Buyers and sellers of companies can waste a lot of time with each other doing the so-called "dance" and never come close to closing on the transaction. We see some buyers who provide a letter of intent (LOI) or an indication of interest (IOI) without even seeing the business or talking with the seller. Other buyers may refuse to provide a LOI and continue to want access to all the due diligence information, then go straight to a purchase agreement. Which way is the right way?
We believe a buyer should submit an LOI prior to due diligence for almost all situations. Normally after a buyer has signed a Non-Disclosure Agreement (NDA), the buyer will review the offering memorandum that the M&A firm has prepared. This document will outline the history, operations, management, financial performance and other significant facts about the business. It should provide the buyer with enough information to make an informed decision about whether the company fits with his or her acquisition objectives and whether to make an offer. A buyer should never be confirming everything that's been provided, learning how to run the business, reviewing intellectual property, or talking with key employees and customers prior to a LOI being signed.
An Indication of Interest (IOI) might be as simple as offering a price range to determine if the buyer is in the ballpark before spending the time for additional conversations, analysis and writing a LOI. The IOI doesn't accomplish a lot, as the buyer will still need to provide a LOI, but if the parties are millions of dollars apart it can cut to the chase and save everyone time. Some selling events allow buyers to see a limited amount of information on a company and then they must submit an IOI in order to proceed to the next level of data release.
There is no reason for a seller to give up confidential information and go through the amount of time and advisors’ expenses if the buyer and seller can't agree on the key points to a transaction. And a buyer won’t want to waste time if the seller is wanting more for the business than the buyer is willing to pay.
There are many variables that a buyer should provide beyond price when making the first offer. The seller needs to understand what the buyer is purchasing and on what terms. Most components of LOIs are non-binding and subject to change if inaccurate information has been provided. Typically, LOIs should:
• Be in writing to be signed by both parties
• Indicate whether the buyer plans to acquire the stock of the company or the assets
• State the known price, plus other possible additions
• State the amount of any ownership the seller will be retaining, if any
• List the specific assets and liabilities that are being acquired
• List dollar amounts of current assets and liabilities that are included in the price
• Outline the amount of cash and other terms ( seller notes, earn-outs, royalties)
• Estimate the timeline to closing
• Propose the timeline for the seller to remain with the buyer
• Explain contingencies the buyer is relying on ( financing, due diligence, etc)
• Confirm that the statement that confidentiality will remain in place
• Indicate a defined time period that the seller will stop looking for other buyers
• Include any other important items critical to the buyer or seller
• Indicate what elements are binding
There are other items that could potentially be included, such as purchase price allocation, owner compensation, holdbacks, and reps and warranties. It can often take more time to get to some of those other deal points, so keeping the LOI simple makes sense in some cases.
Once a LOI is negotiated, agreed upon and executed, the parties can work on due diligence and begin working on a legal purchase agreement.