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) or letter of intent records the intention of buyer and seller to enter into and negotiate a transaction with each other. It is not meant to be a final and binding purchase agreement; that only follows after the bookkeeping review.
The Letter of Intent has two functions:
- Recording the main topics agreed upon, including delineating the negotiations.
- Recording agreements about the negotiation process.
Tip: Include a tight time schedule in the LOI. This ensures that all parties involved are in a hurry and the pace remains high. If that time schedule is not there, you run the risk that the speed goes out of the negotiations, the seller becomes impatient and the atmosphere deteriorates.
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 looks different in form and content, the following is usually covered:
- 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? - Book review: due diligence
This is one of the most important elements of the sales process. The parties agree in the letter of intent on the scope of the due diligence. Standard is the provision that the due diligence is to the buyer's satisfaction - a condition precedent. This offers the buyer a way out if he finds things he did not expect. - 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.
- Reserved financing: in some cases, the buyer will want to stipulate that he can obtain financing for the acquisition and that he 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. - Timeframe acquisition to closing
It may be wise to work out a timeline, especially for the book review and preparation of transaction documentation. This ensures that all parties involved are in a hurry and the pace remains high. - Competition clause
Is not a standard provision. Parties usually choose because the non-compete clause is negotiated later 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.
In the negotiation round, you and the seller fill in the outstanding issues and work through the remaining points of contention. You record the final details at this stage, often in the presence of an acquisition consultant, attorney and notary. 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 point of view 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 therefore contain a clause to that effect. In addition, the letter of intent usually stipulates that the parties must maintain confidentiality about all that they learn about each other during the negotiation process. This is particularly in the interest of the seller, as the seller will provide all kinds of information about his company to be sold.
More importantly, the letter of intent contains a number of conditions precedent. These are conditions that must be met in order for the business acquisition to eventually take place and thus for the final purchase agreement to be entered into with each other. For example, the buyer will want to determine that he can obtain sufficient business acquisition financing to pay the purchase price and that he can obtain this financing on market terms.
In addition, a letter of intent will stipulate that the buyer is entitled to do due diligence for a certain period of time after signing the letter of intent. He will then have the opportunity to investigate the condition of the business. He can then look at the accounting records and talk to management.
It will be stipulated that the results of this due diligence must be to the satisfaction of the buyer. Another condition precedent that can be considered is that the buyer can establish that the management and key customers will stay on after the business sale by the then former owner.
Is the LOI binding?
A letter of intent is soon binding. Of course, the extent depends on how the LOI is worded. Therefore, this remains a legally thorny issue, which has been the subject of many battles in court. As a maxim, you could say that the buyer benefits from the LOI being non-binding, apart from exclusivity and confidentiality. He will make sure 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 commits as much as possible, and that the document counts as a preliminary purchase agreement.
