The Letter of Intent
The Letter of Intent
From a legal perspective, the purchase agreement is the centerpiece of any deal.
It’s where the rubber hits the road: What’s being bought, for how much, and on what terms. This is especially so in smaller deals, where legal diligence (although important) is relatively light.
Yet as many searchers know, negotiations begin a lot earlier.
In the normal course, before a seller completely opens the company drawers to diligence, the parties will negotiate a Letter of Intent (LOI)–a largely non-binding document that memorializes the parties’ preliminary understanding of the deal.
Since the LOI is largely non-binding, it is tempting for inexperienced buyers to give it insufficient thought and consideration in the rush to get “under LOI.”
That would be a mistake.
A comprehensive and well thought out LOI represents a crucial step in the deal-making process. A strong LOI makes it more likely that your deal will close, that it will so efficiently; and that if it doesn’t, you’re not too out of pocket or exposed to unnecessary risks. The LOI sets the stage for a successful transaction.
The LOI should clearly state all material business terms.
Although the LOI is largely non-binding, the seller will resist renegotiating material terms once memorialized, and may refuse to consider additional terms that were omitted.
Your LOI should include any proposed purchase price adjustments; whether the acquisition involves assets or stock; and, if it involves stock, whether the parties agree to treat the deal as an asset purchase for tax purposes.
You should also include any other important points that comprise your offer, whether a give—you agree to retain all of the seller’s employees after the closing date—or a take—the seller must provide transition support for 90 days following the closing.
In addition, the LOI should clearly set expectations with respect to getting to close.
How long does the buyer expect to spend on diligence? Will the parties sign the purchase agreement and close the deal in one swoop, or will the parties sign and close at a later date (SBA financing will require a signed purchase agreement before the lender can fund). How long does the buyer expect to need between signing and closing?
Deals die when buyers fail to manage expectations.
Of equal importance, the LOI should create a safe zone for the parties to negotiate further.
A well drafted LOI should include binding provisions addressing confidentiality and exclusivity (the latter preventing the seller from looking for other suitors while hammering out the purchase agreement). Moreover, the LOI should define the terms by which either party may withdraw from negotiations—that is, terminate the LOI and walk away.
Ultimately, the LOI is negotiated and signed after the buyer has completed some basic diligence but before the buyer embarks on major diligence. It therefore permits the parties to feel out the likelihood of success before risking additional dead deal costs.
By forcing the parties to agree on the important things upfront, the LOI makes it more likely that the deal will close successfully.
Have an LLC sign the LOI on your behalf. As noted, some elements of an LOI are binding. Although unlikely in a smaller transaction, it is possible that a breach of contract dispute could arise. LLCs are quick and cheap to organize, and offer limited liability protections.
Beware of brokers attempting to force the parties into a form LOI or, worse, a form purchase agreement. At best, form contracts hinder attempts to negotiate the specifics of a deal. At worst, they include potentially harmful provisions.
If you intend to draft the LOI yourself, you should start by reviewing several good templates. Don’t just copy and paste blindly. Take the time to understand each provision. Ask for help where necessary.