Making and Sizing Up an Offer

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Properly making or evaluating an offer to buy a business starts with understanding the basic components involved. From there, negotiations can begin.

An offer to purchase a business can come in many forms, from simple oral offers, to presentations, term sheets or letters of intent. To effectively negotiate an offer, owners and buyers must first understand the various forms it can take, the general processes and procedures that usually follow, and other basic components.

The most common method for presenting and documenting a proposed deal is by using a Letter of Intent (LOI) or Term Sheet. A Term Sheet is typically a bullet list of terms and is often written in the third person. A Letter of Intent is usually written from the buyer to the seller. Often, an LOI is more detailed than a Term Sheet, but this is not always the case. A good example of where a Term Sheet is more appropriate than an LOI is where the principal deal terms have already been agreed upon by the parties, and the purpose is to document those terms. Often, an M&A advisor or other third-party representative drafts the Term Sheet as a memorial of the terms that have already been discussed and agreed upon. By contrast, an LOI is often used as a proposal, usually from the buyer to the seller, which is meant to start negotiations.

Other methods of making an initial offer include oral offers and strawman offers. A strawman offer, whether oral or written, is a simple list of a few items that are often used to determine if the parties are in the same ballpark with regard to valuation. A Letter of Interest is also used on occasion to precede a Letter of Intent, and is simply a more formal version of a strawman offer.

What Should be Covered?The Letter of Intent or Term Sheet is the basis for negotiating a definitive agreement and, therefore, certain things will remain "to be determined" during the due diligence period, and covered in the definitive agreement. What follows are some of the major sections of a good LOI or Term Sheet, in addition to many customary boilerplate sections.

Purchase Consideration and Equity Participation: This section should include not only a "price," but the structure of the price. Is it all cash? Is the seller going to hold a note? Is a portion contingent on future events (an earnout)? Will there be a holdback? Will existing owners or management get stock in the buying company or hold stock in the company being acquired? The fine details can be covered in the definitive agreements, but all of these questions should be answered by this section of the LOI or Term Sheet.

Closing Adjustments and Balance Sheet Treatment: This section should outline all known adjustments that are expected to be made at closing. There will certainly be other things that come up in due diligence, but a reasonable outline of how to treat the Balance Sheet and items that fluctuate, such as inventory, liabilities, pre-payments, accounts receivable, and so forth, should be covered.

Stock, Assets and/or Liabilities being Transferred: The opening paragraph will most often state whether the transaction is proposed to be the purchase of stock, membership interests, or assets. However, a section should be dedicated to exactly what is being purchased and note any excluded assets or liabilities.

Consulting or Employment of Owners: In most transactions, even an exiting owner will stay on board for some period of time, whether as a consultant or employee. The details are sometimes better left to negotiate after the LOI or Term Sheet is signed, however important expectations should be set in the LOI or Term Sheet to ensure the deal does not fall apart later because expectations were misaligned in this area.

Restrictive Covenants and Reps and Warranties: Many pages will be dedicated to such topics as non-compete, non-disclosure, and representations and warranties in the definitive agreements. These provisions do not have to be completely hashed out in the LOI or Term Sheet, however, a framework should be included to make sure, for example, that the buyer isn't thinking of a 5 year non-compete when the seller is thinking one year.

Representations and warranties will cover many things and often make up a large portion of the agreements. They are often statements one party makes to the other, such as a representation that all financial information provided is true and correct, which are then backed up by such things as indemnifications and hold backs. The Letter of Intent or Term Sheet usually simply notes that customary representations and warranties will be included in the definitive agreements.

Conditions and Due Diligence Provisions: Since the LOI or Term Sheet is a framework from which to negotiate, it should contain detailed provision for due diligence, conditions that affect the LOI or Term Sheet and any known conditions to close the final transaction. The due diligence provision should set forth the items to be reviewed by the buyer, the time frame, and any special provisions such as when contact with employees and customers will occur. Likewise, any known contingencies, such as the buyer obtaining financing should be stated.

Closing Details and Costs: Closing dates are like baby due dates. Closings happen early and late, but rarely on the date planned. However, it is still important to select a target time frame in the LOI or Term Sheet and outline any known provisions such as whether it will happen over time (a progressive close), whether there will be a escrow period, or if everything is expected to happen on a single day (a sign and close). In addition, the LOI or Term Sheet should clearly set forth who pays what costs associated with due diligence, closing, and so forth. Usually, each party bears their own expenses.

Exclusive Negotiations: More often than not, a buyer will require that once a LOI or Term Sheet is signed, that the seller negotiate exclusively with them and no other buyer. These provisions should be spelled out clearly and in detailed fashion, including upon what provision or dates the exclusivity no longer applies.

Binding and Non-binding Sections: In most transactions, a Letter of Intent or Term Sheet is a non-binding document, which means that it sets for the parties understanding to enter into more formal negotiations, due diligence and ultimately the definitive agreements, but does not legally bind or force the parties to move forward with the transaction. It is important, however, that the LOI or Term Sheet be written in a very specific way. Some sections, such as due diligence provisions, confidentiality, and exclusive negotiations may be binding, while others such as purchase price may not. The LOI or Term Sheet must state which sections are binding and which are non-binding.

If a legally binding contract is desired, then a full blown stock or asset purchase agreement should be used and drafted by an attorney.

Whether drafting a Letter of Intent or evaluating a Term Sheet, part of the art is balancing the needed details that should be covered at this stage and not getting bogged down with those details that should be left for the definitive agreements. In any event, if you are sure to address the items listed above, you'll be off to a good start.

Last updated: Apr 17, 2008




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