Broker Going Straight to APA

March 13, 2024

by a searcher from Stanford University - Graduate School of Business in Tampa, FL, USA

Hello everyone,

I'm still getting my feet under me when it comes to working with sellside brokers so perhaps this is a very ignorant question, but is it common for brokers to have what I would describe as disdain for LOIs?

I've read a high level CIM for a business and had a one hour call with the Seller (+broker) for a ~$4.5M asking price opportunity. The broker is recommending that we respond to his 13 question survey - the responses to which would constitute the binding Asset Purchase Agreement. He tells me not to worry about that because there are "plenty of contingencies" and I "can always back out of the deal" before the clock expires.

I'm not comfortable with this approach as my experience has been to sign up an LOI to get to the next phase of diligence, with an APA being signed at closing (more like an M&A transaction and less like a house closing). There is SO much I don't yet know about the business - it just feels like moving to APA now is putting the cart way before the horse.

Am I crazy? Any advice on how to navigate this without pissing off the broker too much?

Thank you!

Reply by an intermediary
in Campbell, CA, USA

The thing that disturbs me most about this discussion is the number of people who have attributed nefarious motives to a way of doing things merely because it is different from what they are accustomed. Our brokerage services both Main Street and Lower Middle Market business transactions and there is sometimes a clash in the way things are done differently in the two markets.

The business broker profession grew out of the need for intermediary services in the sale of smaller Main Street businesses. Naturally, licensed real estate brokers filled the void. So, the framework for doing these smaller less complicated transactions was patterned after the real estate industry, not the investment banking industry. Thus, in Main Street transactions, after the buyer, usually a working owner, submits an NDA and Buyer Profile, the CBR is released to him/her. Then, there is a round or two of written questions, conference calls, and/or site visits, Typically, we go straight to an Asset Purchase Agreement with an earnest money deposit and contingencies on due diligence, obtaining a lease, and/or securing financing. Sometimes negotiation occurs verbally before the APA, but most of the time, it is done in writing with counteroffers. There is nothing nefarious nor unprofessional about this process. It is just one that evolved from the needs of the market.

Nearly all of the Lower Middle Market buyers we deal with are professional investors who are more accustomed to using IOIs, LOIs, and Stock Purchase Agreements. For these transactions, this is normal, and we accommodate them.

So, there is a customary Main Street procedure and a customary LMM procedure, and neither is nefarious or unprofessional; they're just two different ways of achieving the same result in two different markets. The clash of method and culture occurs most often at the boundary.

Reply by a professional
from University of Denver in Denver, CO, USA

Run away. I've seen this on several occasions and I think it is a terrible process. In every case in which I've represented a buyer where the broker made a similar demand we pushed back hard on this process because you can't draft a purchase agreement with appropriate representations, warranties, covenants, and indemnification provisions without performing significant confirmatory due diligence and you don't want to spend the time and money on due diligence unless you have an LOI with an exclusivity/no shop provision. Unfortunately, I've seen this with brokers, but it has been in only a small number of deals (best guess is 5% of deals that cross my desk). I think this process may work for very small market deals (under $1mm), but otherwise it is unworkable. I hope it isn't a growing trend. When I've had buyers who really wanted to move forward on a deal and we couldn't get the broker to move from this process of starting with a purchase agreement, I always explain that they are incurring additional costs to draft the purchase agreement prior to due diligence. In every case in which this has happened, something has come up in due diligence that required an amendment to the purchase agreement and the broker has pushed back and caused the deal to die. In other words, I've never had a deal close when the broker has demanded that we start with a purchase agreement before an LOI. My theory is that brokers try to use this process when they have something to hide regarding the business. I think they are trying to get buyers to spend lots of money and feel like they are already too committed to the deal to back out. The buyer loses all leverage when this happens. My recommendation is that buyers avoid deals and brokers that require a purchase agreement before an LOI.

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