Just as most stories and deals start out, everyone is optimistic, idealistic and full of hope for clear skies. It's a perfect outlook with a perfect setup for the ups and downs yet to come.
Peek further behind the curtain and into the first steps of buying a business: the letter of intent. After the first episode, you already have an idea and context of our buyer's situation. Listen to the call, as we walk through the important points and considerations when drafting our buyer's letter of intent, that happens to include a no-shop provision.
Full Podcast Transcript
NASIR: Welcome to Legally Sound Smart Business, this is our second episode of Behind the Buy, our series where we take a look at the transaction of buying a business with our client, you get to listen in on our phone calls. My name is Nasir Pasha.
MATT: And I'm Matt Staub.
NASIR: This is our first real episode, I think our first episode was just kind of an introduction of our series, but this is where we really get to the meat. We're going to play our first phone call. At this stage, we're just setting things up. We're talking about the actual initial transaction of negotiating the business terms through what is called a letter of intent.
MATT: It's just some table setting if you will, the document that starts the whole transaction and discussing the terms that are in there, what should we include, what shouldn't we include. Just prepping our client and getting this whole thing started.
NASIR: Even though I think this is a pretty straightforward part of the transaction, there's a lot of important information here when a buyer's looking to purchase a business, the different options they have on how they make the offer and how they structure it. There is a lot of discussion to be had before things are put in writing. This is a critical step, but this also really sets up everything that's going to be coming, the twists and turns if you will, of this particular transaction.
NASIR: As always, we're going to have a little overview of some of the defined terms or vocabulary. It's not to say that — most of you probably know this information, but in the phone call itself, we may not take a moment to define them during the call because of course, it's a natural conversation, so let's go over a few words in here so that everyone's prepped for this listen. The first are a set of three. There's the term sheet, the letter of intent and memorandum of understanding. From a client's perspective, often, they use these different three terms interchangeably. In a way, they could be very interchangeable in the sense that from a legal perspective, a term sheet and letter of intent and a memorandum, they all can have the same legal effect if they're drafted in such a way. The best way to distinguish each of them is usually just from a formatting perspective. I know that sounds oversimplified, but I would say that a term sheet is probably the most informal of the three and the Memorandum of Understanding is the most formal, but all three are some written document and they all include the basic terms of the business transaction. However, a term sheet is very rarely an enforceable document. Sometimes it can be very casual, a letter of intent is pretty much always an unenforceable document. However, it may have enforceable provisions and a memorandum of understanding is almost always an enforceable document, but may have some non-binding provisions in it. Really, the distinction between the three is in the details because for example, a term sheet for which you outline the terms of buying a business that is signed by both parties could end up being unintentionally a binding document and similarly with the letter of intent and an MOU. That's why even if you want to casually offer something in a term sheet, even in an email exchange, you really should get an attorney involved very early to make sure you don't accidentally walk into an enforceable transaction that you can't get out of.
MATT: And just to chime in real quick on this. Like you said, all three could take different forms and each one is known to have certain things or not have certain terms in it, but it is like you always say, the devil's in the details on this and you have to look at the actual underlying provisions in each document to really get what you're working with. The substance is ultimately what's important.
NASIR: We focus on the letter of intent here, that's our kind of go-to because often, you can have most of your terms outlined as you make an offer to buy a business or if you're making an offer to sell your business are going be non-binding provisions so that's the default for most letters of intent if it's drafted properly, but then in this particular call, we also talked about something called a no-shop provision. This is actually going to be a binding part of the letter of intent. Just to define what that is, a no-shop provision basically prevents the seller from "shopping around" or entertaining offers. For example, if they're publicizing the fact that they're selling their business, they'll have to stop publicizing that because that would be a violation of that no-shop provision. That's what we call it, but obviously it's a two or three sentence paragraph that defines what the seller can't do.MIKE: Then a couple of other terms here and grouped these together as well. We have asset purchase and equity or stock purchase. We did this in great detail not only in this episode but kind of throughout the whole series, but an asset purchase is when you're buying just the assets of a company as opposed to a stock equity purchase where you're buying everything. So you have a good analogy in here with the whole building hypothetical that you posed. I don't want to spoil that here, but that's kind of the way to look at it.
