A letter of intent ("LOI") is a short document that parties to a potential transaction execute to establish expectations for the transaction and establish some ground rules for the negotiations moving forward.
The purpose of a Letter of Intent is to describe the outline of the business deal between the parties. It is important for the parties to settle differences about key issues such as the sales structure (i.e. will there be earn outs), price, management, post-closing and financing of the transaction.
The LOI is a preliminary step. Both sides should understand that other terms will be decided later during formal negotiations. However, this important document should be taken seriously. There can be unpleasant ramifications if terms are left out or if the LOI is ambiguous.
Letters of Intent may be binding or entirely non-binding statements of present intention. They can also be partially binding and partially non-binding.
The buyer and seller have differing objectives, so one party may want the Letter of Intent to be binding and the other party many not. The buyer will likely want to conduct due diligence. Alternatively, the seller may want to lock the buyer into a purchase price or retain the ability to walk away from the deal without incurring substantial expense.
Letters of Intent usually include both binding and nonbinding provisions. It is important that to clearly separate the nonbinding and binding provisions to avoid confusion. For example, the buyer may want the price term to be non-binding while the confidentiality provision should be binding.
If the parties intend for the LOI to be non-binding, the Letter of Intent could indicate:
This LOI is a non-binding statement of the parties’ current intentions but the parties do not intend for any of the provisions in this LOI to be legally binding. Neither party is bound to consummate any transaction as a consequence of this LOI.
Most LOIs in mergers or acquisitions between private companies are non-binding except for a few key provisions: usually “Confidentiality,” “Expenses” and “No-Shop/Exclusivity.” Private company purchasers tend to prefer this because they want the “No Shop/Exclusivity” provisions to apply for the period after the LOI is executed until the definitive purchase agreement is executed. Having a binding “No-Shop/Exclusivity” provision in place ensures that the target will not leverage the purchaser’s pricing and other deal terms in negotiations with alternative purchasers in an attempt to get a better deal or push the purchaser’s price upward.
Practical Pointers
Drafting and negotiating a Letter of Intent gives counsel for the purchaser and the seller to get acquainted. Since the deal process will inevitability be adversarial at times, making a human connection with opposing counsel early in the process helps to establish a positive working relationship. By collaborating on the Letter of Intent, opposing counsel can develop a rapport that may prove helpful later in the process.
The tax effects of the transaction will always be important to the parties. Tax counsel or a CPA should review the Letter of Intent. If there are any particular tax outcomes that are material to the deal, they should be spelled out in the Letter of Intent. If the tax analysis is not complete at the time the Letter of Intent is being prepared, and either party is going to reserve the right to require structuring changes to accommodate its tax planning, that reservation should also be expressly stated in the Letter of Intent.
If the deal structure is sufficiently definite in the Letter of Intent, counsel for the purchaser may also want to provide a preliminary closing checklist along with the Letter of Intent. Preparing a checklist makes clear to the parties the documents they expect to complete, the party responsible for the first draft and similar details.