In my last blog post I discussed the importance of starting at the very beginning when entering into a transaction to purchase or sell a business. And that starting point is entering into a letter of intent. This post is intended to provide insight into the types of details covered by a letter of intent. Initially, a letter of intent is often divided into a section containing nonbinding provisions and a second section containing binding provisions. The nonbinding provisions describe the basic transaction, as I will explore in more depth below. And the binding provisions set forth the various obligations of both parties as they negotiate and effectuate the final agreement to transfer ownership of the business. I will discuss the binding provisions in an upcoming blog post.
The nonbinding provisions set forth exactly what is being sold. Is it the business itself? If so, that’s known as an asset sale. Or, is the underlying business entity that operates the business? That’s called an entity sale. What do the parties intend the closing date to be? What is the proposed purchase price? And how will that purchase price be paid? For example, suppose Molly is purchasing an ice cream store for $100,000? Perhaps she plans to pay $50,000 to the sellers at closing, and then the balance will be paid via a promissory note. Will that note be secured, so that the seller can go after one or more of Molly’s assets if she fails to make the payments? Or will the note be unsecured, so that the seller is taking much more of a risk in the event of nonpayment. How is the promissory note set up? When are the payments due? What is the interest rate? Is there a balloon payment? As you can see, many details need to be addressed.
The nonbinding provisions generally contain a section on due diligence, which involves the buyer’s through, methodical and systematic investigation of the seller’s business. I will be discussing the due diligence process in a future blog post.
What form will the Purchase and Sale Agreement take? What conditions to the proposed transaction are present? Types of conditions include: proper documented approval of the transaction by the business entities, in accordance, as applicable, with the corporate Bylaws, LLC Operating Agreement, and pertinent Washington law; assurances that the business has not deteriorated in value during the negotiation process; confirmation that the business to be sold is not facing actual or pending litigation; the buyer’s ability to obtain financing and demonstrate to the seller that all financial obligations will be met; the successful transfer of key third party contracts from the seller to the purchaser; and the landlord’s consent to transferring the lease obligations over to the purchaser. The nonbinding section of the letter of intent should set forth any conditions of this nature.
What other agreements will be involved in the final transaction? For example, suppose, after closing, the seller works in the ice cream store to train Molly on the ins and outs of the business? In that case, likely an employment agreement will be needed. Suppose Molly is worried that the seller may go out after the transaction has concluded and start a competing ice cream business down the block? Then a non-competition agreement will be needed. Will a proposed escrow agreement be needed? All of the anticipated agreements should be described in the nonbinding section.
What types of binding obligations will be required from the buyer and seller as part of entering into a letter of intent? Be sure to read my next blog post to find out!
Photo credit: Yogendra Joshi on Flickr