Letter of Intent
When selling a business, the first thing you do is enter into a letter of intent with the buyer or prospective buyer. A letter of intent is a non-binding agreement; however, it sets the stage for what is typically known as a definitive agreement.
It’s non-binding in the sense that the parties agree upon sales price, employees, and things of that nature, but eventually that changes as the process continues.
Although the letter of intent is non-binding, there are components of it that can be binding, like the non-disclosure components. And although it’s a non-binding document, parties will sometimes look back to that agreement once they’re finalizing their definitive agreements.
The due diligence part of the transaction is where the potential buyer will start to try to figure out what it is that they’re buying. They will typically ask for a lot of information that you may or may not have. So, it’s really critical for companies who might be interested in selling to basically get their house in order. They’ll need to get all their documents lined up, and all the agreements they have in one place that’s easy to find.
After you finish due diligence, the next phase is where you go about drafting and preparing the definitive agreement. The really critical part of that, aside from the sales price, is the reps and warrantees, and the covenants that the parties are going to agree to post-closing. There could be a little bit of a tug of war between the two sides, where one party, the buyer, would like extensive representations and warrantees, and the seller may try to minimize those. So typically, that’s a very strong negotiating point as you’re drafting the definitive agreements.
The other parts, that tend to do with covenants not to compete and things of that nature, are typically negotiated at this time.
Once you finish this process, you get to prepare for closing. One of the key components to a post-closing involves how the seller is able to obtain the most out of their sales price. And sometimes this is considered an earn-out. As you finish the definitive agreements, and you’re going towards closing, the parties focus on issues such as earn-outs and covenants that are going to come into play after you’ve closed—known as post-closing covenants.
These can get very hairy sometimes, and typically once you do actually get to closing and you look forward, a buyer will often like the seller to help with transition issues. Some of the things that a seller can anticipate are potential issues that come about due to how the earn-out is calculated post-closing.
I like that every transaction is so different. It’s a great process for me to be involved in and help to educate the client on how to prepare for a sale, what happens during a sales process, and then what happens after you’ve closed—because a lot of times there are a few post-closing obligations that the seller may not have thought about ahead of time.