Tag Archive for: LOI

Managing Confidentiality Throughout a Business Sale

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Selling a privately held business requires sharing sensitive information with prospective buyers and their advisors. At the same time, premature disclosure may create significant disruption. Employees may worry about their jobs. Customers may question future relationships, while competitors may use the information to their advantage.

For these reasons, protecting confidential business information requires more than signing a nondisclosure agreement. Confidentiality should guide the entire sale process.

Controlling the Initial Disclosure

The M&A advisor should initially approach prospective buyers without identifying the seller. A blind teaser may describe the opportunity while protecting the company’s identity. Interested buyers should then demonstrate sufficient credibility before receiving additional information. Qualified buyers typically execute a confidentiality agreement before learning the company’s identity.

Once that threshold is met, the advisor may provide the Confidential Information Memorandum and other appropriate materials. Even then, sellers should not disclose every sensitive detail immediately. Information should become progressively more detailed as buyers advance through the process.

Managing Employees and Business Relationships

Employee disclosure requires particular care. Some owners involve selected executives early, while others maintain confidentiality until much later. Neither approach fits every transaction. The appropriate strategy depends on management responsibilities, transaction needs, and the potential consequences of premature disclosure.

Customers and vendors generally require similar discretion. Early disclosure could create uncertainty and potentially affect valuable business relationships. For competitive buyers, confidentiality requires additional attention. Customer lists, pricing, margins, proprietary processes, and other competitive information may require restricted access. The seller may delay particularly sensitive disclosures until later due diligence. Redacted information or aggregated data may also provide buyers with necessary information while reducing exposure.

Maintaining Confidentiality Through Closing

Confidentiality does not end after a buyer signs an agreement. Sellers should continually evaluate who receives information and why they need it. A Virtual Data Room may provide controlled access and maintain an organized record of shared information.

As the transaction progresses, disclosure naturally expands. However, each stage should provide only the information reasonably necessary for the buyer’s evaluation. An experienced M&A advisor helps manage this progression while coordinating with the seller’s legal counsel. Protecting confidential business information requires discipline from initial buyer outreach through closing. The objective is simple: provide buyers what they need without unnecessarily exposing the seller’s business.

Negotiating the LOI Before Granting Exclusivity

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The Letter of Intent represents a major turning point in the sale of a business. Until this stage, multiple prospective buyers may still compete for the opportunity. Once the seller signs an LOI, the dynamics change significantly. The selected buyer typically receives exclusivity and begins confirmatory due diligence. For this reason, sellers should use their LOI negotiating leverage before committing to a single buyer.

Establish the Major Economic Terms

Although most LOI provisions remain nonbinding, the document establishes the framework for the transaction. Reopening major business terms later may erode trust and create unnecessary tension between the parties. It may also cause either party to question whether previously negotiated terms remain settled.

Therefore, the LOI should clearly address the purchase price, transaction structure, and form of consideration. It should also define other significant economic terms. These terms may include working capital, seller financing, earnouts, rollover equity, escrows, and other holdbacks. Before exclusivity begins, sellers should resolve as many significant economics issues as reasonably possible.

Address the Seller’s Post-Closing Role

Many sellers remain involved after closing through employment, consulting, or transition agreements. Others may retain an economic interest through an earnout or rollover equity. The LOI should address these arrangements when they represent a meaningful part of the transaction. At this point, the seller still has meaningful negotiating leverage. Postponing difficult issues or conversations may shift that leverage toward the buyer.

Provide Accurate Information Early

Sellers should provide accurate financial and operational information before accepting an LOI. Material inconsistencies discovered later may give the buyer grounds to renegotiate. Sellers should also disclose known weaknesses that could materially affect the transaction. Surprises during the confirmatory due diligence may damage credibility and threaten the deal.

Understand What Changes After Signing

Signing an LOI does not complete the transaction. However, it usually removes the seller from the competitive marketplace for a defined period. From that moment forward, the buyer will devote substantial resources to diligence and definitive agreements. Meanwhile, the seller’s alternatives become temporarily limited.

An experienced M&A advisor should negotiate the LOI with the definitive transaction already in mind. The advisor should identify unresolved issues before the seller grants exclusivity. Effective LOI negotiating leverage comes from addressing significant terms while buyers still compete. Sellers should use that leverage before choosing the buyer who moves forward.