NASIR: Don't steal my thunder, of course. I'm looking forward to seeing how that analogy plays out. Yeah, that is kind of a basic — I feel like we do define that in good detail, but at least understand that there are two different things. There are two types of structures of buying a business and asset purchase versus an equity purchase. One thing that also comes up is something that's called a change of control provision. The context of what this is is that when you do an asset purchase, you only assume the contracts that you choose to do so and those contracts have to be assigned. Usually, an assignment requires permission of both parties whereas if you buy and equity purchase, if you buy the company and its stock, then you actually are in the shoes of the seller and, so therefore, usually you don't require an assignment or you don't require permission from the third party contract. If there's a change of control provision, often that other party requires consent before that contract can also apply to the new owner even though it may be an equity or stock purchase agreement. That's the context of the actual change of control provision. This episode's a little vocab heavy, but it's still an introduction, so don't worry. We go through this in a little bit more detail later in the episode.
MATT: Yes, that makes sense too. We're introducing a whole new transaction and a lot of things especially for our client here, she hasn't encountered before, so it's very helpful to explain all these out or provide an explanation before we really jump into everything.
NASIR: Right, so let's listen to our call. You'll hear our buyer for the first time in-depth. She's very, very smart, a little optimistic which of course I think everybody is including the attorneys at this point. We'll see what lies ahead and what kind of twists and turns come through there.
MATT: All right. Let's have a listen.
[Start of Call]
NASIR: Matt, you there?
MATT: Yeah, I'm on.
NASIR: Okay, great. [Buyer] You there?
BUYER: Yup, I'm here.
NASIR: Okay perfect. Let's start. We wanted to provide a window to this whole buying process, so I just want to give you some advice from the beginning as you go through this. Every process is the same, it always ends up differently how you expect. You have to be agile and be ready to face those twists and turns.
BUYER: For sure, I agree. It's my first time buying a business, so I don't really have a lot of expectations, but I totally get your point.
NASIR: Okay, perfect. Great, let's get through this.
BUYER: Actually, I'm a little anxious because we may have moved a little faster than we originally discussed. I really don't want the seller to start talking to other buyers as he's pretty much agreed to our valuation of [beep] dollars, but I can really see other buyers trying to bid that up.
MATT: Yeah, I think we can help with that. Let's start with the background of the business and go from there.
BUYER: Okay, so my partner and I have been planning on opening an urgent care in San Diego, California. He's a physician and he happened to know a colleague who runs an urgent care, but he moved out of the state a couple of months ago and I think he just wants out.
MATT: Okay, and how old is the business?
BUYER: I think it's only about two or three years at most, and it has many of the basic payor contracts and it's in a really good location, but we have some bigger plans to take it to the next level, like adding some wellness and spa aspects to it.
NASIR: That's obviously a big trend going on. We can talk about that more later.
BUYER: Okay, right.
NASIR: Have you thought about how you'll structure the business? As you probably know in California, like many states, it prohibits the corporate practice of medicine. You have a physician partner, so you're aware that you're going to have to have your physician partner be the one to actually buy the business and be the actual owner, right?
BUYER: Yes, exactly and that's the plan. We were going to have a management company set up to operate the business and I would basically run that.
NASIR: Okay, got it. That's the MSO model, very common and we can discuss more on how to structure that, but that's pretty typical.
MATT: Okay, and that's some good background. I think next, we should talk about how we can lock in the seller from going anywhere else. We understand that you haven't made a formal offer, but if you do not want the seller to walk away, we need something to bind them with a letter of intent.
BUYER: Okay, how does that work?
