The Letter of Intent
As we saw earlier, your financial model led to a valuation which is based heavily on your revenue and a multiplier. It’s also based on things like headcount, client base, and the goal of the acquisition (for example, Facebook was entirely uninterested in Maria’s clients, but wanted to really understand the staff they would be hiring). When you’ve worked the roadshow and gotten some interest from potential buyers, you’ll arrive at the Letter of Intent, or LOI, part of the process.
This is when things start to get and feel pretty real, and is really the main chance you have to negotiate for the things that matter to you: it’s when you have a big opportunity to exercise your “walk away” leverage, because—while you’ve likely invested hours and hours in time so far—it’s actually the least amount of effort you’ll put into the process, compared to what comes next. If the buyer is serious about acquiring your company, this is your chance to both implicitly or explicitly threaten to abandon the deal.
What’s in the LOI?
The letter of intent is a meaningful signal that a buyer is interested in a purchase, and is interested in a purchase at a certain price. It includes cash, but also all other parts of a deal.
For example, let’s say you’ve built a business that generates $5 million in revenue, and you’ve been valued, at a 2x multiple, as having a $10 million dollar company. When the deal is done, you aren’t going to have a $10 million dollar check in your pocket.
A typical package is likely to be built on a combination of cash, stock, retention, and incidentals. Cash on close is what most of us imagine when we think of selling our company, and it is almost always a substantial part of a deal. In our $10 million example, you may actually walk away with a check for $4 million in cash, and like Maria described, that feels pretty amazing!
So, what about the rest? It may be tied to some, or all, of these items:
- Equity (stock) in the buyer’s company. If the acquiring company is a public company, you’ll be able to easily map their (current) stock price to the number of shares you are being offered. You may be granted shares of stock at that price, but you don’t get them all at once: they vest over a period of time, in chunks (often about ¼ per year). If the company isn’t publicly traded, you’ll have to think hard about the potential worth of that stock. Do you think the buyer will have an exit event—going public, or selling themselves? If not, you’ll end up with some worthless paper.
- The retention of you. Depending on how “important” you are to the brand and the daily running of the company, you’ll likely be financially motivated to stick around: often, you’ll receive money if you stay one year, two years, and so-on. This one’s a leap of faith, too. Maria left Facebook with a lot of money on the table, and you’ll read about others doing the same, because they just couldn’t handle the new company culture.
- The retention of your team members.
- Hitting financial targets (“earning out” the rest of the money owed—what Alan Cooper advised to never sign up for).
- Selling work, yourself.
What happens if it isn’t in the LOI?
The legal part of the process that follows a signed letter of intent will leave room for negotiating various parts of the deal. But a buyer will be highly reluctant to revisit and argue about the financial parts of the deal. And finances touch a lot of different parts of the agreement, not just the cash up front.
Simply, if it isn’t in the LOI and it’s related to money, it is going to be extremely hard to argue for later, and so you may end up in a situation where, like Gavin and Sue and Alan, you’re taking someone on their word.
For example, let’s say you want to work with your co-founders again after you leave the acquiring company. You may view this as a fairly simple point, but a buyer will see this as a point of leverage—fine, they may say, if you want the freedom to leave as a group, we’ll need to minimize that risk by taking something away or including a penalty. If you wait to discuss this after you’ve signed an LOI, you are negotiating without much leverage, because you’ve all already agreed upon the value of the company and the transaction. Any penalty or takeaway is coming out of that agreed-upon value.
You’ll have months and months to negotiate the details of the transaction, but before you sign the LOI, you have the most leverage and are the least emotionally invested. Explore this space as long as possible to make sure you get the most out of the details.
