Below are some steps we have found effective in negotiating letters of intent for the acquisition or sale of a business. This is written from the point of view of making suggestions to a business buyer who is going to propose a letter of intent to a seller as this is the normal process.
(Please note this is NOT legal advice. Please retain an attorney familiar with local laws and customs before you finalize any purchase agreement).
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Prior to beginning to write the letter of intent for a business purchase or sale review the overall facts of the business and the proposed transaction. Most importantly, confirm that you believe all the parties involved have high integrity. This is a difficult process that gets more difficult if you really don’t trust one-another. (On the other hand, remember Ronald Regan’s “Trust but Verify”). Very wise words.
It is useful to ask questions about what might be acceptable, how might the transaction be structured, etc. If a broker is involved have those conversations with the broker. Remember when asking about any part of an offer that the hard part in giving a useful answer is it all has to tie together. This means that asking what the minimum or maximum of something (price, down payment, seller financing, etc.) is not always productive. If you take the most favorable possibility in each term you end up with a poor offer. For that reason, it is almost impossible to get specific on a part of the transaction without have a reference to the whole offer. The answer is always – “it depends”.
Keep in mind that business sellers want enough of a down-payment (usually from you and the bank) that it is your baby not theirs. Business sellers as a group (and your seller is likely to be no different) believe that if they have to worry too much about getting paid from the business they might as well run it and collect the whole profit. We have found 75 to 90% down often is acceptable. Of course there are a few business owners who do want to provide most of the financing but this is usually dependent on a prior relationship or superior collateral etc.
Often to protect themselves business buyers add earn-out or claw-back clauses to adjust the total price. At a high level this means you tie payments into resulting cash flows. Usually we use revenues because any other cash flow (such as profit) is hard to agree on later. An example from a recent transaction is:
- Last 3 years average revenues was $1,300,000. If revenues from the 12 months following closing are less than $1,235,000 then the price will be reduced $1 for every $2 of revenue loss. The price will not adjust beyond the $130,000 note amount and will be offset against the note to the extent the note is outstanding. (sellers like if you give them an upside also but…)
Sometimes there are performance bonuses or purchase payments if people stay or other milestones are achieved. Compensation for new sales to clients or bringing in new clients during a transition can be built in and compensated if formally desired.
If you are going to use SBA financing for your business purchase, all variables (other than payment of a fixed amount note) must be fully determined by one year from the closing date. As a rule, sellers tend to believe that after a year its really your baby too. Of course, as I said above, many things are possible if the risk/reward makes sense.
We also have to consider how taxes tie into your transaction and the seller’s transaction. That is another topic altogether. I know what applies to the types of transactions I put together. We certainly are doing our best to convert any offer to “after tax dollars” and I assume you will do the same.
So it is a dance and in the end we will find something everyone can live with at the time of negotiation and be quite pleased with one year downstream.
These are a few of the bigger terms when negotiating a letter of intent for the purchase or sale of a business. You can also join our member section and download a letter of intent template. Again, this is just a template not legal advice. Always retain local counsel when proposing a transaction.
Clients choose Harvest Business Advisors for our accurate business valuations and our consistent ability to deliver the highest price in the smoothest sale transaction possible. Harvest provides business brokerage, business valuation, and business succession planning services. We have extensive experience in the information technology and professional services, manufacturing, distribution, and contracting fields. We maintain offices in Maryland, New Jersey and Virginia. Connect with us at firstname.lastname@example.org or 443.334.8000 to discuss selling your business, ordering a business valuation or buying a business.