Home Insights & Advice Succeeding with LOI and alternatives during acquisitions

Succeeding with LOI and alternatives during acquisitions

by Alejandro Cremades
7th Sep 21 9:54 am

Some investors will use the phrase “term sheet” for an LOI, which is completely different from safe notes in financings A term sheet is more applicable when talking about fundraising and investments. Then there is an indication of interest (IOI), an informal letter expressing their interest in your start-up, which often precedes the letter of intent.

Long and short letter of intent

There are short-form and long-form letters of intent, and both get constructed to highlight key terms of the acquisition. There are benefits to both.

Long-form letter of intent

Quickly identify any “deal-breaker” issues and get them resolved early in the acquisition process before spending a fortune on legal fees with a long-form letter of intent. Then, when both parties have reached a resolution, the acquisition process will be more efficient and save everyone time and money.

A disadvantage is that it slows down the momentum from following through on the acquisition because of any issues that need to be dealt with early on. As a result, negotiations could drag on for months instead of deferring some issues for the acquisition negotiation.

Short-form letter of intent

A short-form letter of intent only addresses the purchasing price and some key terms and conditions, such as exclusivity. The disadvantage is that some essential issues only get dealt with later, leaving the seller with many questions.

How to get an LOI

An acquisition starts with a conversation between the seller and buyer where both parties will propose the main terms of the deal. Also known as the memorandum of understanding (MOU), the letter of intent will briefly describe these terms. But, how do you get a letter of intent? It all starts with finding the right buyer. 

Acquirers include:

  • Private Equity Funds: Funds may be interested in holding your company in their portfolio for cash flow and yields. 
  • Competitors: If a competitor sees a significant advantage in buying your start-up or simply wants to increase its market share, they can pursue purchasing your business. They might wish to take over your consumer base if it’s large enough to make a difference and eliminate the competition.
  • Strategic buyer: If your start-up supplies to other businesses, they may find it beneficial to purchase your business to save money, or they want to sell your products to its consumers and increase their revenue.
  • SPACs: Companies specifically created to take start-ups public, and profit in the process.

How can an LOI help you succeed during an acquisition?

There are numerous reasons why a letter of intent can help you succeed during a start-up acquisition. Signing an LOI shows the potential buyer that you are serious about the acquisition. You are not wasting their time, and they are more willing to invest time and money evaluating your company and moving forward with negotiations. It opens the door for the start-up to state their ‘demands’ moving forward while protecting sensitive information about their business.

The LOI sets the stage for the final agreement, and the acquirer starts their due diligence formally. Therefore, it is also more likely to reach the final phase of the purchasing agreement fulfilling your intention.

The LOI will also discourage re-negotiations. Again, this is useful for early start-ups with little to no revenue because the acquirer has already spent money and time throughout the due diligence process and drafting the final agreement with their legal team; they would want to avoid further delays.

A letter of intent will help to avoid misinterpretations throughout the negotiating process. However, be wary that the more detailed the LOI becomes, the more  binding it is. Therefore, ensure that you have sought legal advice before signing on the dotted line. A detailed LOI with ambiguous statements could hold you up in court.

How to negotiate an LOI to help you succeed during an acquisition

As with any business contract, both parties will request tweaks and changes after they have looked it over. This is especially true throughout the acquisition process. However, as the lead on the transaction, you have already given the selling price. The buyer knows your price, though it is common that once they have performed due diligence and evaluated every detail of your financials and valuation, they will want to renegotiate or make adjustments. 

It is essential to conduct business meetings concerning the acquisition with a legal team. If you are going up against a large corporation, rest assured they have lawyers providing advice, and you may feel backed in a corner or intimidated.

Let’s explore some situations that you should consider as the founder going into an acquisition:

  • What are you selling? The purchasing agreement and tax implications differ according to what you are selling. Is it an asset or share deal? 
  • How will the start-up be bought? Will it be with cash, shares, or both? The buyer might want to pay in shares. In this case, contact your legal team or a valuation professional to ensure that you’re getting a fair deal. 
  • Does the buyer have the funds to execute the transaction? Do they require funding, and will the deal fall through due to their inability to receive the financing? 
  • Exclusivity is one of the few binding sections of the letter of intent. The acquirer wants to ensure that they can invest time, money, and resources into the due diligence and purchasing agreement knowing you aren’t negotiating with other buyers or investors. 

The acquirer will ask for all of the information you have that you are willing to share. What should you share? You don’t want to get caught up in a lengthy fishing scheme that doesn’t lead to a letter of intent. If you already have a connection with the potential buyer, they most likely have your business model, strategy, and consumer market information. 

Still, with those that you have never heard of, as well as some intermediaries, the buyer only knows what’s public information. In that case, there needs to be some level of compromise with how much information you want to share, and when. It should be enough to lead them to send an offer and plan an LOI. If the deal doesn’t go through, the last thing that you want is to be thinking is how much sensitive company information is out there. Acquirers who have drafted and signed the LOI have the right to comb through virtually as much detail on your business as they want. Except and exclusions. 

How much information is too much

That leads us to the next question. How far is too far? What do you do if potential buyers ask for more that you want to share? There are two important things you can say to ensure that you stay protected and get the LOI. 

  1. Sensitive information must not get shared until there is a formal confidentiality agreement and LOI
  2. List specific data you will not disclose

Being straightforward shows the buyer that you know how LOIs work and everything that goes into an acquisition process. It also shows them that you don’t have to sell today, but they may want to buy now. So it is an excellent position to be in. Of course, there will be some power struggle, and often the seller loses the most leverage. Remove yourself from that role before they place you in it.

The bottom line

A letter of intent is an important step of the acquisition process. Both the buyer and seller can list their intentions and save time during the negotiation process. It also gives the founder confidence in the buyer because they are willing to invest money and resources in the due diligence process. 

Set the stage for a smooth acquisition process with a well-written LOI, and remember to seek legal advice before signing on the dotted line. While the LOI is not legally binding, some courts will rule in favour of the document if intentions seem final in the document. 

Author Bio

Alejandro Cremades is a serial entrepreneur and the author of The Art of Start-up Fundraising. With a foreword by ‘Shark Tank‘ star Barbara Corcoran, and published by John Wiley & Sons, the book was named one of the best books for entrepreneurs. The book offers a step-by-step guide to today‘s way of raising money for entrepreneurs.

Most recently, Alejandro built and exited CoFoundersLab which is one of the largest communities of founders online.

Prior to CoFoundersLab, Alejandro worked as a lawyer at King & Spalding where he was involved in one of the biggest investment arbitration cases in history ($113 billion at stake).

Alejandro is an active speaker and has given guest lectures at the Wharton School of Business, Columbia Business School, and NYU Stern School of Business.

Alejandro has been involved with the JOBS Act since inception and was invited to the White House and the US House of Representatives to provide his stands on the new regulatory changes concerning fundraising online.

 

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