Sign California Banking Letter Of Intent Secure

Industry sign banking california letter of intent secure

[Music] now we're going to talk about frequently used provisions in a LOI and we'll start with some frequently used non-binding provisions first up is purchase price oh well the purchase price in an LOI is generally not a non-binding term it might be and it might change a little bit during due diligence it's probably one of the most important terms of your LOI it can be fixed it could be based on a formula it is usually the parties put forth how they're going to pay the purchase price in the LOI you know is it going to be all cash up front and there going to be a down payment with a promissory note for later is it going to be per cash part stock another another tool is you know that people should consider as a promissory note or it could you know hold pull back which we'll talk about later but portion could be paid through a promissory note which can help bridge a gap between you know discrepancy you know debate about purchase price between the two parties or it could help the parties allocate risk where a seller needs to sort something out before can't sort something out before closing and has to do it post closing so the the buyer will have to you know will be able to be assured you know taking a little bit less risk an example of this is this came up in a deal I closed last year the the sellers knew they would not be able to get all of their landlord consents before closing they just knew it wasn't going to happen and so the parties agreed to put some of the purchase price on a contingent promissory note that would be paid later if certain conditions were met fortunately in that situation it motivated the sellers to really work at it and we got the seller notes paid off but it can I could be a useful tool for situations like that related is how the purchase price might be adjusted a common adjustment tool is networking capital networking capital can be a good gauge of a company short term ability to cover obligations and it's typically calculated based on the balance sheet but agreeing to how it's actually calculated can prove difficult often you'll see in LOI is a shorthand of you know as mutually agreed or it'll be calculated based on past practice or some some shorthand like that and it kept that can lead to problems later now you might not be able to agree to it upfront but having more detail about it in the LOI can save some headaches save you some headaches later and network capital is a moving target so the parties will need to come up with a target capital for closing and then we'll actually need some time to true it up it could be 30 60 90 days and you know some of the nuances there are seasonality accounts receivable of the company you know their typical collection time so it could you know drastically change and the parties need to Trude up after the true up could be a dollar-for-dollar adjustment or it could be if it's above or below a certain dollar amount more or less the purchase price would then be adjusted then I have a couple of examples these are just examples of how you might see it in an LOI this first example shows that you know the net working capital will exclude cash and debts so that's a little bit of detail and that the target will be calculated based on historical average and will be mutually agreed again these are short hands but at least they're providing a little bit of detail to how it might be calculated and then in this one you'll see that it does it'll only be a just if it's above or below a certain dollar amount but then it would be on a dollar-for-dollar basis this next example is very short-handed it just says it's anticipated to be based on an average net working capital for the last six months that leaves a little wiggle room about how it's actually going to be calculated and this example also shows that you can do the adjustment adding or subtracting to seller notes that can be a good tool buyers don't want to have to provide more cash thirty or sixty days later and sellers don't want to pay the buyer cash you know they don't pay them back so instead of having an escrow or some other mechanism to pay back or you know sell using the seller notes if they're already part of the transaction could be a good tool for that another area of purchase price adjustments is the whole topic of earn out and earn outs or something that if you're going to have it as part of the transaction you definitely want to mention it in the letter of intent because it's a very important part of the purchase price let me back up for just a second and describe a situation where in Bernal may come up typical negotiation for one where that might end up with internet would be something where the seller comes to you and says okay I want 20 million dollars for my business the buyer comes in and says I am willing to pay 10 I've got an obvious difference there but the parties decide that even though there's a difference in in price it's a good fit otherwise and they want to find a way to make it work it may be that the buyer is willing to pay more if the business does well post acquisition also let's assume in this particular situation the buyer knows that they need the seller to remain active and involved in the business for a period of several years after the deal closes this is the perfect situation for an earn out the parties could agree in the in this example to pay a base purchase price of ten million dollars at closing they could agree to some percentage new revenues being payable as an addition to the purchase price for the three years following the closing and perhaps in this case the total could be capped at ten million dollars if that's the price that the seller is willing to accept as a top in so this additional payment that we're talking about is what's referred to as an earn out and it is in effect a contingent purchase purchase for us as you would expect earn outs are a frequent topic of disputes and we'll touch on this when we talk about cases later in the presentation the reasons up for it are pretty obvious first of all it's much easier if you're the the buyer to think that maybe after you've got the business that isn't such a good idea to pay more for it second there can be disputes over just the basic method of calculation third gift anytime you have and earn out even if it's detailed in the agreement that's is finally signed there's a risk that some some level of detail will be left to future decision that can lead to disputes obviously the earn out is not going to be described in huge detail in the letter of intent but there are some topics that should be covered and those are basically the percentage that's going to be used for the calculation of the year now the duration