While deal professionals are most likely familiar with what an LOI means (and doesn't mean), Anthony Manna chairman of Signet Enterprises LLC, says there are some common misunderstandings, held especially by those who may be first-time sellers.
"Most people on the outside think that is the purchase agreement. It is not. All it does is set the parameters of what the deal will be and then the details are in the purchase agreement," he says. "Sometimes you spend an enormous amount of time negotiating just a letter of intent on a deal and when you're done with it, you feel like Oh my God, you would have thought that was the purchase agreement."
And there are important steps to undertake when a company puts itself up for a sale that are well before an LOI. For instance, it can be the case when working with a sell-side advisers to start by coming up with a valuation so that everyone is on the same page before going to market.
"If you're putting your company up for sale, we say, before we get going, we're going to put a valuation on it," Manna says. "And we come back and say it was worth $100 and you're saying it's worth $200, we got ourselves a problem. There's no use us representing you if we think this is unrealistic or you're thinking, all they're trying to do is make the quick sale to make a quick buck. So, the first thing is to make sure we're on the same general page as to what we think is worth."
The next step is to put together a comprehensive list of potential buyers and make sure that the seller is comfortable with that list. Then preliminary information is discussed, finalized and sent out to potential buyers. Once interested parties start inquiring, they're asked to sign an NDA before the seller shares its "book," which contains more detailed financial statements, customer lists and intellectual property.
If a potential buyer likes what they see in the book, and the seller is interested, a letter of intent is produced. The LOI contains the general price the buyer and seller have agreed upon and some general terms — number of days for due diligence and the financing breakdown, typically.
There can also be provisions asked for on the buy-side such as a no-look or no-shop clause, which is the buyer asking the seller not to work with other buyers while in the process of negotiating after a price has been agreed upon and a time limit to reach a binding purchase and sale contract is set. But that's not always accepted.
"Sometimes the seller says, 'No, I'm not agreeing to that. You guys got to speed it up. I'm going to keep talking until we have a deal,'" Manna says. "And if they have a hot enough business, they can do it."
Manna spoke on the Smart Business Dealmakers Podcast about the letter of intent. He breaks down a deal at this very early stage, discussing some of the key choices sellers need to make as they take their company to market.