My thanks this month to Rick Bliss, managing shareholder of Godfrey & Kahn S.C., TEC’s corporate counsel, and the valuable input of Brett Koeller, a member of the law firm’s merger and acquisition group in Milwaukee.
Many business buyouts have failed to successfully conclude at the “witching hour,” after buyer and seller spent a lot of time and money to reach that point. A carefully written letter of intent that precedes a “no surprise” due diligence process can often reduce this possibility. So, why then are letters of intent not routineω
First, buyers and sellers may view them as an added unnecessary cost item that wastes time getting to the closing. Second, sellers might resist them if they contain time-specific provisions that restrict the seller’s options to seek out alternative buyout partners.
Also, due diligence traditionally is or will be in process at the time the letter of intent is being drafted or negotiated. As a result, it’s in the buyer’s interest for the letter to be as general as possible, subject to findings specific to due diligence. It’s also in the seller’s best interest to ask for specifics, especially if the buyer has been granted an exclusive relationship for a certain amount of time.
Can due diligence be accomplished effectively without a letter of intentω The answer is yes. But at what costω A key advantage of a letter of intent is that it puts on the table, up front, the major issues that could make or break the deal. To have these possible “deal breaker” issues surface after the buyer has spent considerable time and cost on due diligence can be totally counterproductive to the offer-to-purchase process. Not to mention the fact that distrust and “deal fatigue” among the parties will result.
So what, then, are some typical provisions that a letter of intent would attempt to clarifyω The most common would include:
1. The proposed type of transaction: stock or asset purchase or mergerω In the case of a stock or merger transaction, will the acquired entity be purchased cash or debt free, or bothω
2. What is the buyer offering for
consideration: cash or stock, or both; marketable securities; or promissory notesω
3. The cooperative sharing of accurate due diligence information to arrive at any post-closing adjustments that may benefit either the buyer or seller such as inventory physicals, receivables quality, other items increasing or decreasing net worth.
4. Conditions or contingencies that must be satisfied before the deal can close, such as obtaining financing or credit approvals.
5. The nature and declaration of seller representations and warranties.
6. A description of ancillary agreements that require negotiation or other continuance, review or modification prior to closing. Examples include employment contracts, supply and transition services agreements, and pension/401(k) obligations.
7. A sunset time for the due diligence review and a date by which the first draft of a definitive purchase agreement will be delivered.
8. The party’s commitment to hold one another’s proprietary information confidential.
9. If the seller is agreeing to an exclusive relationship with the buyer, the length of time this relationship will be honored before the seller will consider other interested parties.
In my experience, letters of intent are invariably works in progress. As we all know, any effective two-party communication exchange entails give-and-take. For a buyer to simply present a seller with a “definitive” letter of intent with no opportunity for give-and-take is setting up a possible, if not probable, rejection scenario. Instead, prospective buyers should consider this approach:
• The buyer presents a first draft.
• The seller either accepts or responds with modifications.
• The buyer presents a final draft.
• If the seller finds the final draft unacceptable, both buyer and seller agree to sit down with a third party and work out their differences.
TEC members tell us that common sense plays an important role in both the letter of intent and due diligence process. Professional advisors and consultants work for the benefit of their clients. It’s their job to see that the “i’s” are dotted and the “t’s” crossed. The buyer and seller are responsible for bargaining in good faith and representing the collateral interests of all parties that will be affected by the outcome of the transaction.
Some issues simply can’t be addressed in a letter of intent. And they shouldn’t. But they’re nevertheless critical to a successful sale. Call this the “human side” of the transition to a new owner.
For privately held family businesses, this is especially important. Here are
my thoughts:
1. Trying to hide due diligence and the impending transaction from employees never works — they find out.
2. Stating that the status quo in terms of management leadership will prevail after a buyout should only be said if this is, in fact, a truthful likelihood.
3. Having a new owner meet with the management team as soon as practical after closing is a very good idea. Having the new owner meet with all employees to discuss the firm’s future is an even better idea.
4. Having the new owner or the owner’s representative personally contact key customers and vendors immediately after the closing is also a very good idea.
5. Prepare a joint buyer-seller
press release.
Many other “human side” issues accompany a great business sale. Over the past 30 years, I’ve seen transactions that fall on both sides of the fence. Some have been inhumane and brutal and have turned out to be disasters. Following the five basic guidelines above is a major step to ensuring that when ownership of a company changes hands, the human side of the enterprise and its immediate constituencies aren’t ignored.
The ultimate answer, I believe, is to start out by working with trusted advisors who buy into the line of thinking presented in this article. You won’t regret it. I did that 16 years ago when I purchased TEC, and I’ve never looked back with a regretful “would have,” “could have” or “should have.”
Until next month, if you’re in a buy or sell mode, consider the benefits of using a well-written letter of intent to complement your due diligence work.
Harry S. Dennis III is the president of The Executive Committee (TEC) in Wisconsin and Michigan. TEC is a professional development group for CEOs, presidents and business owners. He can be reached at (262) 821-3340.
