In prior blog posts on the LOI, we
- identified key elements you should see in the LOI
provided a basic overview of the pluses and minuses of entering into a LOI.
Today’s post covers a few issues that could turn your negotiations into pain points and/or deal killers prior to getting an offer. As a seller, after you’ve made it past the buyer’s initial screening process, the next step is providing the buyer with information so they can do their groundwork on your company before formulating a price and terms. The buyer’s deal team will want to meet with the owner (and, if the company is of significant size, key members of the senior management team), assess their strategic fit with the buyer, run the business opportunity through their financial modeling, possibly contact their lenders about the feasibility and cost of funds for purchasing your company, and get a view into the clients, employees, operations, fleet and equipment and technology at a high but thorough level. It is important to realize that most buyers won’t enter into a LOI with the thought of backing out of it. Any major issues should be identified by the seller and his/her representative in this period of assessment that occurs prior to the Letter of Intent. Your business advisor will give you the best advice on how to approach the market with any potential major issues.
Most buyers—especially serial acquirers–will want to have an 80% sense of certainty that by the time they are finished with due diligence, they will do the deal. It doesn’t serve anyone’s purpose to “hide” serious issues in order to get an offer. Here are some actual examples our team dealt with that would be a problem for most buyers.
- Environmental claims that were still open and/or not resolved. In this case, it was years of asbestos exposure for employees in a rented building. The employees were trying to hold the employer responsible in addition to the building owners (separate parties). The first buyer backed out of the original deal, the second buyer was interested but knew about the issue before making an offer.
- Serious HR issues that were resolved through settlements with employees but that were not disclosed even in general terms prior to LOI. (We had several of these, including a serial harasser that cost the company hundreds of thousands of dollars in settlements), senior executives with repetitive issues with drug/alcohol addiction, etc.) This was before the time of HIPAA, but there was still a high level of confidentiality. Unfortunately, these issues did not arise until well into HR due diligence. In several cases, we bought the company but did not hire those individuals.
- Misrepresentation of contracted revenue and gross margins. This was a spinoff from a large entity that had broken up. Once we got into the due diligence, it was clear that a significant part of the revenue was not solidly recurring and was actually generated upon referrals from other parts of the business that we were not buying. The price was adjusted downward accordingly.
The important thing to keep in mind is that both seller and buyer have anxieties about the price range and deal terms at this stage. Timely but unrushed communication through this phase will provide additional clarity. Improving the deal environment for the parties will lessen anxieties and allow the parties to arrive at the right price and terms. As the parties work through the LOI and beyond, flexibility and willingness to compromise tactically and skillfully will keep the deal moving forward through the signing of the purchase agreement.
If you have questions about the selling process including the Letter of Intent, please email me at firstname.lastname@example.org or call me at 224-688-8838. We’re here to help you harvest your potential.