The Letter of Intent (LOI): the first step toward commitment
When the time is right, the potential buyer will draft a Letter of Intent (LOI) or a purchase offer addressed to the shareholders of the target company. Once signed, this document marks the first mutual commitment in the business transfer process. Although a Letter of Intent is often considered legally non-binding, it can include penalty clauses that the buyer must pay in certain situations, particularly when they have failed to make reasonable efforts to move the deal forward. This compensation protects the seller, who may have granted exclusivity, invested time, and incurred expenses during negotiations.
Among the various points addressed in an LOI, the price offered under certain conditions is typically the most discussed. But how should this price be proposed? As a fixed amount? Through a formula? And if so, which one?
The risk of a fixed price
While a fixed price is easy to understand, it has major limitations. A company remains active throughout the sales process; business doesn’t stop just because shares are changing hands. Accounting reflects the company’s status at specific dates, at least annually, and always in hindsight. Financial information can only be shared once fully processed and approved. Therefore, negotiations between buyer and seller are inevitably based on past financials. But there’s more. The “blind period” begins the day after the most recent financials and lasts until the LOI is signed. Then comes another long stretch before the transaction is finalised. Several months can pass between the latest approved accounts and the signing of the share purchase agreement, making the buyer’s offer a gamble on the company’s stability or growth.
The (imperfect) adjustment mechanism
A company’s value includes both tangible assets (real estate, equipment, stock, receivables, net cash) and intangible assets (human capital, brand, business model, customer base, reputation, etc.).
Savvy buyers often separate the valuation of tangible and intangible assets. Their price proposal might include a fixed portion (representing mostly intangible value) and a variable portion (linked to tangible value). For example:
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Sale Price = Enterprise Value (fixed) + Net Cash Position (variable)
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Sale Price = Accounting Equity or Adjusted Equity (variable) + Goodwill (fixed)
Some go even further, breaking down the Enterprise Value to limit over-optimisation at closing. For instance, sellers could try to pressure clients to pay early or delay paying suppliers to inflate the cash position on the deal date. The second pricing method (equity + goodwill) helps avoid these manipulations, which can leave a sour taste for the buyer once the transaction is complete.
Using an adjustment variable helps the buyer hedge against short-term uncertainty, but also means they miss out on potential gains if the business performs well during negotiations.
A complex formula: safer but hard to swallow
But what if the long “blind period” reveals a major structural shift in the business? In a short time, an SME can face significant changes. While a variable adjustment can smooth out short-term turbulence, it may not absorb a lasting decline in performance. Buyers typically value intangible assets based on the business’s structural profitability. When a serious crisis affects the company, its sector, or the broader economy, a simple adjustment for cash or equity may not be enough to reflect a drop in value.
To manage this risk and keep the seller engaged until the end, some buyers include a more sophisticated formula in the LOI:
- Sale Price = Enterprise Value (variable) + Net Cash (variable)
- Enterprise Value = Adjusted EBITDA (variable) x 5.5 – Normalized Working Capital + Actual Working Capital (variable)
While this method reduces the buyer’s risk, it also prevents them from benefiting from a sudden uptick in business performance during the deal period. In practice, such formulas are rare—they tend to confuse sellers, who may prefer a clearer, simpler offer.
A tailored approach, every time
Other risk-mitigation mechanisms exist, such as earn-out clauses, where part of the price depends on future results.
Many deals fall apart due to unresolved details that could have been addressed earlier, especially through a well-crafted, tailored LOI. Every case is different. Every solution must be too. The key is to step back, analyse the situation thoroughly, and focus negotiations on the core value drivers.
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