For most sellers, how you negotiate the LOI holds more significance than how you negotiate the purchase agreement. Signing a robust LOI that safeguards your interests it’s akin to gaining a substantial advantage.
The dynamics shift dramatically when the seller grants exclusivity to the buyer; they now have the high ground, with comparatively less to lose if negotiations collapse. Conversely, if you were to step back, you’d be faced with the daunting task of restarting negotiations, often in a less favourable position, as potential buyers may perceive your business as tarnished.
Given the shift, it’s essential to invest ample time and attention in crafting an LOI that is specific and precise. Failing to pay due diligence to the terms outlined in the LOI can have disastrous consequences. The buyer, typically preferring a loosely defined LOI, gains flexibility and opportunities to renegotiate the terms later in the transaction. To counteract this vulnerability, it is crucial to establish as many specific details as possible within the LOI, effectively reclaiming some of the high ground.
Simultaneously, an LOI that presents an enticing offer for your business can be skilfully utilised in price negotiations with other interested parties. A well-managed LOI creates a prime opportunity to initiate a competitive bidding process, potentially resulting in a higher valuation for your business. It becomes a strategic tool to elevate your position and maintain control of the high ground throughout the negotiations.
Be Patient
Many LOI offers may appear enticing at first glance, but it’s essential to approach them cautiously. The attractive deal the buyer presents could be a tactic to secure your commitment and remove you from the market, only to return later with a lower offer. Even if the buyer’s intentions are not deceitful, they may encounter difficulties arranging the necessary financing to close the transaction.
Therefore, taking your time during the negotiation of the LOI is crucial. While most buyers may rush to have the LOI signed and secure exclusivity, you should avoid committing too early. This stage represents the final opportunity in the transaction when you hold a position of strength in negotiations. Regardless of the buyer’s urgency and persuasive tactics, maintain a deliberate and measured approach when negotiating the LOI.
Be Nimble
While it’s important to take your time when negotiating the LOI, once it’s signed, it’s crucial to spring into action promptly. Why? Time can be detrimental to the success of a deal. The longer the transaction remains open, the higher the likelihood of encountering obstacles. The buyer may uncover additional issues with the business, or external factors, such as changes in the economy or industry, can impact its value.
Since the LOI and its terms, including the price, are generally non-binding, they can be subject to last-minute alterations until the purchase agreement is finalised. This is why time is a deal-breaker. The buyer’s perception of value may fluctuate as the closing date approaches. The more time between signing the LOI and completing the transaction, the greater the chance for the buyer to discover information that could diminish their valuation. Buyers meticulously scrutinise for any negative findings right up until the closing. Sustaining momentum is the best solution – the quicker you progress, the less room for complications and the higher the potential to maximise the purchase price. How can you achieve this? By keeping the buyer motivated and enthusiastic throughout the transaction.
Continuously introduce the buyer to new information highlighting the attractiveness of your business. This can include updates on opportunities in your sales pipeline, industry advancements, potential new product developments, or any other aspect of your business that would captivate the buyer’s interest.
Ideally, you want to demonstrate to the buyer that your business continues to thrive even after accepting the LOI, and that new developments may make you reconsider the idea of selling altogether. Project an attitude that if the buyer were to back out, it would be a manageable loss for you, as you could capitalise on these opportunities for a few more months before relisting your business at a higher price.
Be Firm
One of the most significant challenges sellers face after accepting the LOI is the potential for the buyer to initiate renegotiation of key terms during the due diligence phase.
It is essential to recognise that price and terms are naturally subject to some level of revision based on the buyer’s due diligence. However, the price agreed upon in the LOI should be regarded as the maximum amount you anticipate receiving. The purpose of conducting due diligence and engaging in purchase agreement negotiations is to address any issues and challenges that emerge throughout the process, consequently adjusting the terms. The extent of these adjustments depends on the buyer’s findings and the negotiation dynamics between both parties. It is worth noting that the stronger the buyer’s desire for your business, the less likely significant changes to the terms will occur.
Two primary reasons drive renegotiation:
- Discovery of undisclosed issues during due diligence: The buyer may uncover unknown issues, such as financial statements showing unexpected revenue fluctuations or the revelation that key employees do not intend to stay post-sale. Failure to disclose non-competition or non-solicitation agreements with crucial staff members could also be a factor. In such cases, it is reasonable to expect renegotiation of the transaction terms.
- Buyer’s pursuit of a lower purchase price or more favourable terms: The buyer may have intended to renegotiate from the outset, or they may perceive your negotiating position as significantly weakened during the process, allowing them to seek revised terms.
