6: Submit a Letter of Intent

*Note: This section is only applicable to those who would like us to prepare the letter of intent (LOI) on their behalf. We commonly draft the LOI if the buyer is an individual or smaller company. The buyer usually drafts the LOI if they’re a private equity firm or other institutional buyer (e.g., family office, strategic buyer, etc.).

Summary of the Process

A) Submit a term sheet, or
B) Submit a letter of intent
C) Submit additional documents

The letter of intent is a non-binding agreement that outlines the key terms of a sale. It’s preceded by a term sheet, which covers key points that must be considered when preparing the LOI. While the LOI is non-binding, it signifies commitment and is replaced by the purchase agreement at closing.

A) Submit a Term Sheet (Optional)

The term sheet is a list of key terms you should consider before making an offer on a business and is required if you’d like us to prepare an LOI on your behalf. The term sheet is a short list of the critical terms you’d like to propose, such as the purchase price, down payment, seller note, due diligence period, transition agreement, non-compete agreement, contingencies, and other essential terms. Once we receive your completed term sheet, we will prepare a letter of intent for your review.

The term sheet is not signed and is for discussion purposes only. It allows you to focus on the key terms of the transaction without concerning yourself with how those terms will be documented. You can use the term sheet as a tool to communicate the terms you’d like to propose so your attorney can prepare the LOI, or you can submit the term sheet, and we’ll draft the LOI for you.

The term sheet includes the following essential terms:

Purchase Price

• The purchase price you’re proposing

Consideration (i.e., how the purchase price will be paid)

• Earnest money deposit, if applicable
• Down payment and source of funds (e.g., cash, bank financing, etc.)
• Additional deposit on completion of due diligence
• Terms of the seller note, such as the amortization period and interest rate

Transition Period

• Proposed training period included in the purchase price
• Proposed terms (e.g., hourly rate, maximum number of hours per week, length, etc.) for additional training not included in the purchase price

Conditions

• Any contingencies

Timing

• Length of the due diligence period
• Any outside parties you will involve during due diligence
• Proposed closing date

B) Submit a Letter of Intent

If we prepare the LOI on your behalf, we will first send it to you for review and comment before presenting it to the seller. Once you approve the LOI, we’ll send it to you for e-signature and then present it to the seller.

The LOI allows both parties to commit to the essential terms so they can begin due diligence and work toward preparing the purchase agreement. The LOI is superseded by the purchase agreement at or prior to closing. Remember, you’re not fully committed to the transaction until the due diligence period has concluded and all contingencies have been resolved.

Even though the LOI we draft is non-binding, for the sake of clarity, it will contain a list of contingencies the parties will attempt to resolve before closing occurs. These can include obtaining approval for a license, securing bank financing, or numerous other contingencies.

Primary Components of the LOI

The following are the primary components of the LOI:

Purchase Price and Terms

• Purchase Price: Some businesses we represent are marketed without an asking price. If this is the case, we can’t provide any pricing or valuation guidance on that particular business. If you’re bidding on a business without an asking price, we suggest submitting your best offer. We’ll counter or accept your offer if it’s close to our valuation expectations. If your offer is significantly below our expectations, we may reject the offer outright.
• Earnest Money Deposit: If you’re an individual or represent a smaller company that has made no previous acquisitions, we’ll request you submit an earnest money deposit, which is typically 5% of the purchase price. The earnest money is preferably held by a neutral third party, such as an escrow agent, and applied toward the purchase price at closing. If you prefer not to use an escrow firm to hold the earnest money, then the seller or their attorney can alternatively hold the earnest money deposit. Earnest money deposits offer demonstrable proof that you have a legitimate interest in the business and help secure the seller’s cooperation.
• Seller Note: Most seller notes range in length from two to five years, and the interest rate usually varies from 6% to 10%. If the seller note comprises a smaller percentage of the purchase price (e.g., 10% to 30%), then the term of the note is often on the shorter end of the range. On the other hand, if the seller note comprises a greater percentage of the purchase price (e.g., 50%+), then the term of the note is often longer, so the business can afford to make the monthly payments.
• Bank (SBA) Financing (for Small Companies): Funds received from third-party lenders are customarily paid in the form of cash to the seller at closing, and any form of third-party financing is therefore considered cash from the seller’s standpoint. If bank financing is used, the LOI may be contingent on obtaining financing. Most SBA loans require a 10% to 20% cash down payment. It’s common for a 10% seller note to be counted toward the cash down payment, in which case a 20% down payment is usually required. SBA loans have a maximum loan limit of $5 million, and any additional amount can be bridged with cash or a seller note.
• Earnout: An earnout is a useful means of bridging a valuation gap and getting a deal done. It’s a financial arrangement in which you agree to pay the seller a predetermined amount if certain targets are met post-closing. In the complex world of buying and selling a business, coming to an agreement on the proper price for a business can be difficult. When submitting your LOI, if you propose an earnout, we recommend including a sample calculation (in an editable spreadsheet with the input cells clearly identified) that includes multiple scenarios. Earnouts are rare in small transactions but common in mid-market deals. Few sellers of small businesses are willing to accept an earnout, and we don’t recommend them for smaller transactions due to their inherent complexity. They are notoriously difficult to administer and subject to numerous complications post-closing. Earnouts are generally only appropriate for mid-sized companies.

