Negotiating a Letter of Intent When You Are Selling the Business

The letter of intent is the point in a sale where the seller holds the most leverage. Before it is signed, the buyer is competing with every other buyer, real or imagined. After it is signed, exclusivity takes the business off the market, the buyer learns everything about the company during due diligence, and every later request from the buyer arrives as a "diligence finding" that justifies a price reduction. A seller who signs a thin letter to get the process moving usually pays for it at the purchase agreement.

The seller's goal is therefore to settle as much of the economic deal in the letter as the buyer will accept, so that the purchase agreement confirms terms rather than reopening them. The buyer's goal is often the opposite: keep the letter general, get exclusivity, and negotiate the detail once the seller is committed. Our guide to selling your business sets out the whole process; this article is about the letter.

Expect the buyer to send the first draft. You do not have to accept its structure. Sellers in a competitive process often circulate their own form of letter and ask bidders to mark it up, which puts the seller's terms on the page first.

A headline price is the easy part. The mechanics decide what you actually receive.

Cash-free, debt-free. Confirm that the price assumes the company is sold without cash and without debt, and state which items count as debt. Buyers like to classify deferred revenue, accrued bonuses, customer deposits and unpaid taxes as debt, each of which reduces the cash you receive. Settle the list now.

Working capital target. If there is a working capital adjustment, the target should be set from the company's actual trailing average, not a figure proposed by the buyer. Ask for the methodology and the reference period in the letter, and for a collar, a band within which no adjustment is made, so that small seasonal swings do not become price negotiations.

Earn-outs. An earn-out moves risk from the buyer to you. If you accept one, the letter should state the metric (revenue is harder to manipulate than profit), the period, the maximum, and that the buyer will operate the business in a way that gives the earn-out a fair chance. Ask for acceleration if the buyer sells the business or terminates your involvement during the earn-out.

Vendor take-back. If you are lending part of the price back to the buyer, treat it as a loan: interest, term, security over the business and a personal guarantee from the buyer's principal. A take-back with no security is an unsecured loan to a leveraged buyer.

Holdbacks. Resist a holdback at the letter stage. If one is unavoidable, cap it, limit it to specified risks, and fix a release date.

Exclusivity is the buyer's main ask and your main concession. Give it for a fixed period matched to the work the buyer must do, with extension only by your written agreement. Thirty to forty-five days is usual for a private business. Make the period start when you deliver the diligence materials, and tie any extension to the buyer's progress: a delivered draft purchase agreement, written confirmation that diligence is complete, or evidence of financing.

Build in a release. Exclusivity should end early if the buyer proposes a price below the letter without a written diligence finding to justify it, misses a milestone, or tells you its financing is uncertain. Without a release, you are waiting on the buyer's timetable with no recourse.

Remember that Canadian law does not impose a general duty to negotiate in good faith. The Supreme Court of Canada in Martel Building Ltd. v. Canada declined to recognize a duty of care in commercial negotiations, so a buyer who takes the exclusivity period and then walks is usually not liable to you unless it breached a binding term or misled you along the way. The protection is in the binding terms you draft: milestones, a cost-reimbursement obligation if the buyer withdraws after you have met your obligations, and a short period. Our guide to exclusivity and no-shop clauses covers the drafting.

Due diligence means handing a potential competitor your customer list, pricing, margins, supplier terms and employee compensation. The confidentiality clause in the letter, or the non-disclosure agreement it incorporates, should be the strongest binding term in the document.

Stage disclosure. Financial statements and contracts can go into the data room at the start. Customer names, pricing by customer, supplier terms and employee files should wait until the buyer has confirmed financing and the purchase agreement is in near-final form. Redact what the buyer does not need to value the business. Keep a log of what was disclosed and when.