MATT: Most transactions like these typically start with the term sheet, memorandum of understanding or in this case, a letter of intent. It's basically an offer, but it's typically non-binding for the most part. The big advantage of LOI is they typically have a no-shop provision or also called an exclusivity period, which is enforceable. This prohibits the seller from talking to other potential buyers for a certain period of time. 30 or 60 days or whatever the parties agree to.
NASIR: Think of it this way, you're pretty much locking them in a room for you to negotiate the details of the acquisition even though you're signing something — most of the material terms aren't going to be binding, but it's a good way to lock them in without really actually committing fully especially on your side because you don't know everything about the business yet.
BUYER: I'm pretty sure we want to make the purchase, so would it be possible or maybe even quicker to just go ahead straight to the purchase paperwork?
NASIR: We can, but I would avoid doing that. I'll tell you why, LOI's can be really simple to draft out quickly. Our office can do it within a day if need be. Whereas a full purchase agreement — yeah we have forms that we've used before but to do it right, to make sure that you're protected, we really need to spend some time on that. That takes some time to get that done.
MATT: I was going to say we also need to discuss what terms are going to be in the LOI too.
BUYER: Okay, well we have a price, but what other terms would we need for the LOI?
MATT: Typically, you'll want some closing terms and also whether this is going to be an asset or equity purchase. Is that something you've thought about in terms of how to structure it?
BUYER: No, actually. I think I'm going to need some help and guidance on that.
NASIR: I could see it going either way for this, but we don't have to put that in the LOI if we're unsure. Usually, it's pretty obvious in the beginning, but if we're unsure, I don't want to commit one way or the other without doing some further due diligence on this, but we do need to talk about it though.
BUYER: Okay, so it's non-binding and we can change it later so it doesn't necessarily have to be perfect?
NASIR: Yes, it is non-binding and technically, you can change it later, but this is more a practical advice than a legal one. If you're not sure of a term, I'd rather leave it out because once you put it in there, just from a basis of negotiation, it's kind of hard to move from that. Unless you have some kind of baseline where you know where you think you'll be. I just want to commit to anything if we don't have to.
BUYER: Got it, that makes sense.
NASIR: Let's try to figure out this structure issue. Matt, let's go through the differences between the equity or asset purchase, and then perhaps we can decide on this call or if we need more time, we can look into it further.
MATT: Sure, so generally speaking, an asset purchase is going to be more common. It allows you to buy the assets without assuming any of the liabilities unless you specifically choose to, of course. The assets can include everything from the name of the business to the office furniture and equipment. We're talking about both tangible and intangible assets. On the flip side of an equity or stock purchase, which puts you in the shoes of the seller who owns the business entity giving you everything. All the assets, the entity owned as well as the liabilities. Now, you would have limited protections from third party creditors even if the seller usually, in either case, promises to identify you if there are any claims that deal with any issues part of closing. Sometimes that may not be very comforting since the seller may have just sold their income-generating business to you and it may not have a way to pay if any big issues come up.
BUYER: Okay, I think I understand.
NASIR: Yeah, I know that was a lot, but let me put it this way. Let's say that if the seller has an LLC, let's picture this LLC has a building with all sorts of stuff in it, basically their assets. In an asset sale, the seller will sell you all the stuff inside the building and he's going to stay in the building and he's just going to move all the stuff to you, you're basically purchasing. Whereas an equity deal, he's like, "Okay, forget about moving all this stuff, just come into my building and I'll leave and you'll take over this building." The problem with that is, yeah you get all the stuff inside, but you also have this building to take care of. You don't know if there are underlying issues like a leaky roof or what have you, or to be more practical to this analogy, if there are underlying lawsuits or debt that that LLC may own, it could cause problems down the line.
BUYER: Okay, I think I got it, but it doesn't really seem like there would be any reason to do an equity purchase just so that there's no liability.
