You’re finally ready.
You’ve found an opportunity to buy the business of your dreams. You’ve reviewed the buyer presentation, spoke to the owner, and are now ready to submit an offer-*record scratch sound effect*
“Wait - how do I write an offer to buy a business?”
That’s an excellent question and something we get asked all the time here at DealBuilder. So, rather than keep it a secret, we wrote it out to answer our most commonly asked questions:
- The different types of offers to purchase a business
- Common mistakes when writing an offer
- The implications of writing an offer & what happens next
- Offer red flags
Let’s jump in.
The different types of offers to purchase a business 📝
It is important to note that there are a few different formats in which you can submit an offer:
1. Napkin Offer:
- The term ‘napkin offer’ comes from the concept of literally writing up your offer on the back of your napkin while having a business lunch. The 21st century version of the napkin offer is sending an offer via email or text message, usually in a short bullet-point format (we can’t wait to receive an offer via Snapchat with their disappearing messages).
- Why would someone do this? This is the least expensive (from both a cost & time perspective) of submitting an offer to a seller. The biggest issue with napkin offers is that they are so informal, so it is very easy for misunderstandings to occur between buyer and seller. Napkin offers lack many of the essential details of the transaction, which can quickly kill a deal from occurring. Because of this, we recommend (at the bare minimum) that buyers submit an offer using a semi-formal format such as an Expression of Interest (EOI).
2. Expression of Interest (EOI)
- An EOI is more formal than a napkin offer but still often excludes many of the details you may find in a more formal Letter of Intent (LOI). What’s the point? Well, an EOI allows you to quickly establish the most important deal terms with the seller (purchase price, closing date, and the amount of cash at closing) without getting bogged down in the nitty-gritty details. We recommend you save some money and allow your lawyer to worry about those details later in the transaction.
- PSA: you can actually submit EOI’s directly through the DealBuilder platform as a buyer and save yourself a lot of trouble. You can access our EOI tool by visiting the following: app.dealbuilder.co/offer
3. Letter of Intent (LOI)
- There isn’t a big difference between an EOI and LOI (it’s mostly semantics) but generally an LOI is more formal/detailed than an EOI. An LOI will typically include a cover letter (where the buyer will share their interest/reasoning behind their offer) in addition to a complete list of conditions to the purchase (transferring lease agreement, the included number of training hours, condition for the buyer to obtain financing, etc.)
Common mistakes when writing an offer 🚫
Most first-time buyers are actually pretty good at drafting an offer, the bigger issue actually has to do with their negotiation skills.
1. Submitting low-ball offers
For example, buyers will often tell us that they, “do not want to offend the seller with a low-ball offer” and proceed to write up an offer that has a purchase price that is a 50% discount to the asking price. Surprise! You ended-up offending the seller. Our first recommendation is to determine whether the asking price is even close to your valuation. If it is not, and you think the business is worth less than 30% of the asking price, we recommend either not submitting an offer or using an earn-out deal structure to overcome the valuation gap.
Does this mean you need to submit a full-price offer for every business? Of course not, but we do recommend keeping your initial offer within 30% to encourage a respond and/or counter-offer from the owner.
2. Missing basic information
Another common mistake is not supplying essential information within your offer (doesn’t matter which format you select). At the very minimum this should include:
- The purchase price
- Closing date
- Included number of hours of training included in the transition period (and when it ends)
- How the money will work (is it an all-cash offer or are you asking the owner to provide seller financing?)
Without these key details, you are asking for misunderstandings to occur between you and the business owner.
3. Waiting too long to submit an offer
Unlike residential real estate, it is uncommon for ‘bidding wars’ to occur during the sale of a small business. Most buyers are aware of this - giving buyers some inherent leverage over the seller as to when/if they will submit an offer or not.
Unfortunately, some buyers forget that this leverage doesn’t last forever and quickly goes away once another offer has been submitted. The seller now has the leverage in the negotiation because they have 2 buyers to choose from. Over the years we’ve seen many buyers become disappointed because they waited too long to submit an offer, another buyer moved faster, and they ended up losing the deal.
