BizQuest's Business for Sale Blog

Letter of Intent or Full Purchase Agreement?

When the time comes to make an offer on a business, there are two choices for the type of  agreement you can present. You can either submit a Letter of Intent (LOI) or Offer to Purchase Agreement (PA).

There are substantial differences between the two and the situation will generally dictate what is best.

What’s the Difference?

An LOI is generally a “non-binding” agreement that simply lays out some initial conditions of the transaction such as price and terms and the timing for future steps of the transaction. It will also refer to subsequent documentation to be presented. Additionally, it can, and should, present a “no-shop” clause which prevents the seller from accepting other offers as long as all of the milestones are met along the way to closing.

LOIs are standard in larger transactions. In smaller deals, the seller and broker can perceive them as not being a serious agreement and may resist tying up the business for any unreasonable length of time. While there is some validity to this perception, it’s not always accurate.

A “full-blown” Offer to Purchase is far more detailed, and will include all of the material deal terms, conditions, representations, warranties. It will also cover non-compete conditions, inventory, financing, training, leases and contracts, etc.

Which One to Use?

Personally, I prefer and recommend that a detailed Offer to Purchase Agreement is used whenever possible. Doing so allows you to set forth all of the terms you are prepared to offer, and eliminates a lot of the ambiguity that can surface later on.

On the other hand, there are times when an LOI makes more sense. This can be when:

• You have not yet received adequate information to present an offer on all points.
• The business has attracted a lot of interest and you want to tie up the deal quickly
• There are certain conditions that still need to be negotiated
• The buyer does not believe the seller is serious and wants to get them to play their hand
• The buyer and seller are far apart on their individual valuations and you want to learn if there is any possibility of a deal before spending substantial legal fees

On the last point above, regardless if you use an LOI or PA, you must have it reviewed by an attorney.

Although an LOI is a non-binding document, a buyer should not look at it as anything less than a true commitment and the seller should address it as a serious initiative. Both parties should use it as a platform to demonstrate their mutual sincerity to getting a deal done together.

Buyers should familiarize themselves with the contents of both of these agreements so they are properly informed and can utilize the most effective document for the particular situation.

While both agreements have their place, if an LOI is used, it should simply be a short-term solution. In other words, once you have an LOI signed, everyone should move expeditiously to finalize all other deal points and memorialize the terms in a bona fide Offer to Purchase Agreement.

Buy a Business with the Attributes of the NY Giants

A good life-lesson was learned from Sunday’s Super Bowl. Leading up to the game, none of the talking heads (i.e. network analysts) would dare predict the NY Giants having much of a chance. The most risqué prediction was that the Giants would have to be flawless to even “make it a ballgame”. Most fans figured it would be a blowout.

The results are now in and while I thought it would be nice to witness a perfect season; my heart was in favor of the Giants because my brother has been such a devoted fan for 40 years and I always root for the underdog. Besides, with the Giants winning eleven straight road games and three in the playoffs (an unbelievable accomplishment), I just thought they were peaking at the right time.

So why am I using today’s column to discuss a football game? Actually, there are a lot of similarities between the game and the process you’ll encounter to buy a business.

Slow and Steady Wins the Race

Buying a business is not a sprint; it’s more of a marathon. There are specific stages you must navigate from searching business for sale listings, determining the right business, negotiating, conducting business valuations, doing research, compiling analysis, undertaking due diligence  through to closing the deal. There are going to ups and downs. There will be lost deals, misrepresented numbers, and numerous other issues that come up which will deter fainthearted buyers.

It would be easy to drop out of the process, but that’s pointless. Plus, it’s good practice to experience these gut-wrenching scenarios. Just as the Giants could have easily given up time and again, they didn’t. They remained focused. They had and air of quiet confidence while their opponents simply became more shaken with each setback.

You Need a Plan - He Who Prepares Usually Wins

All the experts agreed that the Giants would need everything to go right to even keep the game close. The Giants laid out a spectacular plan and they knew they needed to exploit the little vulnerability that the Patriots had. It worked brilliantly.

The same holds true when buying a business. You cannot simply go into this process thinking it’s easy or not anticipating what obstacles will be thrown your way. You need to be prepared and well-informed. And you need to stay focused.

When evaluating any business for sale, you need to dissect the issues and look for the volatile areas. If not, you will feel too uncertain and will not be able to get the deal to closing.

Despite all the hoopla surrounding Bill Belichick's coaching acumen, the NY Giants staff annihilated him and his assistants. The lesson here is to surround yourself with the best advisors you can assemble, put your plan into place and execute.

Good Defense Beats Good Offense

I can’t even tell you how many times buyers will point out issues about a business and will not have any foundation to back up their position. This is especially true when it comes to valuations. It is so common for a buyer to say: “the business is overpriced” and they may be right, but based upon what?

When challenging a seller’s valuation, you need to have specifics to validate your point. Your argument must be factual, not emotional. You need to draw upon rate of return examples, industry statistics, demographics, market conditions, flaws in the business itself, and any other ammunition that will build your case. Unless the seller has an accomplished advisor at their side, they may not have any basis to their valuation, but if you can’t debate it logically, you will not win the point or make any headway.

The Pursuit of the Perfect Season and the Hunt for the Perfect Business

The Miami Dolphins recorded a 17-0 record in 1972. Since then, well over 10,000 NFL games have been played, and their record still stands (much to my dismay as an ardent Buffalo Bills fan). In that period, there are been some incredible teams and thirty-five Super Bowl champions. To those teams, winning the big one was the goal, not perfection.

So too does it apply when looking for a business. The “perfect” one may exist, but the chances are highly improbable (personally, I’ve never seen it). Unfortunately, many buyers keep looking and looking for the one that’s blemish-free. They find fault with every opportunity. If your goal is to acquire a perfect company, let me save you some time – it won’t happen. What you want is a platform- and that’s defined as a solid business, with robust core fundamentals, which through an effective plan, can be built into a champion business.

The NY Giants aren’t fancy. They’re a team with low-key personnel. They’re not flashy. In reality, they are a basic, bland, boring, unsexy team (the same attributes I like in a business). Just as the NY Giants flew under the radar for the entire season - you don’t need a high profile business either. Just get your hands on a rock-solid business that provides you with immediate cash flow that you can grow.

At the end of the day, people may look back at The Patriots as still being one of the greatest teams ever, but the NY Giants are the champs. So while you may be leaning towards an industry that's hot, substance is more important than the flash.