The following is adapted from the book I wrote, Getting Acquired.
Receiving a Letter of Intent (LOI) to buy your business can be a milestone that an entrepreneur never forgets. Set the stage. You’ll be holding a piece of paper that says you stand to receive life-changing money if you sell what you’ve worked tirelessly on for the last several years.
Time to pop the champagne? Not just yet.
As a business owner who has been through this process more than a few times, allow me to detail how you can negotiate the LOI and ensure a smooth transition.
Peace of mind will follow and a smooth acquisition process will follow, knowing that you’ve done your homework.
Get Your House in Order
Finish as much pre-sale due diligence as possible. A lot of deals can go sideways when the seller’s books or organizational structure aren’t clear and organized.
The buyer needs to see that there are no hidden surprises waiting for them.
A little hard work now will pay big dividends further along in the acquisition process.
Yes, it might take longer to close the deal, but if your buyer is talking LOI, you know they’re serious, and it makes sense to get your house in order to make the acquisition process as smooth as possible.
Lawyer Up
Preparation is a powerful ally in the acquisition process.
Chances are, you won’t be the buyer’s first acquisition, nor will you be their last, so don’t underestimate them.
They’ll test you for weaknesses, and unless you happen to be well versed in M&A law, it’ll be legal. Buyers will have M&A lawyers on their side or even entire teams working to secure the best outcome for them. Why wouldn’t you do the same?
Hire counsel to escort you through these legally choppy waters. Not every buyer will use the law to exploit you, but there will be elements of the negotiation (the definition of company debt, for example) that are open to interpretation, and they’ll push their interpretation over yours every time.
Lawyer up and the chance for serious regret diminish greatly.
Negotiate a Timeline and Exclusivity Period
Deadlines manage the buyer’s and your expectations, but you don’t have to set your time by the buyer’s watch. Yes, once the LOI has been accepted, the buyer is in control of most of the situation.
You still have to be comfortable with the timeline to get things done on your end and ensure you’re making the right decision.
For example, your buyer might want due diligence done quickly but also require a long exclusivity period so they can scrutinize your business without the pressure of competing offers. They might even bulldoze through negotiations to pressure you into accepting terms in their favor.
Set an appropriate timeline that includes an exclusivity period of thirty days or less (seven days if you can get it!). Provide ample time to complete due diligence and other negotiations.
This is not something with which you can afford to be submissive.
Timelines and the exclusivity period need to be reasonable and agreeable to both parties.
What’s the Purchase Price, and How Will They Pay?
If price is a sticking point, consider an earnout to close the gap. Earnouts are agreements where you receive future payments on the condition of certain financial goals being met.
A buyer might agree to the purchase price plus a percentage of revenue on future sales for a limited time, for example.
Once you’ve agreed on a purchase price, a cash settlement is usually better for you and the buyer, unless your buyer is another company.
In this case, you might want to swap stock to own equity in this new entity. The buyer won’t always be willing to negotiate such a term, but it’s worthy of consideration.
Whether you want to own stock in this new entity instead of receiving cash depends on a number of factors, such as the historical performance of the buying company, what their post-acquisition plans are, your immediate cash needs.
For example, do you need seed money for a new business?
Minimize Exposure to Reps and Warranties
Beware of your buyer weaponizing fundamental representations and warranties.
These are legal assertions of facts relating to your business and how you’ll respond should those facts turn out to be false.
Buyers may selectively choose the representations that require the most stringent warranties, potentially to your disadvantage.
For SaaS businesses, for example, your IP is everything. It’s what your customers pay for: the software, the implementation, the code that powers your product or service.
However, competitors’ products, cyberthreats, and regulatory or market conditions can thwart even the best IP. To avoid overexposing yourself post-acquisition, limit your reps and warranties to 10 percent or less for a period of no more than twelve months.
Obviously the more robust your IP, the better placed you’ll be to negotiate. This is why doing as much due diligence before signing the LOI is so important.
Decide How Much You’ll Leave Behind
Most buyers will expect you to leave the business cash-free and debt-free. This affects working capital too.
Positive working capital will naturally appeal to the buyer, but a negative figure isn’t always a bad thing. For example, you could be funding growth by using supplier or customer funds. Keep in mind, however, that buyers won’t ignore consistent negative capital, as this could indicate a deeper problem.
You might need to negotiate working capital before the sale completes. Just remember this is a point of negotiation and not always a judgment on the long-term potential of your business.
LOI negotiations can be stressful, but if you follow the advice here, from someone who has been there and done that, you should leave the negotiating table looking forward to the day the deal is done. Then, you may commence with the champagne popping.
For more advice on negotiating a Letter of Intent (LOI), you can find Getting Acquired on Amazon.
Andrew Gazdecki is a four-time startup founder with three-time exits, former CRO, and founder of MicroAcquire. Gazdecki has been featured in The New York Times, Forbes, Wall Street Journal, Inc. Magazine, and Entrepreneur Magazine, as well as prominent industry blogs such as Mashable, TechCrunch, and VentureBeat. Now, for the first time, Gazdecki shares the complete story of the company that started it all.
