It’s perfectly acceptable for a business to ask for (or even demand) earnest money when signing an LOI. The buyer, via the LOI, is asking for the right to negotiate with you exclusively. That’s worth something and if they refuse, that tells you how serious they really are.
The amount of that earnest money is up to the parties involved - 50k might be high for some situations, low for others, and just right for the rest. But they should pony up something. Otherwise you are just giving away leverage.
As the article mentions, there is an incredible amount of work that goes into due diligence and sometimes an even larger emotional investment. A sale falling through, and I can speak from experience, can be devastating.
It would make more sense to give an absolute assurance that you’re talking to all possible buyers and that the potential buyer should understand that you might easily sell at any moment.
Exclusive negotiation is the precise opposite of a good approach.
Indeed implying that there are other negotiating parties is almost an essential component of any such negotiation.
Before the LOI? Go crazy.
A no shop clause destroys so much deal leverage. I can see why the buyer would want it.
In fact a no shop clause is indistinguishable from an exclusivity agreement.
If the buyer absolutely required it I’d put a hefty non refundable price on it, probably 50% of deal value. Such a commitment has to work both ways.
It's reasonable to expect a ("reverse") break-up fee, but it is not likely to be half the deal value.
- Seller attempts to garner interest, sometimes facilitated by an investment bank.
- Buyers indicate interest informally, eventually culminating in a Letter of Intent (LOI) from each buyer indicating a price and other important factors related to a deal.
- A cricitical component of the LOI is an exclusivity period - a duration of time where the buyer is able to conduct due diligence in exclusivity. It's clearly in the best interest of the seller to minimize the duration of the exclusivity period.
- Discoveries in the exclusivity period are typically grounds for renegotiation. Vulture buyers typically crush sellers and completely renegotiate a deal in this period banking on the fact that the seller has no alternatives post exclusivity. Good buyers know their reputation is at stake if they renegotiate an LOI and will only do so if material things show up in diligence (reasonably common).
- The LOI is not an obligation to purchase. Mostly the buyer is putting their reputation on the line.
- Earnest money is extremely rare in corporate acquisitions because the buyer universe is sufficiently small such that reputation is a sufficient motivator for good behavior. That said, anything is negotiable and you can go against tradition at any point if you have enough leverage (interested buyers).
I'm also perfectly happy to let anyone know in private who it is. :) DM me on Twitter (@Shpigford) or email: [email protected]
1. Buyer approaches seller for strategic reasons.
2. Seller tries frantically to probe interest elsewhere while early acquisition discussions continue.
3. Buyer writes a LOI, seller demands reverse break-up fee and changes, tries to stall to continue discussions in #2 without scaring away buyer.
4. Eventually some LOI gets signed.
Also in #2, does "probe interest" mean getting them to sign a LOI?
It's unlikely whatever the buyer throws over the wall first is exactly what you want to sign.
> Also in #2, does "probe interest" mean getting them to sign a LOI?
If company A approaches you, wanting to acquire you, you want to really quickly figure out if company B, company C, and company D are interested before you commit to a period of exclusivity with A.
> If company A approaches you, wanting to acquire you, you want to really quickly figure out if company B, company C, and company D are interested before you commit to a period of exclusivity with A.
Let's say that company A, B and C are interested (with A being interested the most), what would be the next step? Can you get an offer without a LOI?
Or if the buyer doesn't mention it explicitly, does it mean that they're not serious enough?
Who should mention the first amount of money first, buyer or seller?
lesson learned for seller and a good reminder for the rest of us.
The issue is that a lot of smaller deals fall through, either because of unrealistic final price expectations by the seller or because some metric that is super important to the business was calculated and supplied in the wrong way (i.e. churn). Or there are issues in structuring the contract because the seller (or his legal advisor) "overengineers" the contract -- lawyers can and sometimes do end up killing deals.
As a buyer, if I pay you a $25k fee, you now have leverage over me. Because if the deal doesn't happen I'm out $25k. If I don't pay you anything you're incentivized to get the deal done and try and draft a balanced sale/purchase agreement that works for seller and buyer. That means both parties making concessions on terms. In my mind, that is healthy, because if we finalise the deal you're getting a bag of money.
Let's say there is a clause we just can't find each other on. No worries, we can jointly decide to walk away. If I paid you and you're not willing to budge, then I'm out $25k if I walk away. It doesn't keep the discussion balanced.
Add to that that some people might (in the end) be unsure whether they even want to sell or not, and you end up in a situation where it's all mostly uncertainty (for both parties) until the deal closes.
Balanced? Utter nonsense and I suspect you know it. You know that proceeding past an LOI involves the seller accruing costs, sinking massive amounts of time on activities other than working on their business, and, more often than not, becoming emotionally invested in 'doing the deal'. Buyers buy businesses a lot more frequently than sellers sell businesses, and that makes the transaction a "home game" for the buyer, giving buyers an advantage.
Not providing any earnest money minimizes buyer risk, allows buyers an opportunity for a cheap education on the ins and outs of a successful business, and invites other tactics to tilt negotiations away from the seller - all the reasons selling a business becomes one of the most painful experiences of an entrepreneur's professional life.
If you're not prepared to provide any earnest money, you probably haven't done enough work to decide whether you're really entering into an LOI. Hopefully, the sellers negotiating with buyers like you figure that out and push back.
Some notable reverse break up fees include: * a 6 Billion dollar fee AT&T incurred for failing to complete a purchase of T-mobile. * A 10 Billion fee (avoided) if Verizon backed out of buying Vodafone's stake in Verizon.
https://en.wikipedia.org/wiki/Attempted_purchase_of_T-Mobile...
Sounds harsh? Well non-refundable deposits are a thing in real estate. For example in my country it is common to put 0.25% down to take the property off the market, non refundable, allowing you to do due diligence and then 19.75% deposit within 5 days non-refundable, with a closing period of say 30 days to pony up the other 80%, usually from finance. Probably the 19.75% is lost if finance doesn't come through but IANAL not sure if that holds up court or not or if you can get it back in some circumstances. But people understand it's serious you might lose it.
If you don't really need to sell but wouldn't mind $5m this would be a good way to weed out non-serious people. If everyone says NO then that's OK you keep on running the business as before. If anyone says yes then you know they are serious. They might not buy, but you get $50k compensation, which might be less than your costs, but the point is the $50k is like a way of communicating information 'we are serious' than an actual payment.
Asking for $50k from someone who invests $5m is like asking $50 deposit for someone who wants to book a luxury hotel room for a week. Maybe I should have said $100k (!)