This blog is about the timing for submission and execution a Letter of Intent (“LOI”) when a buying or selling a company. This is written for the perspective and benefit of a business seller.

One purpose of a LOI is to document a mutual agreement between the buyer and seller on the major points of the purchase and sale of a business. With this in mind, a LOI is often signed much too early in the process. There is an understandable eagerness if you are selling a business to receive a Letter of Intent from a prospective buyer as early as possible. In some cases, business owners are even advised that they should request a LOI in order to learn price and terms from the prospective buyer.

Listed below are some of the reasons that business sellers are encouraged to execute a LOI early in the process (we disagree with these arguments, but it’s still important to understand both sides):

• Signing a LOI with a prospective buyer demonstrates to them that you are serious.
• The buyer isn’t going to spend considerable time and resources reviewing your company and considering an acquisition unless you have signed a LOI and they have an exclusive period to review your business.
• The buyer won’t proceed through the sale process without a LOI, because they won’t waste time and money in due diligence and preparing a detailed purchase agreement in case there is a disagreement later about price and terms of the transaction.

While some of this makes sense, it doesn’t hold true for most business sales: i) you don’t need a LOI to demonstrate to a buyer that you are serious, it just takes advanced preparation, planning and hard work; ii) if the buyer wants to buy the business, they’ll go through additional steps in the process prior to submitting a LOI – you just have to ask and detail your intended process to them; iii) your business is a unique asset and if your business has significant differentiators that have made the buyer interested in the first place, they’re unlikely to lose interest if you ask them to follow through with additional steps prior to signing a LOI – they’ll also take you more seriously.

So, then comes the question – if someone wants to make an offer to buy your business and you want to sell, why wouldn’t you accept a written offer? The answer: price and terms.

If you sign a LOI early in the process, you are likely to sell for a lower price and weaker terms than you deserve. Unless the buyer is well informed about your business, the growth opportunity and all necessary information on which to make a fully informed decision, they are going to price the offer and terms based on a limited understanding, i.e. they will submit a lower-ball offer than they have to, leaving some wiggle room in consideration of the uncertainty on which they are basing the offer. Once that offer is in writing in a LOI with an exclusive period, it’s much harder to increase the price and terms.

As an example, let’s say you’ve been talking to a strategic buyer that knows your business well and is experienced in your industry. If you run the right sale process, the maximum they’re prepared to pay for your business is $30 million cash at closing (if  they were fully informed about your company.) That same strategic buyer, if submitting a LOI early in the process may only offer $15-$20 million if all they have received is detailed financial information, toured your facility, spoken with you and received answers to some of their questions. We actually had one recent example where the disparity between the initial written indication of interest and final LOI was far greater than this example and the buyer was a sophisticated international, multibillion dollar corporation that initially submitted a valuation that was fair, in terms of market comparisons. It became clear; however, with the more they learned about the acquisition opportunity, that they should be paying a considerable premium to ensure that their offer was accepted and that they could successfully complete the acquisition. It just takes time and effort for all parties to become better informed and the buyer to understand that they need to maximize price and terms to get the deal done.

So, if you are seller, when should you sign a Letter of Intent?

Your advisors should work with you to prepare your business for sale, spend considerable time, effort, analysis, planning, preparation, financial modeling, researching and writing. If they do their job, then it makes sense for you to wait until later in the process to receive a Letter of Intent:

• The buyer knows you are serious about selling if you or your advisor has spent considerable time up front preparing your business for sale – it is obvious to them that you’re going to sell the business and doesn’t require a LOI for them to feel comfortable spending time and resources analyzing your company.
• The work that you have done up front eliminates much of the buyer’s time risk, as you will have already completed most of the work that the buyer would otherwise need to complete. The buyer can issue a LOI based on your presentation of the information and use the period after executing the LOI to challenge, substantiate and investigate all the information and analysis that has been presented to them.
• Before a LOI, it is typical to receive an indication of interest (“IOI”), along with a valuation range. This non-binding indication, without any of the typical LOI provisions, requires less work for the buyer and is a useful starting point for valuation discussions. The purpose of a LOI is not for a preliminary discussion/understanding of price and terms – that only benefits the buyer and gives them an exclusivity period.
• When it does come time to execute a Letter of Intent, it is an agreement that would typically go through multiple edits and negotiations before agreeing upon a final version. After all, this should be as close to the final purchase agreement as is feasible.

There are numerous other considerations, but just know that when it comes to your business, your hard work, sweat and tears, that you should be the one to control the sale process, not the buyer. And don’t be concerned about running the buyer off by holding off on a LOI: i) you have to make a serious misstep to run off an interested buyer – if they are aggressive and insist on an early LOI, they’re not likely someone that you want to buy the business anyway; ii) you’ll invariably find that there are more than a handful of logical buyers for your company. It just takes time, experience and hard work to find them.

It is a real challenge to sell a business the right way, to achieve the best result for you and your stakeholders and it takes a lot of hard work, but the hard work pays off when it is time to close the deal.

Hard work = higher sale price.

Better preparation = higher sale price.

LOI later in the process = higher sale price.