To The Letter

The Dead And The Dying

Truth be told, most deals, public or private, crash and burn before they even get off the runway. But if you did some financial forensics, you would find the cause of death in most cases could be traced to negotiations regarding the letter of intent.

It's not that entrepreneurs aren't good at negotiating letters of intent, says Moceri. "Every deal is so different, there are no hard and fast rules about how to do it." No, the letter of intent document (and the attendant process) kills deals because that is exactly what it's supposed to do.

"It's no good for the company, for the investors or for us if we bring out deals that aren't structured in a way that makes sense," explains Moceri. "When we negotiate the letter of intent, we're also weeding out the deals that won't work."

And parenthetically, this truth leads to a good rule to live by: Never tell people you are going public just because an underwriter says they are doing your deal. Much better to say you are "negotiating a public offering"-there will be far less egg on your face later on.

And while there's more than one way to tackle the letter of intent, there are some important things to know that will keep you from annoying your prospective underwriter into outright rejection of your company.

First, says Moceri, it takes some time for your investment banker to make the transition from a verbal commitment to a written one. The time frame to get the initial draft from the underwriter can be anywhere from three to eight weeks, according to Moceri. And unless you're Microsoft, there's little chance of speeding the process up.

"Entrepreneurs need to realize that a public offering represents a huge commitment for us in terms of resources and potential liability," Moceri says. As a result, your investment banker will spend considerable time conducting a due diligence review of your company and its operations. This kind of analysis, Moceri explains, is the only way the underwriter can find out enough to properly structure the deal.

Second, you'll likely get a bill with your unsigned (in most cases, anyway) letter of intent. Regional firms typically charge around $25,000 to underwrite promising upstarts. The fee is an advance against the underwriter's expense allowance, which is generally 3 percent of the total offering proceeds. For a $5 million deal, this expense allowance will be something like $150,000-so the initial bill may be just the beginning.

Best advice: Don't balk. This is the way the game is played. "The minute we start doing due diligence and drafting the letter of intent, we start committing resources to the project," Moceri says. "We want to know the entrepreneur is as serious as we are."

Don't have that kind of cash? You might not-after all, the objective here is to raise capital. If you don't, offer less, but document that what you are offering is putting you on the line in a big way.

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This article was originally published in the January 1996 print edition of Entrepreneur with the headline: To The Letter.

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