the period it's going to cover what metric is going to be the basis for calculating the earn out is there a tracking or reporting requirement and if so what's the timing and what's the content typically this doesn't get into a letter of intent but it may be important to consider whether you need to state where the obligation to pay the vernet will stand as opposed to other obligations of the buyer for example secured creditors and then another area that can be really important is to consider whether there should be early payment triggers for the earn-out that leads right into a question of control in any urn out to think about if you're representing the seller whether there is an adequate mechanism in place for the seller to be assured that they're going to have the ability to run or control the business post closing in a way that makes it possible to achieve the IRR now what input is the cell are going to have during your doubt period are there some transactions that may occur that would prevent the business from being run as it has been in the past if so then you may want to have an early payment trigger and at a minimum in the letter of intent you may want to say that the definitive agreement will include provisions on changes to the business that would require the sellers consent or early payment of the earn-out we have a couple of examples to show you for earn outs and letters of intent this slide you see right now is a fairly typical or not provision it covers a percentage to be paid for the for the earn-out talks about duration in this case 12 months the metric here to be used for calculation of the yeren out is gross profit there is a cap on the earn out in this case and I should point out that on this slide there is a typo in about the middle line there it says to seller if 2000 xxxx gross profit is equal to or less than a dollar amount that should be equal to or greater then and then it also touches on reporting and track and tracking in a brief way in that there's a statement that a report is due 120 days after the fiscal year end there's an additional feature in this example that's useful there's both an estimated and a final payment so the earn out can be paid in stages and this kind of an arrangement first of all again is important identify in the letter of intent if that's what the parties believe is best second it can be used when the earn out period and the accounting period of the buyer may not be in sync so you may want to have an early payment based on an estimate and a final payment based on actually closing the books for the relevant fiscal periods not covered in this example is anything about control or dispute resolution which often is an extended part of the actual definitive agreement or priority or security let's go to another example this one takes a different approach it is in a letter of intent that is much more general there's a total amount stated but that's really about all major left major items are left for agreement later the milestones to be achieved or not specified the metrics further yearn out really aren't talked about it's not clear whether it's all or nothing all there is there is a reference to the fact that the earn-out may be payable on a sliding scale so a lot is left in negotiation in this example and this one is clearly a much higher risk approach but it might be acceptable if perhaps the earn out is not as significant a part of the purchase price may be the parties have a long-standing good working relationship or maybe this letter of intent is the best you can do because you're very early in negotiations the part you want to parties want to put something in place but they're really not in a position to agree on final formulas this is this example it's obviously much more likely to end up in court if the parties don't reach a definitive agreement and end up negotiated litigating over the letter of intent let's talk now about escrows escrows and holdbacks are another type of purchase price adjustment it means you know they're going to hold back a portion of the purchase price or put you know with an escrow agent for a certain period of time a portion of the purchase price when considering whether to use one of these mechanisms or you know when it's appropriate to use them things to think about are are the seller and buyer and disagreement about what the actual price of the company should be it can this this tool can help bridge the gap between different views on valuation of the company if the buyer has some has some concerns about certain risks this is a risk allocation tool it could could assure them that they have access to indemnification payments for a period of time after closing without having to go hunt down shareholders or you know a company that could have been dissolved it can you know think singing about it would be you know timing of payment you have to think through those things and whether it's going to be over you know a year two years I've seen them longer and then how is it going to be paid back or paid to the to the seller if the buyer is expecting an escrow or hold back it should be in the LOI it would be really difficult to get a seller to agree to this leader in the process and it's helpful for a buyer to think through areas of concern diligence at this point is not likely complete but buyer may have an understanding of certain areas of risk is there pending litigation does this is this company potential target for environmental issues are there point you know depending on the type of transaction is their employment liability risk that they're taking on so they might have an idea of areas of risk and that would be a helpful negotiation tool for the buyer to get one of these into li if a buyer is going to require one of these the seller could then use it to negotiate a cap on their liability I think Eric has a comment on this yeah I do have a thought on this one one this ties back a little bit to the notes that Megan was talking about earlier under purchase price one combination that you can use very successfully in place of a cash escrow in the right circumstances is to have the LOI provide for an indemnity note and this can be both a way to provide something of an escrow and also let the seller basically have a lower financing need obviously we're sorry the buyer obviously the seller needs to be comfortable with this but in a transaction that we closed recently basically 80% of the purchase price was payable at closing 20% was going to be in the form of a two-year note that would be paid only after deducting any indemnity claims that came up during that period so the note serves in essence as a substitute for escrow and that can be a handy feature to include in a letter of intent when the circumstances are right other frequently used