Renegotiation proves effective because the buyer understands that if you choose to withdraw from the deal, you will need to return to the market or approach other potential buyers. However, these new buyers will likely view your business as flawed, resulting in a stigmatised perception and potentially lower purchase offers due to increased perceived risk. Irrespective of the reasons you provide for the previous buyer’s withdrawal, subsequent buyers will approach the situation with scepticism.
Renegotiation may not solely revolve around the price. Other terms, such as including an earnout to mitigate the buyer’s risk or adjustments or escrow terms to protect against warranty or indemnity risks, can also be subject to renegotiation.
To mitigate renegotiation, consider the following:
- Take your time negotiating the LOI, ensuring it contains specific and detailed terms.
- Incorporate deadlines within the LOI to establish a sense of urgency and commitment.
- Opt for the shortest exclusivity period feasible to minimise the buyer’s window for renegotiation.
- Act swiftly and efficiently once you have accepted the LOI, maintaining momentum throughout the transaction.
- Prepare for the due diligence process, expediting the procedure and reducing the likelihood of renegotiation.
Be the Boss
A signed LOI is the beginning of the process, not the deal’s culmination. Once you have committed to the LOI, it is essential to maintain a business-as-usual approach, focusing on running your company as if you were not planning to sell it. Your primary goal should be to sustain profitability and ensure a healthy sales pipeline.
Suppose there is a decline in revenue or profitability after accepting the LOI. In that case, the buyer will likely seek to renegotiate the price or terms of the agreement. To prevent this situation, it is imperative to do everything within your control to preserve the revenue and profitability of your business post-LOI acceptance – don’t fall asleep at the wheel now.
Be Smart About Issues
If you anticipate that the buyer will be meticulous about specific issues, address those concerns in the LOI. It is far better for the deal to encounter challenges and potentially fall through at this stage than for you to remove your company from the market for an extended period, investing significant time and money in due diligence, only to witness the deal derailing later due to unaddressed sensitive issues.
This is where experience plays a vital role. An experienced M&A adviser or investment banker can prove instrumental in foreseeing the buyer’s potential concerns and helping to navigate negotiations to ensure that these issues are addressed within the LOI. Their expertise enables them to anticipate which problems are likely to be the most significant for the buyer and to assist in structuring the LOI to safeguard your interests and to align with the buyer’s expectations.
Be Prepared for Due Diligence
Preparation for due diligence will significantly expedite the overall process. In some cases, buyers may present sellers with an extensive due diligence checklist consisting of hundreds of requested documents. It can take sellers over a month to compile all the necessary documents, causing due diligence to stretch over two months or sometimes longer. Delays in the process often stem from the seller’s failure to prepare.
To mitigate these delays, having the primary documents most buyers typically request readily available when you accept the LOI is vital. These documents should be well-organized and easily accessible to third parties, preferably through a virtual data room or at a designated location. As this preparation requires significant time, you should begin preparing about three to six months before bring the business to market. Failing to prepare adequately can result in due diligence negatively impacting your focus on the business, potentially leading to a decline in revenue.
Be Cautious About Confidential Information
While a confidentiality agreement provides protection, it is essential to exercise caution when sharing sensitive information during due diligence, particularly if the buyer is a direct competitor.
It is advisable to withhold sensitive information whenever possible until the later stages of due diligence. If the information is highly confidential, it should only be disclosed once all other issues have been resolved. At this point, the buyer should have provided their sign-off on successfully completing the due diligence process, except for the remaining confidential details.
In cases where the buyer requests confidential information before making an offer, ask the buyer for one. Each time the buyer requests additional information, it presents an opportunity to request an offer in return.
By adopting this approach, you can exercise greater control over releasing sensitive information, ensuring that it is shared only when appropriate and minimising the risk of exposing critical details to potential competitors who are merely fishing for information.
Be Thorough
The LOI should encompass all significant transaction terms. Delaying negotiations until later stages often leads to unfavourable terms for the seller.
The purchase agreement should flow smoothly from the LOI, with key terms already negotiated. Avoid LOIs with price ranges or missing essential terms like escrow amounts, price adjustment mechanisms, earnout provisions, or limitations of liability.
Prioritise finalising all crucial terms in the LOI before accepting it. Avoid vague clauses like establishing the seller’s role and compensation during due diligence, which can result in unfavourable arrangements. Specify in the LOI that key terms must be agreed upon within a defined timeframe.
Takeaways
The LOI plays a crucial role in the transaction process, setting the stage for successful negotiations and mitigating potential challenges. By prioritising a comprehensive and specific LOI, sellers can assert their position, maintain control, and avoid unfavourable terms later in the process.
Negotiating key terms, being prepared for due diligence, and carefully managing sensitive information contribute to a smoother transaction. By strategically navigating the LOI phase, sellers can maximise their chances of a successful outcome.