By Cliff Ennico
“I am looking to buy a local business. The owner and I have agreed on a purchase price subject to my reviewing his books and records. I was expecting the owner to send me a sales contract for the business, but he sent me something called a ‘letter of intent’ instead.
“I read over the letter, and there are several things in there that I don’t like. At the bottom of the letter, though, it says it is ‘not legally binding’ and subject to legal contracts that I assume will be prepared later.
“I don’t want to antagonize the owner, but I don’t want to sign up for anything I can’t change later. Should I negotiate this now or wait until we do the legal contracts?”
A letter of intent is a “term sheet” describing the purchase price and other terms and conditions under which you will buy the business. There is usually no “legal language” in the LOI, and it is technically “nonbinding” — you and the owner both have the right to walk from the deal if you do not agree on a “definitive” (binding) sales contract later on.
But.
While the LOI is only a “blueprint” for the binding sales contract, if something is spelled out in an LOI, it is generally considered a “good faith” agreement on that specific point and will be difficult to change later. You should show this LOI to your attorney right away and change anything you don’t like before you sign it.
Here are some of the things you should watch out for:
“Nonrefundable” Deposits. It is customary for the buyer of a business to put up a “good faith” deposit — sometimes as much as 5 percent to 10 percent of the total purchase price — when the contract of sale is signed (never earlier). The seller is taking the business off the market while he’s negotiating with you in good faith and wants to be sure you are committed to doing the deal.
If the deposit is “nonrefundable,” that’s a problem. A nonrefundable deposit means you never, ever get it back under any circumstances whatsoever. There could be good reasons why you may change your mind later about buying this business. For example, the seller may have “cooked the books” by inflating his revenues and profits. Or perhaps the owner’s landlord won’t let you take over the lease of the business’ storefront location. Or perhaps you suffer a stroke and can no longer run the business.
In such situations, which are beyond your control, you should not only be able to walk from the deal but get your deposit back. If the deposit is nonrefundable, you’re out of luck. The fact that the LOI is nonbinding will not help you; the owner will keep the money and force you to sue him to get it back.
The LOI should make it clear that any upfront deposit will be refunded to you if you are forced to walk from the deal due to “circumstances beyond your reasonable control” that will be spelled out in the contract of sale.
Two more things about upfront deposits:
• The deposit should be paid when the contract of sale is signed, never earlier than that. If the owner wants a nonrefundable deposit when you sign the LOI, that’s not acceptable.
• Never pay the deposit directly to the seller. The deposit should be paid to the seller’s attorney and held in his escrow or trust account, which all attorneys are legally required to maintain and are subject to lots of rules about what he can and cannot do with your money.
The Closing Timetable. The date on which the closing must take place should be spelled out in the LOI. Be sure to give yourself enough time to review the seller’s books and records, obtain any necessary financing you need from a bank or other lender and negotiate the transfer of the owner’s lease. You will need at least 30 days after the LOI date to prepare and sign a contract of sale and another 30 to 60 days after that to close the deal.
Noncompete Terms. The owner should agree in the LOI not to compete with you for a period of X years from the closing date within a Y mile radius of the business location. Noncompete clauses are frequently “deal breakers” in business sales, but many LOIs omit them. If the owner is a corporation or limited liability company, the owner’s principals should also sign noncompetes.
Two Clauses That Should Be Binding. While an LOI is nonbinding, there are two clauses that should be binding on the parties, and the LOI should clearly say so:
• A clause requiring both parties to keep their negotiations, and all information exchanged before closing, strictly confidential; and
• A clause prohibiting the owner from “shopping” the business to other buyers as long as you are negotiating in good faith.
Cliff Ennico (crennico@gmail.com) is a syndicated columnist, author and former host of the PBS television series “Money Hunt.”
COPYRIGHT 2021 CLIFFORD R. ENNICO
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