? 2. Flexibility clauses for unforeseen delays and extensions

?? C. Provisions for termination of the LOI if conditions are not met

????? 1. Clearly defined consequences and procedures for terminating the LOI

????? 2. Consideration of any financial implications in case of termination

VII. Confidentiality and Exclusivity

Before a buyer begins negotiating an LOI with a seller, the buyer often executes a non-disclosure and confidentiality agreement with the seller’s broker. As a result, it’s easy to think that the parties are covered by confidentiality, which may be the case, as many broker NDAs also cover the seller.

However, the seller is generally not a party to the broker’s NDA, and the broker’s NDA usually only covers information the seller shares with the buyer, not vice versa.

For all those reasons, it’s essential to include a confidentiality provision in an LOI that covers information sharing by both the seller and the buyer.

Question for Panel: What are some things that you look for in any confidentiality clause? Are there any “gotchas” or issues that we should keep an eye out for?

The exclusivity and no-shop provision prohibits the seller from continuing to market the business and negotiate with alternate buyers while your transaction is pending.

Many sellers - especially their brokers - may resist agreeing to exclusivity on the theory that they shouldn’t have to stop marketing the business if the buyer leaves the seller “at the alter.”

While a buyer may empathize with that argument, it’s flawed.

The buyer is making a substantial investment of cost and time on due diligence and other elements of the negotiation process. Suppose the seller is free to continue negotiating with other potential buyers. In that case, nothing is stopping the seller from causing you to spend substantial time and resources (financial and otherwise) only to drop the buyer at the 11th hour in favor of another buyer with a slightly higher offer.

A buyer should always resist any attempt by the seller and broker to permit continued business marketing once the LOI is signed.

VIII. Governing Law and Dispute Resolution

?? A. Specification of the governing law that will apply to the transaction

????? 1. Clearly stated jurisdiction for legal matters

????? 2. Compliance with relevant local and international laws

?? B. Agreement on a method for resolving disputes (e.g., arbitration, mediation)

????? 1. Selection of a specific dispute resolution method

????? 2. Designation of a neutral third party or institution, if applicable

IX. Closing and Timeline

?? A. Outline of the expected timeline for the completion of the transaction

????? 1. Definition of critical milestones leading to the closing

????? 2. Provisions for penalties or adjustments if timelines are not met

?? B. Provisions for extensions or modifications to the timeline if needed

????? 1. Clauses allowing for mutually agreed-upon extensions

????? 2. Mechanisms for modifying the timeline due to unforeseen circumstances

?? C. Confirmation of commitment to a timely closing process

????? 1. Express commitment from both parties to cooperate and facilitate a smooth closing

????? 2. Recognition of the importance of meeting deadlines for a successful transaction

Below is a sample timeline for a typical?small business buying transaction with SBA financing. Note that this timeline is being provided for illustrative purposes and could vary significantly depending on the nuances of any given transaction:

·??????? Week 1?- Parties sign an NDA, and the buyer receives the CIM

·??????? Weeks 1-2?- Parties commence negotiations, have seller calls and begin preliminary due diligence. Buyer seeks initial input from lender and advisors.

·??????? Week 2?- Parties sign a non-binding letter of intent. The buyer begins the process to receive formal approval from lenders and equity investors and begins Q of E.?

·??????? Weeks 3-6?- Buyer conducts financial due diligence, including Q of E, engages in discussions with equity investors, and thoroughly examines the business. Due diligence continues.?

·??????? Weeks 6-9?- Buyer and Seller negotiate the purchase agreement and other ancillary legal documents.

·??????? Weeks 9-10?- Parties sign a purchase agreement and finalize ancillary agreements.

·??????? Week 12+ - Parties close transaction.

X. Miscellaneous Provisions

?? A. Regulatory approvals and compliance

????? 1. Identification of specific regulatory approvals required for the transaction

????? 2. Commitment to compliance with relevant laws and regulations

?? B. Assignment of rights and obligations

????? 1. Provision for the transferability of rights and obligations under the LOI

????? 2. Consideration of any restrictions on assignment

?? C. Indemnification clauses for potential breaches

????? 1. Definition of indemnifiable breaches and corresponding remedies

????? 2. Procedures for making indemnification claims and resolving disputes related to indemnification

XI. Signatures and Date

?? A. Space for signatures of authorized representatives from both parties

????? 1. Identification of individuals authorized to sign on behalf of the buyer and seller

????? 2. Confirmation of the legal capacity of signatories

?? B. Inclusion of the date to indicate the commencement of negotiations

????? 1. Specific date of the LOI's execution

????? 2. Reference to the effective date to calculate timelines and deadlines

XII. Appendix (Optional)

?? A. Additional documents or information relevant to the transaction

????? 1. Examples include financial statements, organizational charts, or relevant contracts

????? 2. Clarity on the role and relevance of each document included in the appendix

?? B. Supporting materials for specific terms outlined in the LOI

????? 1. References to exhibits or attachments providing additional context or detail

????? 2. Cross-references to specific sections in the LOI that are complemented by the supporting materials

It's crucial to adapt the level of detail based on the complexity and specific requirements of the business transaction. Legal advice and consultation with relevant professionals are recommended to ensure compliance and accuracy.