Letters of Intent

Many transactions begin with the delivery by one party to the other of a letter of intent (“LOI”).[1]  The LOI is a document setting forth the parties’ intent to enter into a transaction and summarizing certain salient business terms.  If the parties cannot agree, it would be better to learn that early on during the LOI stage rather than later after expending substantially more time and resources.  In many cases, LOIs include both non-binding and binding terms, each of which should be clearly delineated to avoid ambiguity.

A signed LOI can ignite deal momentum, comfort parties with respect to key terms, and facilitate and serve as guide for the preparation of definitive agreements.  The LOI can be as specific or vague as the circumstances require, but typically includes some understanding or a proposal with respect to the following areas:

1. Structuring.  Most acquisition transactions are structured as stock purchases, asset purchases, or mergers.  Each transaction structure carries with it differing tax treatment and legal distinctions that can have an impact both on risk-allocation between the parties and speed/certainty of closing.  In addition, at times, advance tax structuring may be required due to tax complications of a transaction.
2. Purchase Price and Payment. Customarily, the LOI will include the buyer’s proposal with respect to the purchase price which may include, without limitation, an upfront cash payment, deferred payments payable in installments post-closing, earnout payments based on the achievement of agreed financial targets, and equity in the buyer or a parent company of the buyer (commonly referred to as rollover equity and customarily between 10% and 20% of the total transaction consideration).  It is also common to include a basis on which the purchase price was calculated (for example, some multiple of the seller’s EBITDA or revenues).
3. Closing Conditions. The LOI will often include conditions precedent to closing which can include financing, diligence and other contingencies such as obtaining any required third-party consents.
4. Due Diligence. By the time the LOI is negotiated, the parties will likely have exchanged some preliminary diligence material subject to a confidentiality agreement (see below). Once the LOI is signed, the buyer will undertake a more comprehensive review of the target.  The LOI may include basic parameters of such further review and a timeline for completion.
5. Confidentiality. Again, parties may exchange diligence prior to the execution of the LOI and in such case, it is imperative for the seller to have a binding confidentiality agreement in place prior to sharing any diligence.  The LOI should either refer to an existing confidentiality agreement or include binding confidentiality provisions absent such prior existing agreement.
6. Exclusivity. In exchange for dedicating resources to a transaction, the buyer will want comfort that the seller is not simultaneously negotiating with other potential buyers.   Accordingly, it is customary for an LOI to include a binding agreement that the seller will not, for some period of time after signing the LOI, discuss or pursue a transaction with any other prospective buyer.  Many times this is related to the due diligence period plus a period of time following completion of due diligence with an extension right.

Some parties will opt to front-load the negotiation of certain other deal points for inclusion in the LOI, addressing matters such as the scope of indemnification, caps, baskets, deductibles, and survivability of representations, warranties, and covenants.  In general, sellers prefer a more comprehensive LOI to limit the buyer’s positioning later on and to ferret out any preliminary issues.  Conversely, buyers prefer a less comprehensive approach to the LOI to provide for flexibility, account for what they have learned in due diligence, and preserve leverage for later on.

The LOI is the first step in a long process.  Often times the business principals negotiate the LOI without counsel, resulting in lack of specificity or key terms.  If you are planning to send out or anticipate being in receipt of an LOI, the earlier you involve counsel the better suited you will be to negotiate your transaction.

[1] This article focuses on letters of intent; however, in some instances, discussions are memorialized or proposals are made under a term sheet, an expression of interest or a memorandum of understanding.