M&A Monday – Make Your LOI Short and Pretty, Defer the Thorny Issues.
Last week I spoke to a seller’s broker after the seller accepted my client’s LOI. I asked him, off the record, why did you take our LOI?
His response – We had two LOIs at the top of the stack. Your LOI was short, organized, and professional. I could tell it was written by someone who knew what they were doing and could move this deal to closing.
I have submitted hundreds of LOIs for clients and have had many of them accepted.
My first tip on LOIs is to make them clear, concise, and professional.
The LOI should be no more than 2 pages of substance and, other than a short intro paragraph, should avoid long-form explanations of the terms.
Use the language of M&A. It is important that you use the right terms because this will indicate to a broker that you are experienced and knowledgeable (or at least you have experienced advisors).
Second tip, do not over-define the thorny issues.
I know there is a desire to define everything upfront to avoid dead deals later, however, this will result in your LOI not being selected because you are trying to negotiate everything upfront.
The two primary examples are working capital and indemnifications. Some LOIs try to fully define working capital calculation and true-up mechanics in the LOI. Second, some LOIs try to define the indemnifications, caps, and baskets. In my view, this is misguided. Here are a few disadvantages to this -
1. The LOI is when the buyer has the least leverage. Later in the process, you will have built a connection with the seller, and the lawyers will have connected. This will allow you to better resolve these issues. For example, it will be easier to discuss working capital when financing is confirmed and other issues are clearer.
2. Knowledge. The buyer simply does not have all the facts at the time of the LOI to lock themselves into a position. I see LOIs that define working capital as the average of 12 months. What if it make more sense to use the average of 3 months? What if current assets should exclude inventory for a business of this type. It does not makes sense to define it at this stage. As for indemnifications, how do you know the cap on non-fundamental indemnifications should be 20% until you have done legal diligence. What if it is a clean business and we feel okay with 15% or it is a mess and there should be no cap? We should not lock ourselves into a position at the LOI stage.
3. Allow the Professionals to Negotiate. At the LOI stage, it is usually the buyer talking with the seller (or broker). Later in the process, the buyer can let their lawyer or CPA discuss these issues directly with their counterparts. An indemnification discussion is much better had lawyer-to-lawyer, and working capital should be discussed between CPAs after QoE is done. This achieves much better results than trying to define everything in the LOI and allows the buyer to preserve their relationship with the seller.
Instead, opt for more open-ended language, for example, the Definitive Agreements will include customary representations and warranties and, The Purchase Price will include a normalized level of Net Working Capital (as determined by a third-party Quality of Earnings Provider).
This will keep your LOI short, define your basic position, and leave your positions open for your advisors to resolve this later.
If you would like my form of LOI, please reach out to me.