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M&A Letters of Intent

A β€œletter of intent” (β€œLOI”) is a legal document summarizing preliminary deal points of a merger, acquisition or sale of a business, or other business combination. An LOI is signed before due diligence review begins and before final, definitive documents are prepared.

This short article contemplates a business acquisition (stock purchase or asset purchase), and addresses three topics:

1.     Negotiating a Letter of Intent

2.     Main Sections of an LOI

3.     Binding and Non-Binding Terms of an LOI

(The term, β€œLetter of Intent,” is sometimes used interchangeably with β€œTerm Sheet”. Read about differences between an LOI and Term Sheet and why both are important here.)

NEGOTIATING A LETTER OF INTENT

The LOI process is normally not a "take-it-or-leave-it" proposition (even if the initial draft is signed and appears final). A first draft is typically prepared by a prospective Buyer and delivered to the target entity's management team. This is reviewed by the target and their legal counsel (and sometimes accountants). Seller might revise the LOI and revert for Buyer's further comment. This continues until the parties agree on the principal terms (or one party decides to end the process).

MAIN SECTIONS OF A LETTER OF INTENT

There can be any number of ways to dissect an LOI. This article explores the LOI according to the following categories:

β€’     Nature of the Transaction

β€’     Payment Terms

β€’     Due Diligence

β€’     Closing Conditions

β€’     Post-Closing Obligations

β€’     Other Terms

Nature of the Transaction

A relatively simple statement whether Buyer will purchase target company's assets or its stock, or whether the parties will merge after which Buyer will control the surviving entity. In an asset sale, sometimes this section will specify certain assets or classes of assets being acquired or excluded.  

Payment Terms

This section states the proposed purchase price, and summarizes any possible adjustments (either as a result of pre-signing or pre-closing due diligence or changes of circumstance; or as a result of post-closing matters). In addition, the nature of the purchase price will be noted, which can include one or more of the following:

β€’     Cash

β€’     Promissory Note

β€’     Assumption of Debt

β€’     Shares of Stock of Buyer (or Affiliate of Buyer

β€’     Other Property

In asset sales, the purchase price is allocated among the various asset classes for tax purposes. It is common for the Buyer, in consultation with its accountants, to make the allocation. The parties will commit to an agreed allocation for tax purposes. The LOI should also express who will be responsible for various tax obligations that may be incurred as a result of the sale.

If there is to be an earnest payment, either at signing of the term sheet or the purchase agreement or both, it must be included, as well as a statement of whether it will be held in escrow and, if so, on what terms it will be released (either to Seller or back to Buyer).

Due Diligence

After an LOI is signed, Buyer will have a set period of time to conduct due diligence investigation into Seller's business and its assets. Sometimes, the LOI may contemplate Seller conducting due diligence into Buyer's ability to pay the purchase price. Seller will commit to making its officers, directors, key employees, and professional advisors available to Buyer and its advisors. It is common for Seller to be obligated for a set period of time (a β€œno-shop” period) to not seek other prospective purchasers, or even discuss possible sales with third parties; often, the no-shop period runs with the due diligence period.

Closing Terms

A business transaction can have a simultaneous signing and closing, but it is common to have a separate signing and closing. The LOI will state the closing date (and any possible extensions); and require the Seller to conduct business before closing the same way it historically did business. The LOI will include conditions that must be satisfied for Buyer and Seller to close, even after the purchase agreement is signed. Closing conditions are numerous, but will normally include that the parties are not legally prohibited from closing; that their respective representations in the purchase agreement are true at closing; absence of litigation and governmental proceedings; obtaining required consents (e.g., from lenders, landlords, licensing authorities); signing and delivery of all deal documents; compliance with regulatory requirements (including, in an asset sale, compliance with pre-closing β€œbulk sales” notices); absence of material adverse changes to the assets or the business.

Post-Closing Obligations

Business combination transactions typically include a number of post-closing obligations. These may include governmental filings; press releases; working capital adjustments; β€œearnout” payments; audit rights; compliance with purchase agreement warranties and protective covenants (e.g., non-compete, NDA, non-solicitation/interference) and indemnification requirements.

Other Terms

LOI's should include a non-disclosure provision; a statement that each party is represented by counsel or chose not to be, and is responsible for its own LOI-related expenses; a representation that each party has or has not engaged a business broker or β€œfinder”; an agreement on public disclosures; a provision as to who will prepare initial drafts of the deal documents (usually the Buyer's lawyers); and governing law and dispute resolution provisions. Sometimes an LOI will require the parties to use some level of effort to complete negotiations and prepare deal documents subject to the findings of due diligence review.

BINDING AND NON-BINDING PARTS OF A LETTER OF INTENT

LOI's generally do not require the parties to consummate the contemplated transaction. But, an LOI should bind the parties to the confidentiality, expenses, no-shop, governing law, and dispute resolution provisions.


DO IT RIGHT

Letters of Intent are important legal documents. There are numerous legal, related tax, accounting, and business issues implicated in them. Contact an experienced corporate lawyer if you have been presented with n LOI, or are contemplating negotiating an LOI. Make an appointment now for a free consultation.  


This article is not legal advice, but is provided for general information purposes only: see the disclaimer in the footer of this site, and read our Legal Notices.

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