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Jason Hendren
Jason Hendren speaking to entrepreneurs. Jason Hendren

When you agree in principle to sell your company to a private equity group, you will require more than an attorney advising you on the many details that still need to be hashed out with the buyer. Attorneys are good at legal strategies, but most aren't adept at handling all the deal points.

The best time for the seller to negotiate deal points is before they sign the letter of intent (LOI) from the buyer. While the LOI is a non-binding document outlining an agreement in principle for the buyer to purchase the business, once the seller signs the LOI it establishes an exclusivity period with the buyer. What many people don't realize is when they agree to an LOI, they're basically accepting a significant amount of the architecture of the deal they're signing up for. There's a lot of detail that should be baked into LOIs, but many sellers agree to LOIs that don't have enough structure in them, or to LOIs that have deal points that weren't carefully scrutinized by an advisor on their side.

It can be costly to the seller in the long run if they don't have a good advisor, investment banker, or somebody who's knowledgeable about helping them through the deal points.

Important deal points to put in the LOI

● The equity reinvestment component. This is part of most deals with private equity groups. A lot of times they'll say the seller has to invest a meaningful amount of their equity. The seller should establish what "meaningful" means--put a dollar value on that--in the LOI. An observed behavior I've always seen is that private equity groups place a much higher value on the cash they're putting into a deal over the equity you're reinvesting.

● Unbalanced return. Let's say a private equity group has a preferred rate of return or a liquidity preference. They will put triggers in the LOI that say basically that if the company doesn't meet a minimum return threshold over the life of the partnership, the buyer's return will be significantly diminished. Sometimes lawyers will glaze over this deal point.

● Working capital adjustments. Working capital is a financial metric that is the difference between a company's current assets and current liabilities. It helps plan for a company's future needs. If you're in a high-growth business or a seasonal business, the working capital adjustments can be very meaningful, so it's helpful to get those things included in the LOI and from that, develop a framework for steady cash-flow to keep the business' value high.

● Commitment to new owners. The specifics of this should be spelled out in the LOI. For example, a private equity group may have aggressive or punitive language in the final contract, such as that you must work for them for two years. If you don't, or don't give sufficient effort, you forfeit a portion of your reinvested equity. Employment terms for you should be specified in the LOI. And, if you're going to be an executive or CEO as part of the new partnership, the LOI should include any additional options you will receive as a result.

● A definition of the deal structure. How much debt are they planning to put on the deal? How much equity are you reinvesting? What is your percentage of ownership? How will bad debts be collected by the new owners? It's also useful to understand the structure of the board.

● The earnout. This is a contractual provision stating that the seller is to obtain future compensation if the business achieves certain financial goals. Spell out as much detail as possible in the LOI. The earnout can be tricky because you're getting compensated based on the performance of a company that you're not going to have managing control over. If the new ownership group comes in and makes bad decisions during your earnout period, the company can start operating poorly.

The bottom line is that a seller to private equity needs to know what they're signing up for well before the sale is final. The LOI lays the foundation for the sale and alleviates unwelcome surprises.

(Jason Hendren (https://hendrenba.com), the author of Things I Wish I Knew Before I Sold To Private Equity, is a sought-after CEO coach, speaker, and exit-planning advisor. He is an award-winning entrepreneur and has extensive expertise as a buyer and seller of businesses. Hendren earned a BSIE and MBA from the University of Central Florida, where he supports first-generation scholarships, entrepreneurship programs, and the football Shareholders Society.)