Restrict use and contact. The buyer may use information only to evaluate the transaction, may not contact customers, suppliers or employees without your consent, and must return or destroy everything if the deal fails. Add a non-solicitation covenant so the buyer cannot hire the staff it meets during diligence. These clauses survive the end of the letter; say so. Where the data room holds personal information about individual customers, PIPEDA lets you disclose it for a prospective sale without their consent only if the buyer has agreed to use it solely for the transaction, protect it with appropriate safeguards, and return or destroy it if the deal does not proceed, so put those promises in the confidentiality clause.

Control the announcement. Employees who learn of a sale from a buyer's diligence visit start looking for other jobs. The letter should give you control over what is said to employees, customers and suppliers, and when.

The seller's instinct is to put every protective term in the letter. Some belong in the purchase agreement instead, and raising them too early slows the signing without adding protection.

Representations and warranties. Do not try to settle the scope of your representations in the letter. Buyers will ask for "customary" representations, and the fight over what is customary belongs in the purchase agreement, where your lawyer can qualify each statement by knowledge, materiality and the disclosure schedule.

Indemnity caps and baskets. Likewise, the cap on your liability for breaches, the threshold below which claims are not made and the survival period for representations are purchase-agreement terms. A seller who proposes a cap in the letter anchors the buyer's expectation low; a buyer who proposes one anchors it high. Neither needs to be in the letter unless one side insists.

Detailed allocation of price. Record the structure and the headline price, and the intention to agree an allocation for tax, but leave the numbers to the accountants.

Anything you are not yet sure about. A term written into a letter of intent, even a non-binding one, becomes the baseline for the purchase agreement. If you have not decided whether to offer a vendor take-back, do not include one. The buyer will treat it as agreed and resist its removal.

What should never be left out is the non-binding statement itself, the binding terms you need (confidentiality, exclusivity limits, expenses, governing law) and the outside date. Those three things are what protect you if the deal does not go ahead.

Employees. In a share sale nothing changes for employees on closing. In an asset sale the buyer chooses whom to hire, and section 9 of the Employment Standards Act, 2000 carries forward the service of anyone the buyer employs within 13 weeks, but anyone the buyer does not hire is terminated by you, with notice and, where it applies, severance pay obligations that fall on the seller. The letter should state whether the buyer will offer employment to all employees on substantially similar terms. If it will not, price the terminations into the deal.

Your non-compete. The buyer will ask for a non-compete and non-solicit from you personally. Ontario's prohibition on non-competes in employment, section 67.2 of the Employment Standards Act, 2000, reaches you only if you also become the buyer's employee. If you will, the Act exempts a seller who becomes the buyer's employee immediately after the sale, and separately exempts executives, but the province's guide to the Act reads the sale exception as covering businesses run as sole proprietorships or partnerships. Where you sell through a corporation or holding company, give the covenant in the purchase agreement in your capacity as seller and have the structure checked. A covenant outside the ban can be enforced if it is reasonable in duration, territory and scope. Negotiate the territory to where the business actually operates and the duration to what the goodwill is worth, typically two to five years. Our guide on enforceability of non-competes in Ontario explains the limits.

Shareholder approval. If your corporation is selling all or substantially all of its property, section 184 of the Business Corporations Act requires a special resolution of shareholders, and dissenting shareholders may have appraisal rights under section 185. Confirm you can deliver the vote before you sign.

HST. State that both parties will make the section 167 Excise Tax Act election so that no GST/HST is charged on the sale of the business where the conditions are met. Without the election, HST applies to the taxable assets and the buyer must fund it at closing.

Tax structure. Share and asset sales are taxed very differently for you. A share sale may allow access to the lifetime capital gains exemption where the shares qualify; an asset sale leaves the proceeds inside the corporation. Decide the structure with your accountant before the letter fixes it.

Transition. Limit your post-closing involvement to a defined period at a defined rate, with a clear end. Open-ended "reasonable assistance" becomes unpaid work.

Everything above belongs in the letter, in the binding or non-binding part as appropriate, because that is when the buyer will agree to it. If a buyer's draft has landed in your inbox, send it to us before you respond.