When selling your business, reaching the letter of intent (LOI) stage is a great indicator of success. But, the process is far from over. There are many steps that still lay ahead that can derail or ruin the transaction. Below are 7 pitfalls to be aware of between the LOI and the closing of the transaction:
1. First, get the letter of intent done well, and read all the legal details.
The first step to moving from letter of intent to closing is to make sure that everyone understands all elements of the letter of intent, and that the letter of intent has a reasonable amount of detail. Misunderstandings and miscommunications will blow-up a deal very quickly if the parties have different interpretations of the terms.
In the midst of negotiation, it may be tempting to leave a detail for later, or hope the other party didn’t notice some important detail, or leave an open item to later. There is no one way to do things, but if you truly want the deal to happen, I have had much more success taking the extra time to explain a term or go over something again to make sure that everyone is on the same page. The LOI sets the pace for the rest of the process, so it is important to do it well.
2. Keep the business on budget and performing well.
Ensuring that the business remains on track is critical during the process from LOI to closing. Although it may take a great deal of focus to close the deal, keeping the business running according to plan is necessary for the transaction. This is the most important, of many things, to balance during the closing process. Among private equity buyers, you will hear wisdom shared from investor to investor with things such as, “95% of all bad deals were off budget during the closing process.” The buyer will be watching every twitch of the business with extreme scrutiny. To a buyer, there is nothing more comforting than seeing the financial results come in as expected. Even better for everyone is having the financial results come in ahead of budget. Yes, this is true even when you are the seller wondering if you could have gotten more for your business because it makes the buyer want to close the transaction even more and maybe some small horse trade will go your way in the end (and, there is always one more horse trade).
When the financial results are not on target, it forces the buyer to spend time and energy trying to figure out if the miss is a short-term blip or something more fundamental. Better to avoid having the buyer to think twice about anything.
Most deals require the seller to operate the business as usual during the closing process. This should be obvious and intuitive to all involved. However, I have seen sellers try to be clever and change some aspect of the business during the last months or weeks to try and tweak the deal to be more favorable to them. This never works. First, it is counter to the spirit of the deal to keep operating the business as normal, and it’s very difficult to change any reasonable size organization from their normal operations without creating problems, both intended and unintended. Furthermore, it is in the seller’s interest to keep the business operating normally just in case the transaction does not close. It is a fact of life that not all deals close after a signed letter of intent. The seller needs to be aware of this and not make any adjustments that they would not make if they were not selling the business. In particular, do not change a strategy to fit the buyer until after the close.
3. If something bad happens, inform the buyer immediately.
Business results are rarely perfect and on budget. If something happens, the best policy is to be up-front and inform the buyer immediately, just as you would want to be informed if your roles were reversed. If done well, this can increase the buyer’s confidence in the seller and the business. If done poorly, it can torpedo the transaction in a heart beat. In one recent situation where I was not directly involved, the seller lost several clients in late November that was going to reduce their revenue by >20% (probably only for a few months, but it wasn’t totally clear). The seller did not tell the buyer until the December and January financial statements were ready, and it cratered the deal. They may have had a chance to save the deal if they had been up-front immediately. More importantly, they should have done everything in their power to keep those clients and keep the business on track (or presented more conservative financial forecasts that accounted for some potential lost clients).
4. Have scrubbed and analyzed your previously presented financial statements.
Most serious buyers will perform a “Quality of Earnings” accounting due diligence on your company. This means that they will review, in detail, the financial statements that you have previously presented to make sure the earnings presented are high quality. It is inevitable that they will find various adjustments that make the earnings a bit better and a bit worse than expected — that is normal. However, it will save sellers a ton of time if they have performed their own analysis to find the unusual items or the items that the buyer may ask about. It is much more efficient to be prepared up-front than to scramble around trying to understand the questions yourself and to explain what the buyer may be finding.
5. Be organized.
The buyer will need all sorts of information about the financial results, legal, insurance, human resources, major contracts, etc. Of course, the seller wants the information to be strong and supportive of the picture that was painted during the sale process. Almost equally as important is how the information is organized and presented. Buyers appreciate indications that the company is well managed and organized — such indications provide more confidence to the buyer.
6. Manage the lawyers — don’t let them manage you.
The lawyers view their job as doing everything they can to protect you, so they will always take the most conservative path and recommend the most protected, conservative position. There is nothing wrong with that, but if both parties take that same stance, there is no room to find a middle ground that makes sense. The lawyers work for you — you should have the confidence to tell them what you want, make the final business decisions around the deal, and not let the lawyers manage you. Finishing the Letter of Intent does not mean that all the deal decisions are done. There are many more small details and decisions in the final documents, and both parties need to continue compromising and negotiating the details that are not covered in the Letter of Intent.
7. Communicate well with everyone involved.
Special effort needs to be made to communicate (probably more than you think) among all the parties. And, special effort should be made to think about the best methods to communicate everything. Never take a shortcut by firing off an email when a phone call would be better. Everyone is on edge, and making sure to communicate enough — and via the best method possible — pays off big time.