NASIR: True, but there actually are quite a few reasons why you end up wanting to do an equity purchase. From a buyer's perspective, it's usually more advantageous to do an asset purchase. For example in your case, those network payor contracts, that's going to be important for you, I assume. When you do an asset purchase, the contracts aren't automatically transferred. Whereas an equity purchase, you're put in the shoes of the seller and so typically that's automatic. The only caveat to that with payor contracts is sometimes they have what is called a change of control provision. What will end up happening is even if you do an equity purchase, you still may need to get permission for the payer to actually assign those contracts.
BUYER: I see, and that's really important to our financial modeling because he has a pretty decent network of contracts and I just really want to make sure we secure those.
NASIR: Right, I understand. I assume that's going to be a big focus for us. Another thing to consider is that sometimes certain regulatory licenses are not easily transferred. I don't think urgent cares have a special license in California, I'll confirm that. But as an example, let's say that in order to run the urgent care, you have to get a whole new license or get a whole new CLIA license or pharmacy license where that may take some time or you can just actually buy the equity and you basically own the license from day one. Sometimes these licenses aren't transferable too.
BUYER: Let me contact the payers or I guess I can have the seller contact them to figure out how we can transfer those agreements, but we don't need to decide all of this today, right?
MATT: Right, that's not something we have to put in the LOI.
NASIR: I actually think we have everything we need. We do need the exact name of the business entity that the seller is using, do we have that?
BUYER: I have it somewhere and I'll email it to you, is that okay?
MATT: Yeah and also, I looked up on the Secretary of State, I assume it's him, is it [beep]?
BUYER: Yes, that's the one.
NASIR: Okay, great. We have the seller's name, purchase price and we'll make the due diligence, no-shop provision, 30 days, is that enough time to negotiate everything pretty much?
BUYER: Yeah, that should work, but we would have more time to actually close, right?
MATT: Correct, keep in mind the 30-day period is just for you to do some basic due diligence so we can figure out how to structure the deal and draft the purchase agreement.
NASIR: Also, I assume you're paying all cash or no seller financing in other words, right?
BUYER: Yeah, we may get a loan, but no seller financing.
NASIR: Okay, perfect. Usually, they ask for some down payment or earnest money when you sign the purchase agreement. Sometimes, we put that in the LOI as well. Have they mentioned anything about that at all?
BUYER: They haven't mentioned anything, but honestly, I'm fine doing that and more than willing.
NASIR: Got it. If they haven't mentioned it, let's just leave it out. With this kind of size of a transaction, most likely they will, but we can address it then. Obviously, it's not in your favor to do that necessarily if you don't have to.
BUYER: Okay, perfect so I'll send you that info as soon as I can and as soon as I get in front of a computer, but thank you guys both so much and we'll talk soon.
NASIR: Okay, cool.
MATT: All right, thanks, bye.
[End of Call]
NASIR: Okay, welcome back. Let's just take a quick break because we do have to pay the bills for this podcast. This podcast is sponsored by — Who's our sponsor today, Matt?
MATT: For this first episode, we got a pretty big sponsor and it's Pasha Law PC.
NASIR: Very prominent business law firm and I think if I — let me just look it up here. Yeah, they operate in Illinois, Texas, New York and California, West Coast to East. Again, thank you for your sponsorship Pasha Law, great firm, www.pashalaw.com. Okay, now we got done paying the bills, let's talk about that call, Matt. This is the first step of our buyer's process. We talked to her prior a little bit about buying a business and so forth, and she knows what she wants. In fact, she was pretty familiar with that MSO model which by the way stands for management service organization and the whole corporate practice of medicine — I would say most of our clients even at this point don't really get that and it's kind of a high-level aspect of this particular industry in urgent cares.
MATT: Right, so my initial takeaways were two things, one, what you just said. I was reminded how well-versed she was and how this was going to ultimately be structured in terms of operating the business itself. The other thing was the general understanding of what's supposed to be in the LOI and the terms. She had discussed some of those items, other ones sounded like she might not have even considered. It's difficult to think about it this way because we kind of walked her through from beginning to end. I can't always remember at what point we discussed certain things, but those are the things that really stuck out to me. I agree with you that she had definitely thought this through in more of a long-term perspective which you don't always see in these purchases, it's more so I just need to get to the point where we do the purchase and move on from there, so I was reminded how impressed I was by that.
