Introduction

“The value of a financial asset is directly related to the ability to finance it.”

– Jacob Orosz

When negotiating a letter of intent (LOI), there are many aspects of the transaction you must take into account to ensure you receive the best deal possible. In this chapter, I’ll discuss the primary elements of the deal structure you need to consider when evaluating an offer, which can be broken down into two components – financial and legal.

• Financial Components: A $20 million all-cash offer isn’t the same as a $20 million offer that consists of 10% down, a seller note for 40%, and an earnout for the remaining 50%. When evaluating an offer, one of the first things you should evaluate is the form of consideration, or how the purchase price will be paid. Here are the major financial components of an offer:
  • Cash: Cash is generally preferred by sellers over all other forms of consideration. Most buyers put down 60% to 80%.
  • Debt and Liabilities: The purchase price usually includes working capital, which includes short-term debt (i.e., accounts payable). Long-term debt is rarely assumed by buyers.
  • Seller Financing: Seller financing is common in transactions of all sizes unless the buyer can obtain significant financing from a third party. 
  • Third-Party Financing: Corporate acquirers have many options available to them to finance an acquisition.
  • Stock/Equity: It’s common for the seller to retain equity in the business if they plan to remain with the company after the closing. This strategy is commonly used by private equity firms to ensure alignment with the seller if the seller will continue to operate the business.
  • Earnout: Earnouts constitute a significant portion of the purchase price if they are used to bridge price gaps or for high-growth businesses in which future growth is difficult to predict. Otherwise, earnouts usually comprise 10% to 20% of the purchase price.
  • Employment Agreement: An employment agreement is often used in lieu of, or in addition to, equity to retain you for a defined long-term role in the business.
  • Consulting Agreement: A consulting agreement is often used to ensure your short-term assistance with the transition and can be structured on an hourly or salary basis.
  • Holdback (Escrow): Most transactions include a 10% to 20% holdback to cover any indemnification claims due to a breach of the reps and warranties.
  • Royalties and Licensing Fees: Licensing fees are sometimes used to compensate you for new product launches that haven’t yet generated revenue and are therefore difficult to value using other means.
• Legal Components: Just as important as the finances of the transaction are the various legal structures that can shape how a transaction is completed. Here are several of the most important you should take into consideration when evaluating your deal structure:
  • Asset vs. Stock: Whether the sale will be structured as an asset or stock purchase is a key consideration in any transaction. The LOI should specify the legal form. Most transactions are structured as an asset sale due to the potential for contingent or unknown liabilities.
  • Entity Structure and Entity Type: The type of your entity – for example, corporation vs. LLC – may also impact how the transaction will be structured for legal and tax purposes. 
  • Partial Sales: In some instances, it may be possible for you to sell a portion of your company as opposed to the entire business. If that’s the case, there are numerous ways to structure a partial sale from a legal and financial standpoint.
  • Taxes and Allocation: Ideally, the LOI should also define how the purchase price will be allocated for tax purposes. The IRS requires that the parties allocate the purchase price among the assets being purchased. How the price is allocated will determine the tax implications of the transaction for both you and the buyer.