If you are on the eve of an acquisition or collaboration, the Letter of Intent (or a Term Sheet) will soon be on the table. Many entrepreneurs see this as a logical intermediate step. Something to establish the contours of the deal, without really committing to anything yet.
This is a persistent misconception.
It is precisely at this stage that you set the ground rules that later determine how much negotiating room you have left and whether you can pull out without consequences if the deal ultimately does not go through.
This is where things often go wrong
In practice, we see that an LOI is often taken too lightly. The focus is on the deal. Think about how things like the purchase price calculation and/or an earn-out are established. These are very important facets, but as a result there is often less focus on other important provisions.
An LOI may not be fully binding and contain many points that are subject to further negotiation, but parts of it are. Consider things like exclusivity and confidentiality. An underexposed risk is the following.
In fact, the way you establish the negotiation process can lead to so-called pre-contractual liability. In other words, you can be held liable under circumstances for breaking off negotiations.
That risk is often underestimated.
Less non-committal than you think
A recent ruling by the District Court of Amsterdam demonstrates this. The parties wanted to realize an acquisition and recorded their agreements in an LOI. This explicitly stated that both parties could end the negotiations at any time and that the deal would only go through if certain conditions were met.
When it turned out that those terms were not feasible, the sellers decided to quit. The buyer then demanded damages.
The court vindicated the sellers. Not because an LOI is by definition non-binding, but because the LOI explicitly stated that quitting was allowed.
Therein lies the crux.
What does this mean for you?
An LOI does not automatically protect you from liability if negotiations break down. Only a sharply worded LOI does that.
The difference is in the details. How do you formulate the terms. How do you set up the due diligence process. And above all: how explicitly do you record that you can still stop, without becoming liable for damages.
Without that clarity, the other party can argue that you created legitimate expectations. And then you quickly end up in a discussion about costs and damages.
You should always have this in focus
If you are going to sign an LOI, make sure you get this right:
- Establish explicitly that and when you may end negotiations.
- Clearly formulate what conditions must be met first before there is a final deal.
- Know which parts are legally binding, and treat them accordingly.
- And perhaps most importantly: never sign an LOI just to keep pace. It is precisely at this stage that you establish how much wiggle room you have left.
In conclusion
An LOI seems like the beginning of a deal, but in reality it is the moment when you set the ground rules. Not only for how you move forward together, but also for what happens if that doesn't work out after all.
That's precisely where the difference lies between maintaining control and facing legal risk.
