A properly crafted Letter of Intent (LOI) is an important step after making the decision to purchase a business.
(Please note this is NOT legal advice. Please retain an attorney familiar with local laws and customs before you finalize any purchase agreement).
The Letter of Intent is drafted by the Buyer and their advisors to inform the Seller (and their advisors) of the Buyer’s decision to formally discuss purchasing the business for sale.
The Letter of Intent is a preliminary document where the Buyer and Seller “agree to agree”. Changes and edits can be made to the Letter of Intent to satisfy both parties.
The Buyer will have disclosed their financial standing and resources to the Seller already and signed a Non-Disclosure Agreement. The Seller will have shared financial information with the Buyer and provided a Confidential Business Review.
The Letter of Intent sets the due diligence process in motion.
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Discuss with your advisors what you need to include in your letter of intent. Now is the time to ask questions, receive advice and process information about important decisions.
There is no typical Letter of Intent since each business sale is unique. However, there are some standard features:
Purchase Price: The purchase price is the total amount the prospective buyer will pay for the business.
Financing Specifics: Describes the basic deal terms such as down payment, financed amount (either through bank or seller), and if necessary, contingency details. If you intend SBA financing, all variables (other than payment of a fixed amount note) must be fully determined by one year from the closing date.
Due Diligence: The due diligence clause outlines the length of time the buyer has for their investigation process on the business. There should always be a clear start date and end date
Basic Conditions of the Sale including (but not limited to):
Earnest Money: To confirm the buyer’s seriousness about buying the business, the LOI will include a set amount of money paid to confirm the agreement. This protects the seller if the deal does not happen and time and expenses are lost.
Expenses: Outlines who pays what expenses.
Expiration: Details the termination of the agreement presented
Closing or Conditions of Closing: Usually outlines the high level details about closing the transaction, what the parties anticipate. Some of the items that can be listed here are closing date and any important contingencies, by either party. Decisions about who will write the final contact would be stated here.
We have found that asking what the minimum or maximum of something (price, down payment, seller financing, etc.) tends not to be productive. It is almost impossible to get specific on a part of the transaction without have a reference to the whole offer. The answer will always be – “it depends.”
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Often to protect themselves, buyers add earn-out or claw-back clauses. At a high level, this means buyers would tie payments into resulting cash flows. Usually we use revenues because any other cash flow (such as profit) since it 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.
Arrangements for sellers to stay involved with the business beyond the closing or other milestones would also be included in a Letter of Intent.
A well-written Letter of Intent should bring parties together and help lay out terms as a way to reduce the risk of litigation and set the course for a successful deal.
We are happy to answer questions about Letter of Intent or guide you through this negotiation process.
It is an intricate dance.
In the end, with patience and perseverance, a Letter of Intent can be created that everyone can live with at the time of negotiation and be quite pleased with one year later.
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.