How to Use a Letter of Intent for Business Acquisition | Hilton Smythe

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How to Use a Letter of Intent for Business Acquisition

If you believe now is the time to write the next chapter in your business’s story, here’s what you must know about the Letter of Intent process.

Buying or selling a business is a complex endeavour, with business owners often coming up against unfamiliar terms and concepts. One tool you may have heard about is the Letter of Intent (LOI).

Although the UK acquisition market is stagnant, with the value of domestic acquisitions being just £2.6 billion in Q3 2023, a £0.2 billion decrease from the previous quarter, M&A opportunities remain.

If you believe now is the time to write the next chapter in your business’s story, here’s what you must know about the LOI.

An LOI is a document that is a rough outline provided by the buying side within the framework of an M&A transaction. This formal letter crystallises the buyer’s interest in written form, demonstrating that they are serious about the deal proposed.

A typical LOI will contain things like:

·  Terms

·  Purchase price

·  Assets included

·  Liabilities included

·  Exclusivity

·  Other conditions

The above involves some specifics, but an LOI isn’t a legal document and does not replace the final purchase agreement. Sending an LOI is designed to express interest and ensure the seller is also interested in the deal.

Should both sides accept the LOI, the due diligence phase will begin. Since it comes before due diligence, any side is free to withdraw from the transaction if it later arises that the deal doesn’t make sense.

After all, 70% of M&A deals fail to achieve the synergies and financial benefits business owners expect, meaning it’s vital to be 100% sure of a deal before going through with it.

The LOI is merely the starting point.

Most business owners underestimate the importance of an LOI. Despite its formality, there is no legal obligation to proceed with a deal. With this in mind, why bother with an LOI if there are no legal ramifications?

Here are some of the reasons:

Commitment – An LOI tests the commitment of both sides to the deal. The average due diligence time can last for eight to ten weeks, involving multiple professionals. It’s an investment of time and money, and neither side wants to waste those if the other party isn’t serious.

Basis for Negotiation – The LOI isn’t a purchase agreement, but it does set down an initial starting point for negotiations, assuming the due diligence process proceeds without any snags.

Exclusivity – Most LOIs will contain an exclusivity clause. If accepted, the business will be taken off the market, and any other negotiations will be suspended until either a deal occurs or the buyer pulls out.

Clarification – This document also memorialises the key terms of future negotiations. It can prevent any confusion or disagreement when the time comes to draft a purchasing agreement.

Financing – Although some businesses acquire others in cash, most will opt for some financing to protect their cash flows, especially in larger acquisitions. All lenders will require an LOI before they will underwrite a loan.

As you can see, the benefits of an LOI are rooted in constructing a launchpad for the time-consuming due diligence process and establishing a basic sandbox to build upon when in-depth negotiations begin.

In other words, it may not be legally binding, but proceeding without an LOI isn’t a smart move for the buyer or seller.

M&A deals are fraught with potential pitfalls. For one reason or another, up to 90% of all acquisitions fail. This depressing number is usually tied to poor targeting, lack of due diligence and rushed deals.

Step back and tread carefully to avoid becoming part of this figure. Regarding your LOI, the first step is to get this right to set the tone for the following crucial steps.

Firstly, always ensure that you have enlisted the services of a solicitor specialising in M&A deals. Language and wording matters. Getting it wrong can lead to confusion and misunderstanding later.

Writing your LOI will always differ slightly depending on the type of business your transaction involves. However, there are some common similarities that every LOI must have.

Let’s go through the five core points your LOI should touch upon:

1. Introduction – Begin your letter by explaining what type of transaction you seek. Make it clear what you are buying, whether this is an entire business, a division, or even just specific assets.

2. Identification – The next step is to confirm who the buyer and seller are in writing. Identification should be formalised, with names and addresses included.

3. Contingencies – Continue by outlining any conditions you, as the buyer, want to satisfy before reaching a final deal. By far, the most common contingency is whether the buyer will be seeking approval on third-party funding to finance the deal.

4. Due Diligence – As the preliminary step to due diligence, your LOI should also contain references to this pivotal step. In this section, you will cover the finer details of your upcoming deal to avoid any unpleasant surprises that may crop up later.

5. Binding Agreements – Binding agreements provide legal protection for buyers and sellers. Although the LOI isn’t a legally binding document, violating stated binding agreements could result in legal action later. Examples of binding agreements include non-compete clauses and non-disclosure agreements.

Traditionally, businesses consult with a solicitor and write their letter from scratch. Today, you can find LOI templates online for every industry. However, this is no substitute for professional advice.

Ideally, a template should be used to formulate an initial draft, which a professional can scour and improve upon later.

A Letter of Intent usually acts as the basis for final negotiations. Most managing directors spend too much time focusing on the final purchasing agreement when they should be negotiating their LOI.

How strongly you hammer out your purchasing agreement will determine whether your interests are protected and whether you are getting favourable terms and prices later.

An LOI is not a statement of “I want to buy your business.” It’s much more specific than that, so expect to enter negotiations before the final document is accepted.

Follow these tips for negotiating a stronger LOI in your next M&A deal:

Watch the Balance of Power – Buyers prefer less specifics and broad interpretations, whereas sellers want the opposite. Ensure you are not being dominated by acquiescing to whatever the other side wants because it could weaken your negotiating position later.

Take Your Time – As exciting as it is to send or receive an LOI, this is not the time for snap decisions. Take your time to examine every clause and consult a professional before doing anything other than acknowledging its receipt.

Move Fast – While this may seem contradictory, time kills deals. As a non-binding agreement, do your due diligence on the LOI, but don’t get bogged down, or the buyer may withdraw.

Prevent Re-trading – Re-trading means making drastic changes to the price and conditions outlined in the LOI later. You can prevent this by being more specific, including deadlines, and opting for a limited exclusivity period.

Always Be Exclusive/Confidential – Dishonest buyers and sellers exist. Any LOI should contain non-compete and non-disclosure clauses to protect the future of the business if negotiations fall through.

Run Your Business – LOIs are no guarantee of a successful deal. Although a potential M&A deal may be exciting, continue to run your business as before. Allowing it to go off the rails risks hurting your brand and lowering the eventual price.

Negotiations are all about protecting your interests. Adopt the conventional wisdom of not falling for pressure tactics and reading the other party.

Remember, a negotiated LOI is merely the first formal step to a successful deal. Anything can happen between an LOI and the final purchasing agreement being signed.

LOIs are documents that express a meeting of minds regarding a potential M&A deal. They are not purchasing agreements but are also not irrelevant documents that remain purely for tradition.

Never view LOIs as a box-ticking exercise. Treat them with the importance they deserve because the prices and terms you outline now set the stage for future negotiations.

Likewise, LOIs are best used in a business acquisition as merely step one in a potential deal. They’re not the most critical aspects of a deal, but neither do they lack importance because of their non-legally binding nature.

The best way to handle them is to make your terms clear now, whether you’re a buyer or seller. The former will look to keep terms general, whereas the seller will want to be as specific as possible to limit the buyer’s wiggle room later.

As always, professional help is vital to handling your LOI, whether you need an interpretation of the other party’s wishes or draft one from scratch. At Hilton Smythe, our specialist M&A Consultancy team has extensive experience creating and reviewing LOIs.
To learn more about how our team can help, contact us today.

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