19 Nov Major Causes for Middle Market M&A Deal Failure
A poorly worded or structured letter of intent (LOI) is one of the main reasons M&A deals blow up. This is often the case when people try to either navigate this process without an advisor or save money. As with most of the things in life, you get what you pay for. But what is an LOI? When you are looking to sell your company, you often ask for offers from buyers in the form of an LOI. In general, this includes terms and conditions that are ultimately negotiated until the seller and buyer dual sign the LOI. What is very important here and that you need to remember is that the LOI is non-binding. This is important because it ultimately gives both parties an “out”. For this reason, when wording an LOI you need to find a balance between the buyer and seller. Pressing too hard for strict terms as a buyer is a waste of time and being too vague can come back to bite you. Losing a deal due to a poorly written LOI is a waste of everyone’s time and normally your money.
The Buyer’s Advantage
Generally, the buyer will not be a first-time buyer (of course except when they are), especially if you are selling to an institution. They will push you for vague terms, as ultimately this gives them more wriggle room. They will want a LOI that gives them the advantage. The buyers you are dealing with would have probably learned some important and costly lessons in the past. They will, therefore, try and avoid past mistakes but including wording in your LOI to this extent. On the other hand, if you are the seller you will normally be a first-time seller and the whole process might seem very confusing. If you hire a skilled sell-side advisor, they will spot vague terms in favor of a buyer a mile away and will push you in the direction that is best for you.
A definitive purchase agreement
Ultimately, the plan is to translate this LOI into a definitive purchase agreement. This is often lead by the buyer’s team of advisors. Therefore, any term open for interpretation, or more importantly in favor of the buyer, will be interpreted in favor of the buyer. As a seller, you need to decide which points you want to fight and which you can let through. Being too strict on LOI terms is nearly as bad as being too vague. The longer you fight, the longer you remain off the market. Buyers will be fighting terms across several deals and will therefore be less emotionally attached to the deal. As a seller, you are likely to be emotionally invested in your company as it is often your life’s hard work.
An important point to note is that it is common for the seller to interpret buyer challenges as a sign of bad faith. If you are dealing with institutions, this is simply business and they wouldn’t be doing their job if they didn’t try to get the best deal. You need to be careful, returning to other potential buyers you have previously rejected is likely to result in an even worse deal. The LOI is a very important document to get right the first time around.
A few tips to even the playing field
The first, and arguably the most important thing you can do from day one, is to explain that there are several interested and qualified buyers. If you don’t have several buyers lined up, spend time finding them. Competitive tension will not only encourage someone to actually sign the LOI but ultimately increase the value of your company. If you can’t find several buyers, this is a job for your sell-side advisor. Don’t try and play this card too hard, or act “hard to get”. Unless they really need to buy your company, this attitude will generally result in them walking away. You should use the LOI to lead the initial negotiations. When you explain that terms are finalized, and you have multiple interested parties, the buyer can’t barter too hard.
Buyer terms, versus seller terms
We understand writing terms from different perspectives is hard. We have provided a very simple example below for a working capital term.
- A Buyer’s example – This LOI assumes a DFCF (debt free cash free) balance sheet and a normalized level of working capital.
- A Seller’s example – At or near closing, an accounting professional will analyze the accounts payable and receivable. The seller will retain all accounts receivables in excess of payables plus cash and cash equivalents. This proposal assumes a balance sheet with a $0 net working capital balance outstanding.
Get the specifics
Although we are not suggesting using this specific term, we are trying to represent that the buyer’s language is vague and could lead to issues. The seller’s language is more detailed, and although there is still room for interpretation, it is more specific. The objective as a seller, during negotiations, is to truly understand the value of the various offers before countersigning the LOI. The last thing you want to do is arrive at the point of signing, and realize you started from a weak position. You can’t backtrack and walking away will affect how you look to other buyers you may have turned down previously. If you go back to the market after you have signed a LOI, it will likely be at a lower valuation.
Although the LOI is simply a way to start the proper negotiations and is non-binding, the document is very important. It shows the buyer you mean business and sets the foundation for later negotiations. It is a balancing act between being too specific and being too vague. A sell-side expert will help you navigate this fine line, but you should also do your research. If the LOI is poorly written, it could cost you the deal two-fold. You might handicap yourself with the current buyer whilst at the same time lowering your valuation for other interested buyers.