This article was created and originally published by IBG Fox & Fin, a nationally recognized M&A advisory firm based in Scottdale, AZ, and is reprinted here with permission.
Here are seven common questions about a letter of intent and its place in an M&A deal.
- What is a “letter of intent”?
In a business sale, a letter of intent (LOI) is a buyer-originated document through which the buyer expresses its intent to buy the subject business. When signed by the buyer and seller, it should provide:
- A written expression of the parties’ intent to enter into a deal;
- An outline of an agreement in principle for the buyer to purchase the seller’s business at an offered price or range and under certain terms;
- Confidentiality protection for the seller;
- An outline of the buyer’s financing;
- A timeline for due diligence and closing; and, in most cases,
- The buyer’s exclusive right to purchase the company during a specified time period.
- What is an LOI’s purpose?
In the M&A context, the LOI’s fundamental purpose is to formally acknowledge the parties’ (a) intent to enter into a business purchase or merger and (b) good-faith desire to proceed in negotiations.
It bridges the temporary gap between a verbal expression of interest and a definitive purchase agreement. It can be viewed as a roadmap and a timeline for the parties to follow through the due-diligence process to the final closing.
While the LOI provides the basic terms and conditions of the eventual contract, it should acknowledge that negotiations are still in progress. In most cases, some of the contractual elements are omitted (a) to prevent the document from becoming a binding legal document (more below), and (b) because of the impracticality of including every detail in a preliminary document.
- Why is an LOI important?
Negotiating the purchase and sale of a business is expensive and time-consuming for both parties, and an LOI can give both parties some assurance that the associated costs and risks are justifiable.
An experienced buyer will not commit time and money to due diligence, analysis, and legal, tax and accounting services unless they believe they have an earnest seller and will have an exclusive right, expressed by a “no shop” clause, to buy the company.
Meanwhile, a prudent seller will not subject its business to the disruption and exposure of the due-diligence process unless the buyer is committed to the deal.
The simplicity and structure of an LOI allow the parties to move forward with an agreed understanding of what they are trying to accomplish, within certain guidelines.
As North Carolina attorney Amy F. Risseeuw explains in her article, “The Basics of an M&A Letter of Intent,” an LOI:
“allows the parties to determine very early in the process whether there is a basic agreement on key terms and confirm that there are no ‘deal-breaker’ issues before either party has devoted substantial time and resources. In addition, an LOI helps to facilitate the preparation and negotiation of the definitive documents for the transaction by serving as an outline of the key provisions.”
- Is It Legally Binding?
By its language and content, an LOI can be either binding or non-binding. Given the uncertainty of how a deal will progress, in most cases neither buyer or seller wants to be ultimately bound by the LOI and will state in the LOI that it is non-binding. It that circumstance, either party should be able to walk away from the deal without legal liability.
However, courts have ruled that an LOI is a binding contract and can be enforced by the party that wants to move forward, if it contains all the material terms of an agreement and, as one judge wrote, “is complete, clear and unambiguous on its face.”
Also, while the majority of LOI’s have some provisions that are non-binding (e.g., the buyer must buy the company), other provisions are binding, such as the exclusivity period, confidentiality protection, etc.
- What should a seller look (and look out) for?
Be on the lookout for “poison pills” that some buyers might try to sneak past an unwary seller. Language
stating that the parties have agreed to anything should raise a red flag. Also, sellers should be alert to unintended presumptions or default events, such as, “Unless we hear from you to the contrary …”
In addition to vigilance against unwanted language, sellers should expect to see provisions that are common to most well-structured LOIs. In addition to identifying the company or assets to be purchased, the parties and their contact information, and the deal’s price and terms, an LOI might address such issues as:
- Whether it is legally binding or non-binding (discussed above)
- The structure of the transaction
- Confidentiality and non-disclosure protection
- Exclusivity
- Indemnification
- Guidelines for negotiations
- Scope and guidelines for due diligence
- Timelines for due diligence and closing
- Conditions for closing
- Governing law
- What if I want to make changes before I sign it?
An LOI is not a one-way proposition to be dictated by the buyer and is subject to negotiation. Matt Frye, a Principal in IBG’s Oklahoma office, points out that “the LOI is an agreement between the buyer and seller. It is intended to protect both parties, and the seller has the right to negotiate its terms.”
“An experienced M&A broker can help facilitate this process,” Frye continued, “through their knowledge of standard provisions and terms. More important, we always request that our client have all documents vetted, if not drafted, by their legal counsel.”
- What happens after the letter of intent is signed?
The signing of an LOI typically triggers the due-diligence period, during which negotiations occur, the purchase agreement is drafted, and the buyer’s requests for company information are satisfied.
Also, a signed LOI usually marks the start of material expenditures by both sides, which could include a quality of earnings review, equipment valuations, inventory assessments, site surveys, etc.
“Once the parties reach the point where the buyer feels comfortable and the seller has portrayed the business and assets as advertised, the parties will then initiate the bulk of the definitive documents via legal counsel,” said Bob Latham, IBG’s Texas partner. “Prior to that point, only the major topics have been outlined and discussed. The ‘papering’ phase includes a significant amount of negotiation on the finer details, such as seller transition or employment agreements, facility lease terms, purchase price allocations and, importantly, working capital pegs, just to name a few.”
Keeping It Simple
In contrast to the final purchase agreement, which, even without addendums, can easily expand to hundreds of pages, a letter of intent should be relatively brief, focusing mostly on the major issues that will help the buyer and seller reach common ground and justify the risk and expense of pursuing the deal.
In her aforementioned article, attorney Amy Risseeuw writes, “While it is important to include [in an LOI] the key terms proposed for the potential transaction, the details and finer drafting should be deferred until the definitive deal documents are prepared. Including non-material issues at the LOI stage can unnecessarily lengthen the time to complete this first step, potentially causing lost deal momentum, frustration, and a longer overall transaction timeline.”
If you know of someone who’s thinking of selling or buying a business and who might benefit from a complimentary, confidential, consultation with us, have them contact me at: mertel@transworldma.com
Mike Ertel, CBI, M&AMI, CM&AA
Managing Director, Broker
Transworld M&A Advisors
813.299.7862 Direct
©2023 J. Michael Ertel PA