Over the years, our team has helped countless business owners steer away from potential pitfall investments and business purchases that would have sunk their finances. This article talks about the dangers of negotiating a Letter of Intent without a lawyer.
Most sellers list their for-sale business with an intermediary, like a broker or investment banker, hoping for the highest bid. Once an intermediary is engaged, the intermediary will start searching for a buyer. The amount of information that the intermediary may provide to a qualified buyer may vary greatly. At the extreme, some intermediaries may not provide anything more than teaser information until the buyer provides a Letter of Intent to buy the business under specified terms (including price).
First, it’s important to note that most Letters of Intent (LOI) are not legally binding (they typically include explicit “non-binding” language), which makes some parties think that they don’t need a lawyer to assist. However, that can be a huge mistake, as we believe it sets the stage and the “anchors” for the negotiation.
At Doida Law, our approach (to the greatest extent possible) is to negotiate all the material terms of the deal up-front. Under our approach, buyers or sellers will find any deal breakers immediately and you’ll be aware if the deal won’t work. Likewise, it allows the parties to discover the other party’s “sensitive areas” (i.e., maybe not deal breakers, but very important). Our approach is to go through a vigorous LOI process and find out if it’s a good deal for you in the first place. And if it’s not – as disappointing as it may be – you will have at least saved yourself a time (and opportunity cost), money, and stress. The last thing anyone involved in the deal wants is to discover a deal breaker when the deal is nearing the closing (after weeks or months and significant expenses).
In addition, entering into a self-managed LOI that is quickly thrown together and signed without legal counsel, opens you up to having to go back to change the terms later. That alone can be a deal-killer in some situations. It’s better to find out if you disagree on any of the terms at the outset and figure out any work-arounds. We’ve had to re-negotiate material terms that were hastily negotiated in a LOI. Taking such actions can be necessary in some cases, even when a thorough LOI is negotiated (e.g., where diligence items warrant it). But whenever you do so, one of more of the following is likely to be true: the re-negotiation of the term…
(1) creates friction in the relationship between the parties (e.g., loss of trust, disappointment, etc.),
(2) delays the transactions,
(3) opens other terms up for re-negotiation,
(4) is never an easy or pleasant experience, and
(5) is not always successful.
Case Study On An Unusual Term
LOIs are not just used in the context of the purchase and sale of a business. They can be used to negotiate any material transaction. We frequently use them in financing transactions as well. Here’s a real case study highlighting the dangers described above. A party negotiated an investment term sheet with a venture capital fund without counsel. The term sheet contained a highly unusual term. After executing the term sheet, the client engaged with counsel on the deal. After an initial review of the term sheet, counsel noted the danger of the term in the term sheet and advised that, before going further, the company should revisit and renegotiate that term. The client told counsel that they basically had to agree to it at that point and, despite counsel’s efforts during negotiation, that term was in the final agreement. Ultimately, that term was what allowed the venture fund to take over the company, from an equity and control perspective, and oust the original founders of the company.
Now, this example may seem drastic, but we have seen results as bad as this. That’s why we tell our clients to get the deal breakers on the table right now and find out if it’s a problem now—or has the potential to cause a lot of problems for in the future.
We are here to help our clients come out of their ventures in the best situation possible. If you have been asked to sign an LOI, stop and call Doida Law Group at 720.306.1001 today.