provisions in an LOI relate to employment or consulting these are these tend to be very deal specific and one in some cases it is really important to a seller despite the fact that they're selling their business that their current employees be protected that they're going to continue on in the business for some you know that they're going to be offered employment and not just laid off and you know as part of the transaction and in this case the seller would require something like you know buyers going to hire or offer employment to all current employees and a buyer in this case might insist are not being obligated to retain employees for an indifferent indefinite period of time you wouldn't want the LOI to service some sort of employment agreement or obligation on the part of the buyer a buyer may also have to consider whether the transaction is going to result in duplicative employees and having to fire certain people or leave them off and from from buyers perspective this could you know having to hire employees or deal with that those types of issues could also lead to more time and diligence and depending on the structure of the deal they might have to investigate more employment liability issues or employee benefits issues the parties may also have to adjust the adjusts the price because who's going to pay if they're transitioning so if it's an asset deal but they're still having to hire or offer employment to all these employees who's going to pay the their paid time off the accrued paid time off or if people are going to be laid off who's going to pay their severance and Cobra what is that going to look like from a buyer's perspective they may want to make as part of the transaction key employees staying on or signing an employment agreement with them they may not know who those key employees are yet but they can still include in the LOI a closing condition that you know keep personnel as determined by buyer will execute employment agreements with buyer as part of the closing and related to key individuals or consulting services where you know maybe the buyer doesn't need them to be a full-time employee but there's certain key individuals founder a retiring you know or potentially retiring CEO who have been in with the business for a long time every employee knows them they provide a smooth to help provide a smooth transition they'd be a familiar face around the office as they transition to a new owner the buyer may require that those individuals sign a consulting agreement as a closing condition and that those types of things should be in the LOI because without them maybe they'd be difficult to negotiate later one very important provision that comes under the topic of employment consulting and services is a nun competition or a nun solicitation rovision this is something that definitely should go into a letter of intent if it's important for the buyer and typically the buyer is the party that's going to want to have these provisions in place there are two different levels to consider when you're looking at non competition or non solicitation clauses and those levels are the shareholder level and the employee level for the shareholders it's very likely that some of them those who are involved in the business will know the business very well and the motivation for a selling shareholder to turn around later and compete is there and it's very real we've seen it many times you will you will have a individual come in new client and he or she says I'd like to start a new company and we talked to them and it turns out that the reason they're starting the new company is they had a successful business several years ago they sold it they had a non-compete the non-compete expired they're ready to go again and they jump right in and start a new business that may happen for a number of reasons it may happen because the buyer may have taken the direction indicated sorry the company in a direction that the client thinks is unwise or unprofitable or uncompetitive and the client may see an opportunity to jump back in usually our conversations with these clients indicate that the non competition clause has actually done its job they typically approach us either shortly before or right after the non competition clause expires so although this dynamic is out there I think it underscores both the need for and the typical effectiveness of including these clauses in the letter of intent so that they can be part of an agreement it's also important to address non-competition as two key employees who are not shareholders they may not have the same motivation to start their own business although they could but a non competition or non-solicitation clause can encourage them basically not to jump ship under the buyers direction and if the buyer needs them that can be very important if you're going to include a none competition on solicitation clause in your letter of intent and ultimately in the deal to documents it's critical to take into account state law restrictions this is one of the few areas that really you do have to look to outside sources of law when deciding how you're going to draft the letter of intent and where you are matters a lot or where the buyer and seller are matters a lot when you're dealing with shareholders these two levels that we've talked about have different have different effects under state law when you're dealing with shareholders you still have broad discretion as to the scope of business geographic coverage and duration of a non-competition clause but with employees that's often not the case as an example you can't impose a non competition clause at all in some major markets such as California and when you can impose some state law sometimes limits the extent of the clause that will be enforced for example Oregon just changed its law in the last couple of years to move the non-competition period that was allowable from 2 years to 18 months those are the kinds of things that you need to take into account when you're drafting a letter of intent one mistake that we see in this area fairly often and this is usually when we're representing the seller is the letter of intent may state that all key personnel are going to be required to enter new employment agreements with non competition clauses in them with the buyer the buyer needs to really think about that carefully before putting that in the letter of intent and definitely before putting that in deal documents if you're advising the seller you may say look fine go ahead and gree to that because what they're going to end up doing is putting clauses in a place that won't be enforceable under the applicable law that can be the case if the states that are involved allow non competition clauses but only on certain events for example some states will only