Legal Transaction Structure

• Asset Sale: In an asset sale, the buyer (e.g., John Smith) or their entity (Corporation, LLC, etc.) purchases the individual assets of the business from the seller. The seller retains ownership of their entity (e.g., Corporation, LLC, etc.) after closing. The parties jointly decide which assets and liabilities are included in that transfer. The sale usually includes all hard assets necessary to operate the business, such as equipment, supplies, and inventory.
• Stock Sale: In a stock sale, the seller (e.g., Jane Smith, as an individual) sells the actual ownership of their entity (Corporation, LLC, etc.) to the buyer. By purchasing the entity, the buyer then assumes ownership of the assets and liabilities owned by the entity.

Due Diligence

• Length of the Due Diligence Period: Most due diligence periods range from 30 to 60 days. The time period tends to be shorter for smaller companies or for those in which the data room is already prepared and longer for larger companies or those in which the data room has not yet been prepared.

Contingencies

• Bank Financing: If you’re obtaining third-party (e.g., bank) financing, it’s common for the LOI to be contingent on obtaining financing.
• Third-Party Approvals: If approvals must be obtained from third parties, such as a landlord, franchisor, or distributor, then the LOI may also be contingent on obtaining these approvals.
• Licensing: Likewise, if licensing must be obtained prior to the closing, the LOI can also be contingent on obtaining licensing prior to the closing.

Expiration Date

• LOI Expiration Date: The LOI should include an expiration date in which your LOI expires if the seller doesn’t accept it within a specified number of days. Most expiration dates range from five to ten days.

Assets Included in the Purchase Price

• Included Assets: The purchase price usually includes all assets required to operate the business, such as furniture, fixtures, equipment, vehicles, leasehold improvements, business name, website(s), email addresses, phone numbers, software, client and customer lists, marketing materials, contract rights, trade secrets (whether registered or not), intellectual property (patents, trademarks, etc.), and transfer of licenses and permits.
• Excluded Assets: The purchase price for the business should not include the real estate and land, although this can be sold and priced separately. If the real estate is also being offered for sale, it’s customary to prepare a separate purchase agreement for the purchase of the real estate property. The purchase price also does not customarily include the assumption of any long-term liabilities or debt.

3) Submit Additional Information

If you’re an individual, search fund, or smaller company and obtaining third-party (e.g., bank or SBA) financing, please email us the following information:

• Resume or CV: SBA loans require 1 to 3 years of direct or related experience to the business you’re acquiring.
• Credit Report: The better your credit score, the easier it will be to obtain an SBA loan.
• Personal Financial Statement: Please also send a detailed personal financial statement showing your assets, liabilities, and net worth. We recommend using SBA’s Personal Financial Statement Form 413.
• Bank Statement: Please send a bank statement showing proof of the down payment. Note that SBA loans require a minimum 10% cash down payment.

Frequently Asked Questions

Do I need to hire an attorney? Hiring an attorney is not always necessary if the transaction structure is simple, although we encourage all buyers to retain an attorney. If you propose an LOI with a complicated deal structure, we recommend you hire an experienced M&A attorney to assist you in preparing the LOI. We frequently encounter buyers who draft their own letters of intent by downloading a form online and then attempting to edit it. While doing this may be fine for a transaction with a simple deal structure, it rarely works out for transactions with more complicated deal structures.

In many cases, the math doesn’t work out properly, or key clauses may be missing, such as net working capital or legal structure. Hiring an attorney is in your own best interests. If you want to avoid spending money on an attorney early in the process, we recommend you submit an interest of intent (IOI) first before an LOI unless you’ve already done so. Please contact us if you’d like a referral to an M&A attorney.

Can you disclose the seller’s price expectations if the business doesn’t have an asking price? No. For businesses without an asking price, the seller often doesn’t have specific expectations, and we aim to sell the business to the highest bidder or the buyer that offers the most attractive deal structure, or that’s the best fit. Additionally, the purchase price can’t be looked at in isolation as other terms must also be considered. For example, a highly favorable deal structure (e.g., a high down payment or a high interest rate on a seller note) can justify a lower purchase price and vice versa. Additionally, many other factors can impact how attractive an offer is, and all of these factors must be taken into account when evaluating an offer.

Can you disclose the terms the seller is willing to consider for a seller note? The exact terms the owner may consider vary based on several factors, such as the down payment, the interest rate, the amortization period, your credit history, your relevant experience, and the overall deal structure you’re proposing. If you’d like to propose the seller carry a note, we recommend preparing a package of information on yourself similar to what you would present to a bank, such as a personal financial statement, your credit report, and a C.V. or resume, along with your offer. The best way to find out exactly what the seller is really willing to consider is to submit an offer. If the seller doesn’t agree to your initial terms, they may counter with the exact terms they’ll consider. As a general rule of thumb, most sellers are looking for at least 40% to 50% cash down at closing.

Is it necessary to send an LOI even if I submitted an IOI? Yes. The majority of IOIs do not include all of the important terms and clauses that are normally addressed in an LOI, such as confidentiality, exclusivity, and due diligence.

Can I use my own format for the LOI? We strongly discourage you from drafting your own LOI unless you have significant M&A experience. We recommend you ask your attorney to prepare the LOI. The majority of buyer-drafted LOIs we’ve seen lack critical clauses and contain numerous contradictions that are often more time-consuming to correct than to properly draft in the first place. The errors are often so numerous that the LOI needs to be redrafted from scratch by an attorney.

Can I email you the purchase price I’d like to propose without completing the term sheet? No. There is more to consider than just the price. The term sheet is helpful as it contains a comprehensive list of terms you must consider when submitting an offer. The terms are just as important as the price in many circumstances, and neither can be considered in isolation.