Operating the Business Between LOI and Closing

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Signing the Letter of Intent represents a significant transition in the sale process. The buyer receives exclusivity, but the seller still owns the business. During this period, the seller must continue operating the company while the parties complete due diligence and negotiate definitive agreements. For that reason, LOIs often require the seller to operate within the ordinary course of business. The purchase agreement will typically address these obligations in greater detail.

What Does Ordinary Course Mean?

The ordinary course of business generally means operating consistently with the company’s established practices. Management should continue serving customers, paying vendors, managing employees, and making routine operating decisions. The objective is not to prevent management from running the business. Rather, the provision protects the company underlying the buyer’s offer. The buyer expects substantially the same business at closing that existed when the parties signed the LOI.

Decisions That May Require Additional Attention

Certain actions may change the company’s financial condition, operations, or future earnings. Therefore, sellers should carefully evaluate significant decisions during the period before closing. Depending on the transaction, these actions may include:

  • Making significant capital expenditures
  • Increasing owner or employee compensation
  • Hiring or terminating key employees
  • Entering significant customer or vendor contracts
  • Discontinuing products or service lines
  • Changing accounting policies or practices
  • Incurring additional indebtedness
  • Selling significant operating assets
  • Making unusual distributions to owners
  • Changing pricing or customer credit policies

During this interval, sellers should communicate unusual decisions to their M&A and legal advisors before taking action.

Protecting the Transaction Economics

Ordinary course operations may also affect the balance sheet delivered at closing. Working capital provides a common example. The parties may establish a normalized working capital target during negotiations. Changes in receivables, inventory, payables, or accrued expenses may affect the closing adjustment. Against this standard, sellers should avoid manipulating working capital to increase cash distributions before closing. Buyers will examine whether the company maintained normal operating practices. The same principle applies to earnings. Delaying necessary expenses or accelerating revenue may create diligence concerns and undermine buyer confidence.

Managing the Period Before Closing

Operating within the ordinary course of business does not require freezing the company. Businesses must continue making decisions and responding to changing conditions. Instead, sellers should maintain consistency and communicate material deviations before acting.

An experienced M&A advisor will coordinate these issues with transaction counsel and the seller’s accounting professionals. This coordination helps protect the negotiated economics and reduces unnecessary closing disputes.

Setting the Deal Framework in the Letter of Intent

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A Letter of Intent marks a significant transition in the sale of a business. It moves the parties from preliminary discussions toward a defined transaction. The LOI should establish the principal business terms before the parties commit substantial resources to completing the deal. Most provisions remain nonbinding. However, certain provisions, including confidentiality and exclusivity, may create binding obligations.

Define the Transaction Economics

The purchase price represents only one component of an offer. Sellers should understand how and when they will receive the consideration. Accordingly, LOI deal terms should address purchase price, transaction structure, and the form of consideration. The LOI may also address seller financing, earnouts, rollover equity, escrows, and other holdbacks.

Working capital deserves particular attention. The parties should establish the methodology for determining the working capital target and any resulting adjustment. At this point in the negotiations, the parties should also identify whether the transaction involves an asset or equity purchase.

Address the Seller’s Continuing Involvement

Many transactions require the seller to remain involved after closing. The LOI should address significant expectations concerning employment, consulting, transition assistance, or continuing ownership. Compensation and responsibilities may also require discussion when the seller remains employed. Similarly, the parties should identify material noncompetition or non-solicitation expectations before proceeding.

Establish the Path to Closing

The LOI should provide a framework for moving from agreement to closing. This framework may address due diligence, financing, regulatory approvals, closing conditions, and the anticipated closing date. Before the process narrows, the seller should also understand the exclusivity period. During exclusivity, the seller generally stops discussions with competing buyers. The buyer then conducts confirmatory due diligence and negotiates the definitive purchase agreement.

Resolve Major Issues Early

The LOI cannot anticipate every provision contained in the final purchase agreement. Trying to negotiate every legal detail at this stage would also defeat its purpose. However, leaving significant economic issues unresolved may create problems later.

An experienced M&A advisor should negotiate the LOI deal terms with the entire transaction in mind. The advisor can identify economic issues that deserve resolution before exclusivity begins. Legal counsel should review the LOI before execution and address its binding and nonbinding provisions. A well-structured LOI does more than summarize an offer. It establishes the economic framework and provides a clear path toward the definitive purchase agreement.

Allston Advisory Group is an experienced boutique M&A advisory firm providing a variety of services to lower middle market companies. See our footer for contact information.

(502) 742-2933
[email protected]
P.O. Box 21266, Louisville, KY 40221

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