NASIR: I would say also, the terms that you put in an LOI is somewhat natural because generally, you want to put everything in there that are the broad stroke terms of your agreement or what you're offering them, but at the same time, it's not surprising for example, that she had not thought about whether there's going to be any escrow or down payment. We did ask her about whether there's going to be seller financing, these are some things that you would often put in there especially when it comes to the purchase price, a lot of times, the seller is going to want to know, "Am I going to get 100% of the cash at closing, or is it going to be parsed out? Am I going to get any kind of escrow or earnest payment?" Those are some ways to also make the deal a little bit more appealing. It's just like buying a house. We all know when you put in a cash offer and it's a little bit more appealing than if someone that is going to go through financing. Some of these things that if you disclose ahead of time, can actually make your letter of intent or offer a little bit more appealing.
MATT: Right, and if you think about it, let's say you have a prospective buyer or a prospective seller, the first things that are going to be discussed are one, what are you going to be buying, and that kind of touches on the asset versus equity piece, but the next thing is probably the price. We've just had people come to us in the past and they say, "We haven't finalized the price, but we kind of have a range in mind." I think those are the initial items that get focused on.
NASIR: This buyer wanted to move fast. She even mentioned faster than she originally expected, but had concerns about the seller going somewhere else. We talked a little bit about this on the top of the episode is how you get a seller to make sure you're locked in and you mentioned the exclusivity aspect. We call that a no-shop provision and what I found interesting about this is that — because we've been on both sides. We've been on the buyer's side and the seller's side when it comes to these exclusivity provisions. One thing that I'll note is that even if you have this binding exclusivity, they're often just bound from making solicitations, but it's kind of hard to enforce because there's always a lot of backdoor wink-wink like, "Hey, if this deal doesn't go through, we can always go to these guys, maintain the relationship, we don't have to tell them that we're selling, but we can maintain that communication throughout that time." Even if you have that exclusivity, it's one of those things where you got to put it in writing, but it's not your end-all-be-all to protect you. At the end of the day, if you want to get the seller to be committed to you, you have to be the most attractive offer and you have to maintain that. We make this analogy all the time on the series of Behind the Buy with how buying a business is just like marriage and even if you're committed, even if the parties are committed to each other, so to speak, you also have to maintain that attractiveness to each other as well, otherwise, there's going to be problems down the line. Did I take that analogy too far?
MATT: Maybe a little bit. No, if you've listened to our shows in the past, I think that was perfectly fine. The other big discussion listening back to this was the asset versus equity piece. I mentioned before the two things people should probably talk about or prospective sellers, prospective buyers are what are you buying and the price. For me, the "what are you buying" falls under the asset versus equity discussion, but it doesn't always mean that that's what the seller and buyer are talking about, but ultimately, that's kind of what they're getting at. I liked your building analogy actually. I forgot about that because I think that's a very apt way of determining whether you are buying the whole building itself and all of its good things and all of its flaws? Are you picking and choosing what you want which would be more in line with the asset purchase.
NASIR: Right, and you know what's funny is — I don't know if it's the most perfect analogy, but actually, that was the first time I had used it and I've been using it lately now to explain the differences. On the letter of intent, in this case, we chose not to mention whether it's going to mean asset or equity purchase. I think that's pretty uncommon for us because usually, we know right at the beginning, and deciding to leave a blank I think was a good idea because we weren't completely sure even though where we ended up and that's something that we'll talk about in the next episode I think was where we were heading to, but I think it was a good idea to just leave it open.
