Mergers and Acquisitions For Dummies (61 page)

Lawsuits

Change in regulations

Change (downturn) in the economy

However, if Buyer doesn't have a solid reason for asking for a lower price, that Buyer may be exhibiting a little bit of gamesmanship and a lot of negotiating in bad faith, so I don't recommend that Buyers unnecessarily try to lower the valuation. Check out Chapter 11 for more on negotiating in good faith. Similarly, if the business improves (especially profit-wise), Seller may feel that renegotiating for a higher valuation is warranted.

This proposition is tricky, and in most cases I don't recommend it. Focus on getting the deal done. During the time Seller spends convincing Buyer to pay more, the business may take a step backward, reducing profits and thus causing Buyer to ask for a lower valuation. In this situation, the only winners are the lawyers and anyone else billing for time as the process drags on.

Chapter 13

LOI and Behold: Making or Receiving an Offer

In This Chapter

Understanding the LOI's purpose

Looking at the LOI's inner workings

Considering extending exclusivity

Moving forward after the letter is signed

A
lthough many things — an indication of interest (see Chapter 9), a term sheet, a phone call where Buyer says, “We're interested and we're willing to pay $10 million” — can be an offer in the M&A world, not all offers are created equal. In the world of offers, the letter of intent (LOI) is in a class of its own; it's the gold standard of offers. This chapter gives you the lowdown on this document, including its important parts and some considerations to keep in mind while reviewing it.

Signaling Sincerity with a Letter of Intent

An LOI is basically a marriage proposal from Buyer. Both parties promise to stop seeing others and signal to each other that they're very serious about wrapping up the deal. In dating, that deal is wrapped up at the wedding; in M&A, it happens at the closing.

As the name implies, the LOI lays out the intent of both parties: Seller states she is willing to sell for the proposed terms, and Buyer states what he is willing to pay. They are both agreeing to move forward to close a deal based on the terms in the document. It's not binding, which means it's not enforceable in court (well, except for the parts about confidentiality) and it doesn't bind Buyer to the deal. In fact, either side can still walk away for any reason.

Buyer submits the LOI to Seller. If Buyer is working with an investment banker or other M&A advisor, that advisor will most likely submit the LOI to Seller (or to Seller's advisor, if she has one). Buyer's lawyer may be the one to actually craft the LOI, although the lawyer works under the direction of Buyer's advisor to make sure the business terms are what Buyer wants. After the LOI is ready to be submitted, sending it via e-mail is perfectly permissible (I don't recommend sending a marriage proposal that way, though).

The LOI is an important step because it lays out the basics of the final deal: the purchase price and terms, closing date, length of exclusivity, approvals, and much, much more. (See the nearby section “Understanding the Salient Issues in the LOI” for more detail.) However, the LOI isn't necessarily the final deal. Rather, it's the framework or roadmap for that final deal. Based on what each side discovers during due diligence, and/or whether the profits of the company decline, the deal may change.

For most people, the transaction to buy or sell a business will be the biggest deal of their lives and careers. It usually involves lots of money and even more risk. When you buy or sell a pack of gum or a bottle of wine, for example, you don't need to issue an LOI. You simply buy or sell the object. If you sell some bad gum or wine, you may have to refund some money, but neither example will ruin you. Given the size and complexity of a company, on the other hand, one bad merger or acquisition may well ruin you. Because of the risk of buying or selling a company, you need to take gradual steps.

Think about buying a house. Most people don't wake up one morning, decide to go out and buy a home, and expect to own one an hour later. Instead, they talk to a real estate agent, look at a bunch of houses, find one they like, and make an offer. If the seller accepts that offer, the buyer signs an agreement that sets the terms of closing the deal and usually allows the buyer to inspect the house; if the house meets the buyer's satisfaction and the buyer can obtain the financing, the house is sold.

In M&A, the LOI acts as an important step in closing that deal. It defines the terms and the timing, and Seller agrees to stop talking to other potential Buyers. And assuming the company passes the inspection (see Chapter 14 for more info on due diligence) and assuming Buyer has (or can get) the dough, the deal closes.

Although they're similar in some ways, an LOI is different from an indication of interest (IOI). Both documents are part of the process of buying or selling a company; however, the LOI lays out more specific terms. An IOI typically has a valuation range; an LOI has a specific valuation. An IOI doesn't ask for exclusivity, but an LOI usually does ask for exclusivity from Seller. Think of it this way: An IOI is asking for a date, while an LOI is a marriage proposal.

The LOI's more specific terms provide protection for Buyer. The LOI allows Buyer to get serious about closing a deal without having to worry about another Buyer swooping in at the last minute and stealing it. The LOI also allows Buyer to get a close look at the company without having to lay out the money to buy the company.

Exclusivity is a key consideration. An LOI usually includes a lock-up period where Seller is out of the market — that is, unable to speak with other Buyers about doing a deal. Sellers should grant exclusivity very carefully and should do everything possible to limit the amount of time they're prevented from speaking to other Buyers. I cover exclusivity in more depth later in the chapter.

Understanding the Salient Issues in the LOI

Although no one-size-fits-all approach applies to writing an LOI, the basics include some boilerplate legalese and some detail about the specific deal at hand. In the following sections, I lay out some of the main areas of coverage you're likely to see in an LOI. Check out the appendix for an example LOI.

As with all these specific legal documents, speak to your advisors. I highly recommend that Buyers and Sellers speak to their intermediaries about the business issues (price, timing, and so on) and to their attorneys about the legal aspects.

You may notice that I don't include a section for a
break up fee
(a fee Buyer pays Seller if Buyer walks away from the deal). The truth is that most Buyers don't care to include those clauses for obvious reasons, so the odds of getting one in an LOI are slim. Sellers can ask for them, but they shouldn't get their hopes up.

Buyer and Seller should both guard against negotiating every single last detail of the purchase agreement in the LOI. You want to hammer out the main issues, absolutely, but certain advisors (ahem, lawyers) are wont to settle every single minor issue at the LOI stage. Focus on the salient issues in the following sections.