Understanding Letters of Intent: Part 2
You’ve Signed a Letter of Intent with a Buyer, Now Don’t Screw it Up
Once you have reached the Letter of Intent stage, many sellers start to think that the transaction is practically over. They think, “All that’s left is some confirmatory due diligence and I’m on my way.” The truth is, before you sign the LOI, you have a tremendous amount of leverage. After you sign the LOI, you need to be cautious and continue to act in a manner that will get the deal done.
There are quite a few ways we see sellers disrupt the LOI phase of the transaction:
You Are Not Friends with the Buyer
Up until this point, meetings have been fairly pleasant. You may have exchanged information with the buyer about your kids or your hobbies. This is perfectly natural and a big part of sizing up the party that sits across the table. It is important, however, that you not confuse pleasantries with friendship.
You are not friends with the buyer. You are friendly negotiating partners. There is a difference. Friends are willing to take a hit for friends. You should not be willing to compromise anything more than what is necessary during the negotiation.
On the Other Hand, Don’t Get Too Self-Assured
Some business owners go a different direction, and after they have signed the LOI believe that they have “won” and cease being rational negotiators. Post-LOI, there is still a lot of diligence to get through where issues will arise. When they do, you have to be willing to have a reasonable conversation about how to resolve them or adjust your price expectations. You also need to get through the intricacies of negotiating the Purchase Agreement, which is no small task. In short, after you sign the LOI, you still have about 3 months of close personal contact with the buyer and developing an attitude at the LOI stage is a recipe for disaster.
Once the LOI has been signed it is time to really get things moving. Time is not your friend during due diligence. If all parties are not hurtling towards a close at this point, your investment banker will intervene. Delays during diligence can increase the potential of a confidentiality breach and cause deal fatigue in the management team. When deal fatigue sets in, people get cranky and negotiating the Purchase Agreement can be difficult. In a worst case scenario, people get so frustrated that they throw up their hands and walk away from the transaction.
Don’t Buy the Boat
Or the vacation home, or anything that effectively spends your proceeds before you receive them. As the deal progresses, its going to be tempting, but don’t do it. Anything that detracts from your ability to walk away from a transaction that is getting out of hand, puts leverage right into the buyer’s camp. I have seen buyers become much more aggressive negotiators once a business owner has preemptively spent the proceeds of the transaction.
Don’t Take Diligence Personally
After you negotiate and sign the LOI, you will enter into a process of intense due diligence. Due diligence is hard for business owners because it means that a group of people (some that may know very little about your business or industry) will not only ask you about what you do, but why you do it that way. This series of questions can be hard for someone that has worked in a business for a long time because every “why” can seem like it implies that you aren’t doing that thing correctly.
So when a 23 year old with a freshly printed business degree and a fancy suit asks you why you do inventory that way, don’t take it personally. Your investment banker should be managing the questions so that they don’t get out of control and if you remember that, behind all these questions is a checklist that needs to be filled out, you will feel better.