In past issues we have discussed ‘mergers v. acquisitions’ and why firms buy or sell other firms. In this issue we’d like to tackle the initial mechanics of the actual acquisitions process, a letter of intent. The letter of intent sets out the basic program for the buyer and seller to agree on for an acquisition.

Once firms have confidential, positive discussions concerning a possible acquisition, the selling firm discloses its basic, historical financial data and the buying firm evaluates the business practices and assets of the seller. This allows for the buyer to determine the viability of the business in the future , what strengths and economies the acquisition can provide the buyer, and what solutions the deal can provide for the seller’s needs. As we said in earlier issues, hopefully, 1 + 1 > 2. If there are competing buyers, a seller may entertain offers from several and then by signing a letter of intent with one, the seller chooses to negotiate with that buyer exclusively.

What's to be sold?

The first element of any letter of intent is to define what is being sold. If a whole business is being sold, then the stock of the selling company would be wholly acquired, including any and all physical, legal, and information assets that the company owned. If a portion of a company were to be sold, for instance, a particular office, then the purchase would include a limited amount of the company’s assets based on the elements actually being transferred. Typically, a sale does not include accumulated accounts receivable, for which the seller retains the responsibility for collections, and cash on hand.

For how much?

At this stage of the transaction, the companies have negotiated at least a "ballpark" offer figure that reflects the amount of the assets and the projected future earnings of the seller’s company. As the due diligence process goes forward, items to be added to or deducted from the purchase price, such as accrued vacation and sick leave costs, will be determined.

Many times, the purchase price will provide for an initial payment and anniversary payments spread over several years with additional incentives for continued, outstanding performance in the future. Spreading these payments over several years also reduces the seller’s tax liabilities in many instances.

Under what conditions?

A list of the conditions necessary for closing a deal usually follow containing all the legal matters required, including the date the buyer and seller are considering finalizing the deal. This list would include a Purchase Agreement, any employment agreements for ongoing personnel, and the seller’s written corporate approval of the purchase.

The seller also agrees at this point to continue conducting business as usual until the transaction is complete. Any issues relating to changes in names, agreements not to compete, and ceasing business are covered.

As well, the buyer and seller agree to keep the transaction confidential until the purchase agreement is negotiated. This protects both parties in case the sale cannot be negotiated. Normally, the seller grants the buyer a period of exclusivity, usually 60 to 90 days, during which the seller will not negotiate with any other buyer. During this time, the buyer’s legal due diligence information can be completed, operational and personnel transition plans formalized, and the provisions of the purchase agreement be finalized.

An Agenda for the Transaction

A letter of intent is a blueprint for action. It sets out the basic parameters of the seller’s requirements and expectations and the buyer’s offer and its conditions. A clear and comprehensive letter of intent reassures the parties of the basic outlines of the deal and allows them to complete due diligence in good faith.

In our next issue we will discuss the due diligence process and how it clarifies the issues in finalizing an acquisition.