Letter of Intent: The “No-Shop” Clause

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Letter of Intent: The “No-Shop” Clause

A letter of intent – the LOI – from any knowledgeable buyer will often include an exclusivity period meant to restrict the seller’s ability to continue marketing the business to other buyers. We refer to this as a “no-shop” clause because the seller is prohibited from continuing to shop the business in the open marketplace.

This topic has come up in our weekly course Q&As – our Friday Afternoon Wrap Up, or FAWU – on a number of occasions. Usually, the questions relate to how to handle that clause when it appears on the LOI.

We’ve had brokers who, without thinking through the potential consequences, advised their sellers that such a request from a buyer is reasonable – and rightly so.

A letter of intent helps to weeds out the tire-kickers, off which there always seems to be uncountable multitudes. The serious buyer needs some amount of time to gather certain data that will enable them to determine whether the target business is worth pursuing. We expect any serious letter of intent to recognize that need and to request that the seller allow the buyer a short period to confirm its interest.

But the operable word here is “short”.

How Long Does a Buyer Need?

With the exception of the deals involving the smallest and least complex businesses, this doesn’t mean a complete due diligence but enough information so that the buyers are reasonably confident that, absent a major discovery during its due diligence, the chances of completing a deal for the target business are reasonably high.

But there are a couple of issues with a no-shop clause that professional business brokers must try to protect their selling clients from.


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The first is to assure that the no-shop clause has a defined time period.

My comment above about a couple of brokers advising their clients that such a request from a buyer is reasonable is related to a couple of the FAWU questions in this regard. As it happened, on at least three occasions, the no-shop clause in the LOI did not contain an end date. The result was that the buyer was able to drag its feet.

Restricting the seller’s ability to entertain other offers puts the business owner at a distinct disadvantage.

The seller’s position grows weaker with time since there is no ability to create any leverage from a little competition. A reasonable n0-shop period could be as little as 30 days for a small business or as much as 90 days for a larger one.

This is not to say that a buyer’s complete due diligence can be performed in that amount time – though in many cases it can be. And the seller can still allow a longer due diligence period but, at some point, in order to motivate the buyer to act, that buyer has to be under some pressure to do so.

Allowing the seller to restart its marketing efforts within a reasonable no-shop period is one way to do so. When a potential buyer knows it has some competition for the target business, such a buyer will generally get focused quickly.

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But what about a buyer that raises legitimate reasons why the no-shop period should be extended?

Money Talks

It is certainly possible that, in some instances, a buyer would request an additional amount of no-shop time. But it’s also reasonable that such a buyer would appreciate the potential damage an extended no-shop period will do to the seller’s ability to find a buyer within a reasonable period of time. As such, we’ve advised our seller clients to consider requiring a payment for any extension.

Once a buyer has cash invested – cash that went directly to the seller rather than to the costs of research – we’ve seen a remarkable increase in activity.

The buyer essentially “buys” an additional block of time to be the “exclusive” buyer with whom the seller will work. This extension fee is non-refundable, though it sometimes is applied to the purchase price if the deal closes.

Any extension, of course, also has a time limit. The buyer can certainly request a further extension. If the seller agrees, we’d advise that the second fee be significantly higher than the first fee on the theory that the longer the seller’s business is off the market the more costly it will be for the seller.

The Bottom Line

Our objective when receiving a letter of intent is to convert that LOI into an formal purchase agreement as soon as possible.

A purchase agreement will contain a due diligence period that could be structured with strict time limits and even certain defined payment points, as well, but we want to get a purchase agreement negotiated and executed as quickly as possible. To succeed in that objective, strictly observed milestones are important to have in place and be honored.

If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.

I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week!

Joe

#business #businessacquisition #sellabusiness #becomeabusinessbroker #businessbrokering #businessvaluation #MergersandAcquisitions

The author is the founder of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 1,000 in the world. He can be reached at joe@WorldwideBusinessBlog.com

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