Is there a recourse for post-LOI due diligence spend?

January 03, 2021

by a searcher in San Francisco, CA, USA

Happy new year everyone!

I have a deal close to LOI and I'm trying to create a recourse for my due diligence spend if the seller changes his mind about selling post-LOI. The seller has been taking a long time making up their mind and negotiating each item. It has been 3 months since my initial offer. This overall is making me wonder if they will stay true to the deal (nothing stopping them from backing out of the sale after I spend money for due diligence).

1- Are there ways to protect my due diligence spend based on your first or second hand observations? 2- I'm thinking of asking the seller to deposit an amount in an escrow account. If he backs out if there is more than 10% variance in the price agreed upon at LOI (if we have to retrade the LOI at more than 10% price difference) then the seller can back out without penalty. If the seller is backing out even with less than 10% of price variance (which means they are changing their mind about the sale) then I get the money in the escrow account. Can this be a workable solution? 3- If this is a workable solution, are there any suggestions for a good escrow account service? 4- I can bear the cost of escrow account and I'm also happy to pay an interest rate for the escrow account to the seller upon successful closing.

I would love to hear feedback if this can be a workable plan. This seems like a good deal to pursue if not for my personal gut feel about the risk of the seller backing out.

Reply by an intermediary
from The University of Chicago in Chicago, IL, USA

1. You will spend a lot of time and money negotiating a "comprehensive and enforceable" escrow agreement. And, if you close, you will have strained relationship post-closing.
2. Typically the buyer pays the break-up fee, not the seller. And that too occurs on very large transactions where liability rests with entity not with individuals.
3. In small deals (LMM), risk of buyer not being able to close for lack of financing, or wanting price change or tight R&W is significantly higher than seller backing out. I have not seen in my 30+ years as M&A Intermediary, a buyer ever asking seller to protect buyer expenses., let alone escrow the amount. Such buyer risk is even higher with most SF where there is not only debt financing risk but also an added equity financing risk..
4. Typically buyers have more transaction education and experience than seller who is selling for the first time. I wind up spending a significant of time in seller education, and in getting their advisors involved early in the process. Sellers rely more on their advisors than the broker b/c they know the advisors for a longer time. Further, for a large % of sellers, their advisors either do not know the M&A process, or give ultra-conservative advise, or seller does to want to spend the money with them for their good advise. So, as a SF buyer you should keep an eye on seller knowledge before spending too much time and money.

Reply by a professional
from Morehead State University in Miami, FL, USA

Something we include in our LOIs, which doesn't get raised as a red flag by brokers and sellers, is that if the seller chooses to terminate the deal prior to the signing of a definitive purchase agreement they'll reimburse us for any reasonable out-of-pocket expenses directly incurred by us during due diligence up to a define maximum dollar amount. This part is void if we, as buyers, don't act in good faith.

Doesn't totally apply to your current situation, but food for thought on future acquisitions. Happy to share the full verbiage of our Right to Terminate section if you'd like.

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