M & A deals: Should you loiter at the LOI stage?

Whatever you do, take legal advice. But also consider the strategic side.

Money seized by the police and Shin Bet from a terrorist's family in east Jerusalem (photo credit: COURTESY ISRAEL POLICE)
Money seized by the police and Shin Bet from a terrorist's family in east Jerusalem
Entrepreneurs across the Start-Up Nation dream day and night about their multi-million dollar exit. Serial exiters know it isn’t so easy. Exit deals take on a life of their own, especially if you don’t plan ahead and build in some shock absorbers.
One of the reasons is that even if the deal does go ahead, the resulting merged group may still under-perform. And once the deal is announced, not all the employees may stay – on both sides. So the buyer will ask many questions at the negotiation and due diligence stages, aimed at working out how to successfully integrate the “target” company into the post-deal activity.
So negotiating the Letter of Intent (LOI) – also known as the “term sheet” or “memorandum of understanding” – is critical to everyone. The seller wants a good price, the purchaser wants a good buy. Both want the least risks. And yet some skip the LOI to save time and money and go straight to the main agreement.
Whatever you do, take legal advice. But also consider the strategic side.
• The LOI Process
The aim of the LOI is to fix the main terms of the deal, including what is being transferred, the price, the form of payment and other terms.
The seller typically enjoys highest negotiating power at the LOI stage. This declines later on. There are several reasons. First, the seller may have more suitors still in tow. Second, as time passes, a leak is more likely which may unsettle employees, customers and others. Third, at the LOI negotiation stage, the seller can float a few trial balloons. As time passes, things get more formal and the seller may be keener to avoid saying something that might upset the buyer. Fourth, once the LOI is signed, the buyer can more easily resist further demands from the seller.
Much depends on which side has the better playing cards. Waze apparently had the upper hand when negotiating its own sale to Google. It seems Google wanted to shut Facebook out of its mapping service at almost any price. So the price ended up at around $1.15 billion.
THE SELLER will generally want to get as much as possible at the LOI stage. The buyer might prefer a short LOI and will then seek clarifications at the main contract stage when they have greater leverage.
Why? After the LOI stage comes due diligence and contract drafting. At the contract state, each party must provide detailed “reps and warranties.” These are assertions of facts that need to be truthful to avoid lawsuits. The seller’s assertions typically relate to the value of the company. The buyer typically confirms the consideration to be paid. These reps and warranties therefore allocate risks and lay down rules of behavior during and after the deal.  All this puts the dampers on going back to re-opening the LOI terms.
• What about tax?
Sellers in Israeli companies typically prefer a share sale to reduce the tax to between 0%-33%. Buyers typically prefer an asset purchase which increases the sellers’ overall Israeli tax burden to 48%-50%, not to mention foreign taxes for foreign investors. If the seller is paying with its own stock, an Israeli tax ruling is usually needed, which takes time. All this wants sorting out as soon as the LOI looks like being signed. If the deal has to be announced on a stock exchange, timing is especially important.
• Negotiation tactics
There are many negotiation tactics, ranging from quiet to noisy. Sellers might resort to auctions to get the best sale price. Both could seek a win-win failing which they should know as their BATNA (best alternative to a negotiated agreement). 
And negotiations can range from rational to instinctive (= irrational). So study the people, get information, decide the form and channel for offers, never say no straight away, and keep the momentum up by negotiating multiple issues in parallel. And before you go in, consider your strategy and theirs, work out the acceptable price range, keep an open issues list and have a step plan. All in all, do your homework early, in time for the LOI stage.
As always, consult experienced legal and tax advisers in each country at an early stage in specific cases.