By: Taylor C. Auten and Amy E. Risseeuw
In many M&A deals, one of the first documents negotiated by the parties is a letter of intent (often called an “LOI”), which is a written expression of the parties’ intent to enter into a transaction and a summary of the material terms of the deal. Because negotiating an M&A transaction is time-consuming and costly for both the buyer and the seller and can be disruptive to the seller’s management of its daily operations, working through an LOI can be a productive first step. It allows the parties to determine very early in the process whether there is a basic agreement on key terms and confirm that there are no “deal-breaker” issues before either party has devoted substantial time and resources. In addition, an LOI helps to facilitate the preparation and negotiation of the definitive documents for the transaction by serving as an outline of the key provisions.
At the time of negotiating a letter of intent, the parties to the potential transaction often have limited information and typically have not engaged in comprehensive due diligence, and therefore the proposed terms for the transaction that are included in the LOI are generally not legally binding on the parties. However, as a practical matter, the LOI sets the expectations of the parties regarding the final terms, and any deviations from such terms after the LOI is signed will require justification. In addition to the non-binding deal terms, a letter of intent often includes some provisions that are expressly stated to be legally binding.
Letters of intent vary widely based on the needs and goals of the parties to a potential transaction and the specifics of the deal, but in many cases include the following terms and provisions:
Structure. Because the structure of the transaction (i.e. stock sale, merger, asset sale) can have significant implications in respect of purchaser liability, tax treatment, closing mechanics and other things, it is often included as one of the first terms of an LOI. If there will be “rollover” equity (i.e. post-deal ownership of the business by the seller), it may be outlined here as well. (For more information about transaction structures, see our practice brief: M&A Transaction Structures: The Difference Between an Asset Sale and a Stock Sale.)
Purchase Price. An LOI will typically include not just the amount that the buyer proposes to pay for the acquired business but also detail about the form of payment (i.e. cash, stock of the buyer, seller note, a combination of these). In addition, the timing and manner of payment is usually specified to describe how much will be paid at closing versus following the closing and whether any post-closing payments will be contingent upon future events or on the business meeting certain performance targets or other metrics. If the buyer expects a portion of the purchase price to be placed in escrow to secure any indemnification or other obligations of the seller, it is often stated here as well.
Indemnification Framework. Often, an LOI will include a brief summary of the parties’ expectations for the non-financial terms of the definitive purchase agreement, especially regarding the scope of the seller’s indemnification obligations to the buyer. In some cases, the parties will take the time to include specifics such as the length of survival of indemnification and the limitations on indemnification (e.g. baskets and caps). (For more information about indemnification, see our practice brief: Indemnification Caps and Baskets in Private Company M&A Transactions: What’s market?)
Key Closing Conditions. It is not uncommon to include a list of the expected closing conditions, such as any regulatory approvals or third party consents that will be required. If a buyer intends (or does not intend) to include its ability to obtain financing as a condition to closing, that may be included. Also, the buyer may want to specify its expectations regarding noncompetition agreements and other restrictive covenant agreements to be provided at closing. (For more information about noncompetition arrangements, see our practice brief: Non-Competition Agreements in the Sale of a Business.)
Management Arrangements. Some LOIs (particularly when the buyer is a private equity firm) will include a brief description of the buyer’s intentions for key members of management, including key employment terms and a description of any plans for incentive equity grants.
Due Diligence. A letter of intent often describes the scope of the buyer’s proposed due diligence review and the access to information, and any limits thereto, that will be provided by the seller.
Exclusivity. In an M&A deal involving a private company target, the letter of intent usually contains an exclusivity provision that restricts the seller from negotiating or soliciting offers from other potential buyers. The period of exclusivity is a critical term and frequently will drive the timeline for the subsequent diligence process and negotiation of agreements, although it is not uncommon for the period to be later extended by the parties.
Confidentiality. A letter of intent generally provides that its terms are subject to any confidentiality agreement previously entered into by the parties or, if there is no such agreement, that the terms of the LOI and the information shared between the parties will be held in confidence and not disclosed.
Expenses. A letter of intent often includes a provision describing how the transaction expenses will be allocated between the parties. Often this section will provide that each party will bear all expenses incurred for its own benefit (e.g. legal and broker fees) and may provide for sharing of other expenses (e.g. regulatory filing fees).
Governing Law. As with most M&A deal documents, an LOI commonly includes a provision regarding which jurisdiction’s laws will govern any disputes that may arise.
Some Considerations for Buyers and Sellers in Negotiating an LOI:
Use of Advisors. Sometimes, parties to a potential transaction will wait until after a letter of intent is signed before contacting legal, tax and accounting advisors to assist with the deal. We strongly encourage that advisors get involved before the LOI is signed. Some very critical decisions are made at the time of negotiating an LOI, such as the structure to be used for the transaction, which could have a significant impact on the economics and risk-allocation of the transaction. Even though most of the terms of the LOI are non-binding, once the LOI is signed it is intended to serve as the agreed terms for the deal.
Potential Liability. Parties to an LOI should be careful to expressly state that the letter of intent is intended to be generally non-binding, and clearly identify any provisions that are intended to be legally binding. Failure to have clear and unambiguous language in this regard could have the unintended effect of committing the parties to terms before the final documents are agreed and signed.
Process. While it is important to include the key terms proposed for the potential transaction, the details and finer drafting should be deferred until the definitive deal documents are prepared. Including non-material issues at the LOI stage can unnecessarily lengthen the time to complete this first step, potentially causing lost deal momentum, frustration and a longer overall transaction timeline.
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Taylor C. Auten and Amy E. Risseeuw are attorneys in the M&A Practice Group of Wyrick Robbins Yates & Ponton LLP, which represents clients across a broad range of industries in connection with their significant corporate transactions. The group publishes Practice Briefs periodically as a service to clients and friends. The purpose of this Practice Brief is to provide general information, and it is not intended to provide, and should not be relied upon as, legal advice.