A carefully drafted letter of intent (LOI) is a critical part of any business transaction. After the parties have met and discussed ideas and basic business parameters, it is time to reduce these discussions to paper. The LOI is a way to move the transaction forward from initial informal discussions to a more detailed exchange of both the legal and business requirements of the proposed transaction. While a LOI is not a contract binding the parties into a transaction, it can help clarify the parties’ intentions and expectations of each other and serve as a launching point for a successful sale or merger.
As this suggests, the LOI comes into play relatively early in the negotiation timeline. Often, it is the first step after a buyer expresses interest and the broker or business listing makes an initial price offer. This indicates that the proposed transaction has moved past informal discussions and an indication that negotiations have become serious. A well-written LOI will make clear the details of the potential transaction and often contains some binding language, such as an exclusivity clause taking the business or other asset off the market while the proposed buyer performs due diligence.
Set forth below is a list of deal points that a typical LOI might address. Please understand that this is not an exhaustive list and the transaction will dictate what should or should not be in a LOI. It is important that you engage legal counsel before you sign a LOI and not after.
Binding And Nonbinding Terms In The LOI
Most LOIs would have both binding and nonbinding terms. The proposed transaction terms should be nonbinding, allow the parties the opportunity to complete due diligence and reduce detailed transaction terms to writing. The parties must be careful and not to make the LOI the definitive and binding written agreement for the transaction. There have been instances where courts held that if a LOI contained all required material terms and did not have protective language to the contrary, the LOI was the operative agreement and held the parties to the business terms (e.g., a potential buyer was obligated to buy a company after signing a LOI). Language makes it clear that both parties understand the LOI is not a final contract and that the terms contained within have not been finalized yet.
You also want to make certain terms in a LOI binding. For example, confidentiality and exclusivity are important terms to consider. The potential buyer will want to take the target “off the market” for a defined period of time while it invests time and money in a due diligence investigation.
Identify Basic Transaction Terms
Identify the basic asset (or stock) being sold, including goodwill, intellectual property (if any) and the key agreements that would be assumed, such as real estate, equipment and/or license agreements. An exact and clear identification of the asset being sold can avoid surprises or misunderstandings later on.
Purchase Price
Clearly identify the purchase price and all of its components. What is the total value of the consideration and how will it be transferred? Deposit, cash at closing, promissory note, stock, earn-out agreement?
Financing
Is the transaction contingent on securing financing? If so, consideration should be given to identifying the amount needed to acquire the assets and operate during a transition period while accounts receivable buildup. What interest and repayment terms would be acceptable?
Purchase Price Adjustments
An adjustment to the purchase price would be needed when there is a period of time between signing the agreement of sale and closing. During this time, the seller would be obligated to operate the business in the ordinary course with the aim of keeping both work in process and inventory within an acceptable level. To the extent this does not happen, adjustments to the purchase price would need to be made at closing.
Excluded Assets
Clearly identify what assets would be excluded from the sale. Aside from cash, accounts and receivables, are there any specialty items that would not be transferred? Specific vehicles or equipment?
Excluded Liabilities
Identify and exclude employee liabilities, including unpaid wages, through closing or underfunded pension plans. Bulk sales tax laws should be considered as well as state and federal taxes in general. Environmental liabilities. Outstanding obligations under any real estate leases would need to be addressed. How would indemnification operate in relation to the foregoing?
Costs & Expenses
Clearly state that each party would be responsible for its own transaction costs and expenses.
Due Diligence
What information would be required to comply with due diligence? Access to records, bank transactions, employees, customers and premises would need to be considered. Would real estate be altered and if so, who would have the responsibility to return the property to preinspection condition? Would the seller have the right to view a copy of the report? Under what circumstances would either party have the ability to terminate the agreement? How would this impact any initial payment?
Restrictive Covenants
Restrictive covenants that focus on competition, solicitation and disparagement should be considered. This is especially important given the growing trend of disfavoring these types of restrictive clauses. Can a narrowly tailored confidentiality agreement provide more protection?
Required Third Party Consents
Are third party consents required for the transfer of key contracts? This may be a long lead time item. For a detailed discussion, please review our prior blog on this topic by clicking here.
Contingencies
Contingencies include anything that the buyer expects (or needs) to happen before they can close the purchase, such as securing financing or receiving documents from the proposed seller that help determine the business’s profitability. When such contingencies are laid out, the process becomes more predictable for both sides.
Trying to work out a LOI between you and the other party alone, having a business attorney work with you on negotiation and drafting can be crucial for avoiding mistakes. Even seasoned business owners and investors can fail to consider every potential roadblock and detail. Our attorneys have assisted hundreds of clients with negotiating, drafting and reviewing LOIs. Our representation at this phase of the sale can make the process significantly smoother and in line with your business goals.
These are just a few of the considerations that the business-minded attorneys at Anderson Leavitt LLC consider when we represent our clients in their business transactions. The LOI is not just a boilerplate document but a carefully thought-out approach that guides the transaction.
Contact Anderson Leavitt Today
If you have any questions regarding your need for a letter of intent, or any other aspect of your transaction, please don’t hesitate to contact any of our business attorneys at Anderson Leavitt LLC.
This entry is presented for informational purposes only and is not intended to constitute legal advice.