Edison Avenue, a company that specializes in selling quality businesses with revenues of $1 million to $25 million, has had enough of witnessing entrepreneurs giving away their net worth to private equity groups, family offices, and other sophisticated investors.
The unspoken truth is that many former business owners don’t talk about, out of embarrassment, the fact that they fell into one of these costly traps.
Edison Avenue’s passion is to help entrepreneurs exit their business quickly, confidentiality, and at a good price. For this reason, they shared the following reasons to avoid signing a letter of intent when selling a business.
1. Invisible Ink
Frequently, a letter of intent (LOI) is not worth the paper it is written on. Often, far too many of the terms and conditions are left unaddressed or vague. Business owners often think they understand the price and terms of the LOI to purchase their business. After the buyer’s team of accountants, attorneys, and other professionals comb through the business, every flaw will be uncovered and used to reduce the price. Then, when the purchase contract negotiations begin, one will see the deal terms shift so fast one might think the ink is disappearing from the first page while they are reading the eighth page of the purchase agreement.
2. Golden Handcuffs
Most LOIs will have an exclusivity period that restricts one’s ability to entertain other offers, putting the business owner at a distinct disadvantage. The business seller’s position grows weaker with time since there is no ability to create leverage, and keep the buyer “honest” and willing to pay top dollar for the company. Nothing works like a little competition to keep everyone on their best behavior, but with this clause, they don’t have much leverage other than to say “would you please hurry?”
3. Incredible Shrinking Offer
The price and terms at closing are nearly rarely the same as originally offered in the letter of intent. For example, one Private Equity Group’s offer for a Canadian IT Software Company went from $6 million to $1 million over the course of a 12-month period. The business owner took this dismal offer for a combination of the seven reasons listed here.
4. Sinking Feeling
Precious time is lost waiting for this one potential buyer to make a decision. One’s personal life and strategic business plans are on hold while waiting for the decision from on high. Often, the decision is that the buyer would like an extension on their LOI. It is not uncommon to witness three or four LOI extensions, which weakens the business owner’s negotiating position by the week. The toll of this ongoing state of limbo often softens the business owner psychologically and enables the buyer to negotiate increasingly more favorable terms.
Unless you’re represented by a professional M&A Advisor, far too often, you are outmatched in dealing with a professional buyer with the equivalent of a black belt in business transactions. Yes, you are a savvy entrepreneur with exceptional negotiation skills, but that is not enough given your lack of transaction experience, emotional attachment to your business, and the superior skills of your adversary (the buyer). One’s accountant and attorney often don’t have the necessary skills to provide a proper valuation and to quarterback the business sale process across the finish line. Most business owners are playing checkers in the chess world of selling a business.
6. Lone Ranger
One is not entering the negotiation from a position of strength. The business owner has received a random love letter: “I love you and will pay you almost anything to get your business.” The entrepreneur is flattered, excited about this lottery ticket, and thinks they will save money by cutting out the fees of an M&A Advisor. The buyer asks the business owner to meet them for dinner and conversation. They think, what harm can dinner and casual conversation be? After all, the buyer clearly recognizes the value of this tremendous company. The trap has now been set. Why would a buyer prefer to meet a business owner without an M&A Advisor?
All the excitement often leads one to assume this transaction is going to be a sprint since the folks they met for the elegant dinner seemed so nice, honest, and reasonable. The private equity group has half a dozen or more companies under LOI at any point in time. This business is the owner’s life, and the majority of their net worth is tied up in it. The private equity group just needs one or two good transactions, but for the owner, this is their entire future. The distraction from one’s business for countless meetings and fulfilling endless requests from the due diligence team very often harms both financial and operational performance. An M&A Advisor would have buffered and reduced this massive distraction and extra workload imposed upon the company.
In summary, should one sign a LOI? Yes, there may be a time and place for it in the journey of selling a business. However, it is important to understand when one receives that unsolicited phone call or offer that sounds too good to be true that it probably is.
It’s best to hold one’s wallet with one hand and call a qualified M&A Advisor with the other. Few people would remove their own appendix, and CEO’s shouldn’t sell a company by themselves unless the intent is to donate one’s net worth to an investor.