allow non competition clauses to be entered in advance of or in connection with initial employment or at the time of bona fide advancement if you try to do that at a time at the time of a deal and there's no new employment going on then the buyer can end up shooting themselves in the foot just because they wanted to have a different form or a new form of contract in place so it's something to be particularly careful about one last comment on this area there's a big difference between non solicitation and non competition state law restrictions generally are much looser or don't apply to non-solicitation clauses another area that's important under the employment topic and can come up in blood or of intent negotiation is any kind of clause where there's a union that shop involved if you if the seller has a collective bargaining agreement then there are considerations that need to be considered when the buyer before going forward with the letter of intent seller also has some considerations to take into account but both parties need to know whether the buyer is going to assume the union contracts if the buyer doesn't intend to then the seller may find that he or she has some liability under that contract and it can be significant the buyer may want to hire some but not all employees the buyer needs to know that under labor laws if there is a collective bargaining agreement in place and they hire more than 50% of the existing workforce then they must negotiate with the union to that contract there can also be a collective bargaining agreements that require by their term it's not because of applicable law but under the terms of the agreement that the seller require the buyer to assume the contract at any acquisition of the business this is not an unusual clause and it's one of the things that the buyer needs to be aware of in in a business transaction another area that's important in the union area and well particularly in the area is benefit plan withdrawal liability you want to find out if you're a buyer whether your seller is subject to a multi-employer pension plan if they are any change in participation in that plan at least a change that is considered this equivalent to withdrawal can result in very large liability and these are these are big numbers we recently were advising a client on a situation where there may be a withdrawal intended and the calculations showed that the withdrawal liability could be greater than the value of the entire company so this is this is a really important area to look at if you're seeing that there is a collective bargaining agreement involved or a multi-employer pension plan one other area and this is this really applies both Union and non-union it's whether or not you're going to have a Warren Act obligation typically if you're dealing with parties where there are fewer than 100 employees total and you're hiring we're sorry more than 100 total and you're laying off more than 50 then there will be a need to take into account the Warren Act Warren Act requires 60 days notice or sometimes pay in lieu of notice again from the buyers standpoint that's going to be very important on all of these considerations I would say that if you see these topics coming up when you're drafting a letter of intent it's a good idea to talk to a labor attorney and get advice on where the liabilities might stand and how that should be dealt with in the letter of intent next we're going to talk about provisions in the LOI that relate to the definitive agreement most allies will have a paragraph that states the definitive agreement will include typical and customary terms and those customary terms include representations warranties covenants conditions and indemnification sometimes a little bit more detail than that is needed or recommend it you know what is typical and customary if you if you have a unique industry or a complicated deal you might not actually know what is customary in those scenarios you might also want to make sure that certain ones are mutual so you should really think about whether more detail is needed to explain what the parties agree agree to um especially if again if it's a complicated transaction or a unique industry or one where you know maybe every deal is different and so there is no real customary term for those types of reps warranties covenants etc you may want them you know to detail out if it should be if the ref some warranty should be mutual if it's kept if there's going to be a merger or maybe where consideration is paid part in stock or mostly in stock because you know the sellers are going to have certain concerns too about the buying company or the surviving company some typical and customary terms or capitalization of the company Authority no conflict those those are often in every agreement but there's other ones you know that that they may need you know depending on what type of business it is and so you should really think through give it some thought what other ones you might want in there so that there's no surprises later of course the parties have not done a lot of diligence at this stage but you should real if if there is going to be indemnification in the agreement which again most often there is the the LOI should at least reference that there will be indemnity if you don't include that in LOI it may be difficult to negotiate later and Eric will talk a little bit more about indemnification in a couple of slides from now the LOI should also state what what will survive termination or expiration of the LOI in the event the definitive agreement is never executed there are certain types of provisions that should always survive that like confidentiality and those types of things and then lastly what's often included is who will prepare the definitive agreement that should be in there so that all the parties expectations are aligned and typically it's the buyer that prepares it and sometimes even they put in a time line that it will be prepared within X number of days or an initial draft will be given by X date you can include those types of provisions at this point - now we're going to talk about just a couple of examples of what what we see in ello is in this example you'll see there's no specifics about reps and Morty's covenants it just says provisions customary and transactions of a similar nature and in this deal that might have been very easy it's a small asset deal you know it may be very easy to figure out what those are but in other circumstances that might not be appropriate another typical provision is that's often included when talking about Senate agreements is that the letter of intent is non-binding and is expressly subject to mutual due diligence and negotiation and execution of a legally binding stock purchase agreement and related agreements