4. Submitting an offer too quickly
A cousin to mistake #3 - you also don’t want to submit an offer without fully understanding the business. While due diligence provides you the ability to ‘get in the weeds’ and learn more about the inner-workings of the business, you also don’t want to waste you and/or the buyer’s time. Even worse, buyers will also engage their lawyers to draft an offer, making things even more expensive.
While an offer is generally non-binding (allowing both you and the seller to walk away at any time) you should be committed to buying the business. Our general philosophy is to ‘trust, but verify’ which means that you should cautiously believe what has been presented to you from the seller before you submit your offer. Once that offer is submitted, however, you will need to do your diligence to ensure that all the facts presented by the owner about the business (number of clients, contract terms, employee contracts, etc.) actually exist.
The implications of submitting an offer to purchase & what happens next ⏭️
Just like dating - it’s best to avoid the awkward conversation of ‘how serious are we?’
Submitting an LOI or EOI is often a double-edged sword. Why? Because these offers are typically not legally binding and accompanied with a fully refundable deposit from the buyer. This makes it very easy for either party to back out of the deal and doesn’t build a lot of trust.
So what’s the point? Well, the purpose of an offer is to make sure both parties are on the same page and eliminate the risk of any surprises. It also reduces your legal bill as it gives both parties lawyers a tangible set of terms they can use to build the legally-binding Purchase & Sale Agreement.
Here’s the sequence of events that typically takes place before closing:
- Buyer drafts and submits an offer to Seller with a list of deal conditions before closing (obtaining financing, reviewing financial information, legal review, etc.)
- Seller receives the offer and either accepts, counter-offers, or rejects the offer.
- Due Diligence starts once an offer is accepted by both Buyer & Seller (typical time between acceptance to closing is 5-8 weeks).
- Concurrently with Due Diligence, Buyer & Seller engage lawyers to start working on legally-binding Purchase & Sale Agreement. Using the accepted EOI/LOI, the Seller’s Lawyer will start the first draft of the agreement.
- Buyer’s Lawyer will review & revise terms in the first draft of the Purchase & Sale Agreement. They will also run legal reviews of the Seller’s corporate books & records, ensuring they are in good standing, have no pending lawsuits, etc.
- Once the Purchase & Sale Agreement is finalized (typically a week before closing) the next step is to coordinate the actual transfer of funds. If the Buyer is taking out a loan to buy the business, this is coordinated with the relevant banking institution. If they are using their own capital, the lawyers will coordinate the transfer of funds from the Buyer’s bank account and either use a trust account (Canada) or Escrow (USA).
Offer red flags 🚩
Unfortunately, bad actors do exist on both sides of the deal. To save you from future pain, here are a few red flags you want to look out for as a Seller.
- Unspecified closing date - you definitely want the Buyer to commit to a closing date. As it is not uncommon for Buyers to not specify when due diligence will actually end - this puts no pressure on them to move forward with the transaction. This can quickly turn into a game of never-ending due diligence, which can waste everyone’s time.
- Broad purchase price range - sometimes Buyers will put a purchase price range (for example: $1.5 million to $1.8 million) because they are waiting to confirm the valuation based on findings in due diligence. Want to know a secret? They will probably end up offering the lower number regardless - so you might as well get them to commit to an actual purchase price before starting due diligence.
- Buyer exclusivity - before the mob of angry Buyers come after us, this isn’t necessarily a red flag. As it is normal for a Buyer to ask you to stop speaking to other interested parties while they complete due diligence (this avoids them spending a lot of money & time in due diligence to only lose out on the deal last minute). That being said, some buyers do use exclusivity conditions to ‘tie-up’ a deal by quickly submitting an offer - even if they aren’t that serious. Why would they do this? Well it gives them more time to complete due diligence without the worry of competitive offers.
Our solution for this? Push for a small mutual break-up fee. Meaning, that if either of you walk away from the deal after there is an accepted offer, you agree to pay each other $X fee. In most cases this will cause a Buyer to drop the exclusivity clause.
Wrapping Up
Phew! We know it is a lot to consider - but so is buying a business. Hopefully this answered some of your biggest questions and you feel ready to seal the deal on your next business venture.
