A Letter of Intent (LOI) sets out the key terms negotiated between the buyer and seller prior to the final purchase agreement: the price, which shares or assets are being sold, confidentiality, exclusivity, the scope of the due diligence review, and conditions precedent such as financing. An LOI is usually not fully binding, although it typically does contain binding provisions regarding exclusivity and confidentiality.
With a business acquisition, it is customary to first sign a letter of intent prior to the final purchase agreement. What should all be included in this letter of intent?
The Letter of Intent (LOI) sets forth the buyer’s and seller’s intention to enter into a transaction with each other and to negotiate the terms thereof. It is not intended to be a definitive and binding purchase agreement; that will follow only after the due diligence review.
What are the purposes of a Letter of Intent?
- Recording the main topics agreed upon, including delineating the negotiations.
- Recording agreements about the negotiation process.
Tip: Include a tight timeline in the LOI. This ensures that all parties involved are motivated to act quickly and that the pace remains high. Without such a timeline, you run the risk of the negotiations losing momentum, the seller becoming impatient, and the atmosphere deteriorating.
The scope of a letter of intent, also called letter of intent or LOI for short, can vary. 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 stock or assets. No final price is mentioned yet, but, for example, a deadline by which negotiations must be completed.
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, but will have to come up with actual resolutive matters.
Although every letter of intent differs in form and content, it usually includes the following:
- Shares or assets
The parties record how many (and which) shares will be sold or which assets in an asset/liability transaction. - Price
This is rather obvious. Without agreement on the price, no LOI is usually signed. The price is indicative because, of course, there is still a book review to be done that may affect the final (selling) price. - Secrecy
This is also a standard provision, and especially a must for the seller because it reveals a lot of sensitive information. - Form and timing of payment
Payment immediately after delivery? Or is there, for example, an earn-out? - Audit: Due Diligence
This is one of the most important elements of the sales process. In the letter of intent, the parties agree on the scope of the due diligence review. The standard provision is that the due diligence must be to the buyer’s satisfaction—a condition precedent. This gives the buyer a way out if they discover issues they did not anticipate. - Transaction costs
It is helpful to agree on who will bear the costs of the bookkeeping and transaction documentation. - Transaction documentation: at least a purchase agreement. But can also be more such as an earn-out arrangement, an escrow agreement, or a shareholder agreement if existing shareholders remain in the business.
- Financing contingency: In some cases, the buyer will want to stipulate that it can secure financing for the acquisition and that it can obtain this financing on market terms.
- Guarantees
To what extent guarantees are already included in the LOI depends very much on the desire of the parties. Sometimes a guarantee can be so essential that a buyer wants it recorded even before negotiations proceed. But often it is sufficient to agree that the parties include the standard warranties. - Timeline for the Acquisition Through to Closing
It may be wise to develop a timeline, especially for the due diligence process and the preparation of the transaction documentation. This ensures that all parties involved remain focused and that the pace stays high. - Non-Competition Clause
This is not a standard provision. The parties usually choose to negotiate the non-compete clause in the purchase agreement. - Role of seller after acquisition: does he or she remain connected to the business?
- Break fee when negotiations break down: does occur in larger transactions.
During the negotiation phase, you and the seller address the outstanding issues and resolve any remaining points of disagreement. At this stage, you finalize the last details, often in the presence of an acquisition advisor, an attorney, and a notary. Ultimately, this leads to an acquisition agreement.
What is the purpose of a Letter of Intent?
Why is a letter of intent actually necessary? From the buyer’s perspective, it’s because the buyer wants to be certain of exclusivity: that they are the only party negotiating with the seller regarding the purchase of the business. The letter of intent will therefore include a clause to that effect. In addition, the letter of intent typically stipulates that the parties must maintain confidentiality regarding everything they learn about each other during the negotiation process. This is particularly in the seller’s interest, as the seller will provide all kinds of information about the business being sold.
More importantly, the letter of intent contains a number of conditions precedent. These are conditions that must be met in order to ultimately complete the business acquisition and thus enter into the definitive purchase agreement with each other. For example, the buyer will want to ensure that it can secure sufficient acquisition financing to pay the purchase price and that it can obtain this financing on arm’s-length terms.
In addition, a letter of intent will specify that the buyer is entitled to conduct a due diligence review for a certain period after signing the letter of intent. This gives the buyer the opportunity to investigate the company’s condition. The buyer can then review the financial records and speak with management.
It will typically be stipulated that the results of this due diligence review must be satisfactory to the buyer. Another condition precedent that may be considered is that the buyer must be able to confirm that the management and key customers will remain in place after the sale of the business by the then-former owner.
Is the LOI binding?
A letter of intent can easily become binding. The extent to which it is binding naturally depends on how the LOI is worded. That is why this remains a legally sensitive issue, one that has already been the subject of many court battles. As a general rule, you could say that it is in the buyer’s best interest for the LOI to be non-binding, apart from provisions regarding exclusivity and confidentiality. The buyer will ensure that sufficient conditions precedent are included—such as satisfaction with the outcome of the due diligence—so that they can still walk away from the acquisition.
The seller, on the other hand, has an interest in ensuring that the buyer commits as much as possible, and that the document counts as a preliminary purchase agreement.
Frequently Asked Questions
What is a Letter of Intent?
A document in which the buyer and seller set forth their intention to negotiate a business acquisition, including the key terms and conditions prior to the final purchase agreement.
What is usually included in a Letter of Intent?
Among other things, it includes the price, which shares or assets are being sold, confidentiality provisions, the scope of the due diligence review, a financing contingency, and agreements regarding the timeline.
Is a Letter of Intent binding?
Usually, it’s not comprehensive. Provisions regarding exclusivity and confidentiality are generally binding, but the buyer often includes conditions precedent (such as a favorable outcome of due diligence) that allow them to still walk away from the acquisition.
Why does the buyer want exclusivity in the LOI?
So that he can be sure he is the only party negotiating with the seller regarding the purchase of the business.
What is a condition precedent in a Letter of Intent?
A condition that must be met before the final purchase agreement is entered into, such as a satisfactory outcome of the due diligence review or appropriate financing.