MATT: That's fine. Like we mentioned, these aren't necessarily the final terms. You just look at the name itself, it's a letter of intent. You can make it binding, non-binding, what have you, but it's the intent of a buyer to purchase from a seller. If you can't finalize that especially if it's going to be an asset purchase, the seller probably hasn't even disclosed all the assets or may not even be able to disclose all the assets and the buyer hasn't had their chance to do the due diligence which is another episode we'll get into. It's pretty common — that discussion fell the way it did.
NASIR: Yeah, I think that's right, definitely. Another thing that I was just thinking about. You know what we didn't talk about was typically what we have in the LOI if the parties — and I think this was this case — and remind me from wrong, Matt, in this particular transaction, they had not signed an NDA prior, which is uncommon. Usually, sellers are going to want an NDA before you even start talking, or exchanging information, but sometimes it's at this letter of intent at the least. We often include protections mostly for the seller to make them feel comfortable that now that we put this letter of intent and you sign it, we enter into this due diligence period which is coming up in a couple of episodes that the information that you're providing is all confidential. We'll put in a confidentiality provision in an LOI and that's something that I don't think we really elaborated because sometimes it's pretty obvious that that's in there. It's not a term that you often negotiate or differs from LOI to LOI.
MATT: You're going to see some form of that if there hasn't been an NDA signed. You're going to see some form of that in any of those — if it's an LOI or any of the other two documents we discussed just because you don't want a situation where you're discussing an actual purchase and then either party's free to go discuss it with anyone else.
NASIR: An NDA by the way is a non-disclosure agreement just in case we forgot to define that or add that to our vocab words. Let's see, this is just the start guys. This is just the first initiation. We talked about this in our first episode, but this transaction is typical, but still goes through its own twists and turns that are pretty interesting. Just stay tuned. I think the next episode also, we're getting into — a new party comes in, right? It's what I call that interloper broker comes into play and we'll talk more about that in the next episode.
MATT: I've never heard you call the broker an interloper.
NASIR: Well, most brokers are not interlopers, this guy was an interloper.
MATT: Yeah, I view it as this — not the broker piece, but you said the twists and turns of every episode — this is our first season of this form of our podcast, but they always promise that this is going to be the most exciting season ever, most exciting finale. We can definitely promise that, right? Because it's the first one.
NASIR: I like that. All right, very good. Thanks for joining us, don't forget to tune in to our next episode. We also have — this is really important, and if you're listening to this, this is an obligation, you promised to do this. In fact, in consideration of listening to this podcast, you have to do what? You have to leave a positive 5, 10-star review, however many stars there are, multiply that by two, that's how many stars you have to leave us for review for our podcast.
MATT: Should we multiply it by three or two?
NASIR: Two is good.
MATT: Yeah, two is probably sufficient.
NASIR: Then, of course, always looking for feedback and if you have questions that you want to send us, we are going to — specifically regarding this series Behind the Buy, if we didn't cover something that you think we should have covered or if you want to complain about Matt's commentary which I'll probably send in my own, you can send it into firstname.lastname@example.org and that will go to us and we'll take a look at what you have to say.
NASIR: Go to our website, www.legallysoundsmartbusiness.com and that will also have links to all our social media which we're on pretty much every social media except MySpace.
MATT: Aren't we on Myspace anymore?
NASIR: I think we stopped maintaining that. That has all the information of when our next episodes are coming up and some of the information about our series and of course, the podcast itself.
MATT: Yeah, definitely and I think we've discussed this before, but you can also find our blog posts where we go more in-depth on some of the items that were discussed not only in this episode but the series as a whole.
NASIR: If you guys prefer reading instead of listening which you're just weird, we have a ton of writing on the subject from A to Z. If you even want to skip ahead with some of this information on how to buy a business and everything behind it, then there's actually information like that already on our website.
MATT: If you email me one of the blog posts, I will read it, record my voice and then email it back to you.
NASIR: That sounds like a Fiverr thing, but that'd be perfect. Very good. All right, well thanks for joining us.
MATT: Yup, keep it sound, keep it smart.