A Letter of Intent, also called a letter of intent, is the first step prior to the final purchase agreement of a business. What should all be included in this letter of intent?
The Letter of Intent (LOI) records the intention of buyer and seller, to enter into and negotiate a transaction with each other. It is not intended to be a final and binding purchase agreement, as that follows only after the accounting review.
Two functions of the Letter of Intent
The letter of intent has several purposes, including:
- What are the essential points of the negotiation process;
- It establishes the nature of the deal - is it a merger, joint venture or partial acquisition;
- It records the main topics, on which agreement has been reached.
Keep up the pace in negotiations
Include a tight timeframe in the LOI so that all parties involved are aware of the urgency. If that time schedule is not there, you risk taking the speed out of negotiations. As a result, the seller may become impatient, causing the atmosphere to deteriorate or the deal to fall through.
The scope of a letter of intent varies. In its most basic form, it is a document of a few lines, in which the parties merely state their intention to negotiate a possible acquisition of shares or assets. No final price is mentioned yet, but, for example, a deadline, within which they want to complete negotiations.
What does a Letter of Intent contain?
Usually, letters of intent are a lot more extensive and sometimes even have the character of a final agreement with some resolutive conditions. In that case, the buyer and seller cannot simply get out of the commitment unless they come up with actual resolutive matters. Although every Letter of Intent looks different in form and content, there are some fixed topics:
- Equity or asset - Is there an equity transaction or asset liability transaction;
- Price - The price included is indicative, as there is still a book review to be done;
- Confidentiality - A must for the seller because it discloses a lot of sensitive information;
- Form and timing of payment - Is payment made immediately upon delivery or is there earn-out?
- Due Diligence - An essential component is the book examination and must be performed to the satisfaction of the buyer. This condition precedent offers the buyer a way out if unexpected issues arise;
- Cost of transaction - Who bears the cost of bookkeeping and transaction documentation;
- Transaction documentation - The intention to establish an earn-out arrangement, escrow agreement or shareholder agreement is recorded in the Letter of Intent;
- Subject to financing - The buyer will sometimes want to document that they will go through with the acquisition if they can secure financing at market rates;
- Warranties - Warranties are not routinely included in the Letter of Intent, but sometimes this is so important to the buyer that they record it before negotiations begin;
- Timeline acquisition to closing - A timeline ensures urgency so that there are no unnecessary delays in the process;
- Concurrence clause - Also not a standard clause, as this is usually negotiated in the purchase agreement;
- Role of seller after acquisition - Does it remain associated with the business?
- Break fee when negotiations break down - This does occur in larger transactions.
Expert supervisors
During the negotiation phase, you and the seller fill in the outstanding issues and work through the remaining points of contention. At this stage, you record the final details, often under the watchful eye of a notary, lawyer and takeover consultant. Ultimately, this leads to an acquisition contract.
Purpose of a Letter of Intent
Why is a Letter of Intent actually necessary? From the buyer's perspective, because the buyer wants to be sure that he has exclusivity; that he is the only one negotiating with the seller to buy the business. The Letter of Intent will contain a clause to that effect. In addition, the LOI usually provides that the parties must maintain confidentiality about everything they learn about each other during the negotiation process. This is particularly in the seller's interest, as they provide all kinds of information about their company to be sold.
More importantly, the document contains a number of conditions precedent. These are conditions that you must fulfill in order to eventually complete the business acquisition. Otherwise, a final purchase agreement cannot be concluded. For example, the buyer will want to stipulate that he gets sufficient financing to pay the purchase price and that he can obtain this financing on market terms.
Due diligence
A letter of intent will establish that the buyer is entitled to conduct due diligence after signing, for a specified period of time. He will then have the opportunity to investigate the condition of the business. He can then look at the accounts and talk to management.
The results of the book review must be to the satisfaction of the buyer. For example, the buying party undoubtedly wants key customers to stay on after the sale.
Is the Letter of Intent binding?
A letter of intent is easily binding, but the extent of it obviously depends on how the LOI is worded. Therefore, this remains a legally tricky issue, about which many conflicts have already been moved to court. As a maxim, one could say that the buyer benefits from the Letter of Intent being non-binding, apart from exclusivity and confidentiality. He will ensure that sufficient suspensive conditions are included, such as satisfaction with the outcome of the due diligence, so that he can still abandon the acquisition. The seller, on the other hand, has an interest in ensuring that the buyer is as committed as possible and that the document counts as a preliminary purchase agreement.
Can you draft a letter of intent yourself?
In smaller deals (<5 mln), it is often the financieel adviseur, who drafts a Letter of Intent. In larger deals, lawyers are directly involved and will be responsible for drafting this document. Maybe you don't have an adviser or want to do it yourself. Can you? Yes you can!
Standard is the inclusion of a number of conditions precedent, such as satisfaction with the outcome of the book examination.
If, as a buyer, you find that there are unexpected risks associated with the company, you can get out of it unscathed. On the other hand, this letter of intent does commit to exclusivity and the buyer cannot leave the negotiating table without good reason.
