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Avoiding The LOI: Why This Business Broker Favors APAs Over LOIs

A business purchase Letter of Intent ("LOI") is a document stating the intentions of a business owner and a prospective buyer to transfer the ownership of the business. An LOI it is often non-binding depending on the language in the document. While the actual sale and purchase may be non-binding, many restrictions on the parties, particularly the seller, are binding, such as stopping any marketing efforts, refusing any new offers, suspending any negotiations with other parties for a specified period of time (e.g., 30 days, 60 days) unless the LOI is canceled by the buyer before then.

In my opinion and experience, an LOI may very well be appropriate for lower middle market transactions of $5,000,000 or more; but, for deals less than that an Asset Purchase Agreement ("APA") with contingencies on the actions of the buyer (and seller) is much more efficient and effective.

For most small business transactions, an LOI is a distraction that will prolong and possibly endanger the deal going through. The only real purpose for the LOI is to keep the seller from negotiating with anyone else while negotiating the deal and going through due diligence with the buyer proposing the LOI. For a deal that will take 6 to 12 months to conclude and/or involves several millions of dollars, this may make sense; but, in almost all small business sales, the most efficient process is the broker's standard contract of sale submitted as an offer by the buyer to the seller.

In the offer, the buyer can present all their terms and conditions and the seller can negotiate these until both parties have reached agreement. And, unlike the typical LOI, the APA would also include a refundable good faith deposit paid by the buyer into the escrow agent's trust account. At that point, the seller has just about an absolute obligation to sell, despite any other offers he may receive after that; but, the seller can certainly take "back up" offers in case the first one falls through.

The standard contract will provide for a due diligence period during which the buyer can confirm or refute the representations made by the seller and during which the buyer can terminate the contract and recover the deposit. If the seller is "taking back" a loan note from the buyer, the APA should also include a due diligence time for the seller to check out the buyer's creditworthiness and collateral.

This is the due diligence language from my standard APA:

4.1 PURCHASER'S DUE DILIGENCE INSPECTION OF BUSINESS RECORDS, ASSETS, & LEASE. This Agreement is contingent upon PURCHASER’S review and inspection of SELLER'S Business Records, Assets, and Lease within a period of ___________ (____) calendar days following the date of the execution of this Agreement by both SELLER and PURCHASER.

4.2 PURCHASER'S OPTION TO CANCEL. Following PURCHASER’S review and inspection of SELLER’S Business Records, Assets, and Lease, IF PURCHASER IS NOT SATISFIED FOR ANY REASON WHATSOEVER OR FOR NO REASON, PURCHASER shall have the option of canceling this Agreement by written notice to SELLER, BROKER(S), and ESCROW AGENT (the “Due Diligence Cancellation Notice”) made no later than 11:59 p.m. (Pacific time) on the last day of the review and inspection period under Section 4.1, above, and thereafter, upon request, SELLER agrees to execute and deliver a written statement authorizing the release of the escrow deposit(s) to PURCHASER (the “Escrow Release Authorization” form). Written notice may be delivered by U.S. postal mail, commercial delivery service (e.g., FedEx, UPS, etc.), email, or fax, with burden of proof of delivery on the sender of the notice. Upon PURCHASER’S receipt of a refund of the escrow deposit, SELLER, PURCHASER, ESCROW AGENT, and BROKER(S) shall have no further obligation one to the other under this Agreement.

4.2.1 Effect of there being no Due Diligence Cancellation Notice. In the event the Due Diligence Cancellation Notice is not timely sent by PURCHASER to SELLER, BROKER(S), and ESCROW AGENT pursuant to Section 4.2, then this Agreement shall continue to be binding upon SELLER and PURCHASER.

4.3 SELLERS' DUE DILIGENCE INSPECTION & VERIFICATION OF PURCHASERS' CREDIT & SECURED ASSETS. IF and only if SELLER will become a creditor of PURCHASER(S) by “taking back” a Seller Note, this Agreement is contingent upon SELLER'S review and inspection of PURCHASER’S credit and secured assets during the same period of time as provided for in Section 4.1, above.

Immediately upon signing this Agreement, the PURCHASER(S) shall provide to SELLER:

a. a complete personal financial statement
b. a copy of a complete detailed consumer credit report obtained by PURCHASER(S)
c. such other information regarding assets and security as may be requested by SELLER

4.4 SELLER'S OPTION TO CANCEL. Following SELLER’S review and inspection of PURCHASER’S credit, financial statements, etc., if SELLER is reasonably dissatisfied with PURCHASER’S creditworthiness or ability to pay the Note, SELLER shall have the option of canceling this Agreement by written notice to PURCHASER, BROKER(S), and ESCROW AGENT (the "Due Diligence Cancellation Notice") made no later than 11:59 p.m. (Pacific time) on the last day of the review and inspection ("due diligence") period under Section 4.1, above, and thereafter, upon request, SELLER agrees to execute and deliver a written statement authorizing the release of the escrow deposit(s) to PURCHASER (the "Escrow Release Authorization" form). Written notice may be delivered by U.S. postal mail, commercial delivery service (e.g., FedEx, UPS, etc.), email, or fax, with burden of proof of delivery on the sender of the notice. Upon PURCHASER'S receipt of a refund of the escrow deposit, SELLER, PURCHASER, ESCROW AGENT, and BROKER(S) shall have no further obligation one to the other under this Agreement.
4.4.1 Effect of there being no Due Diligence Cancellation Notice. In the event the Due Diligence Cancellation Notice is not timely sent by SELLER to PURCHASER, BROKER(S), and ESCROW AGENT pursuant to Section 4.2, then this Agreement shall continue to be binding upon SELLER and PURCHASER.

The APA should also provide for cancellation for other causes such as failure of either party to close or failure of a contingent condition (e.g., lease transfer, financing approval, etc.).

With an APA, from making the initial offer, to reaching an agreement, to conducting due diligence, ideally no more than about a month should pass. (The Closing could then occur about four weeks later.) That's just about as much time as it might take to just negotiate an LOI, never mind actually drafting and executing the LOI.

I had one deal within the past year where the buyer, who worked for a large firm dealing in 8 and 9 digit deals, insisted on an LOI for a $300,000 business. It complicated the process, frustrated the seller, incurred unnecessary legal fees, delayed due diligence, and ultimately led to the deal falling through.

In my opinion, apply the "KISS" principle - keep it short and simple. Avoid the LOI whenever possible.

Categories: BizBen Blog Contributor, Deal And Escrow Issues, How To Buy A Business, How To Sell A Business, Selling A Business

Contributor:

Tim Cunha
Areas Served: San Francisco Bay Area, North Bay Area
Phone:  650-600-3751 Cell, 650-600-3751 Text
SF Bay Area experienced attorney, & business broker, intermediary. I & my EvergreenGold team offer owners sound advice & expertise to build business value & achieve profitable sales. For a FREE business evaluation & SWOT analysis for your business phone me direct at 650-600-3751, 650-866-5393 Text.




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