Letter of Intent: Lots of QuestionsWow! Last week’s letter of intent post certainly struck a nerve! That post focused on an LOI’s “no-shop” clause because it was an issue that caused significant agita for one of our brokers a while back. But the general topic of letters of intent appears to be one that a lot of brokers – to say nothing of sellers – are not exactly comfortable with. So, this post is intended as a primer. It’s not all-encompassing because letters of intent, though they certainly share certain aspects, can vary widely from deal to deal. But this post will touch on a few of the issues usually covered in most of the LOIs that we’ve seen.
Purpose and UsesThe purpose of a letter of intent is normally to get the most important points – such as purchase price, scope of due diligence, financing terms and closing terms among other things – out of the way before the parties – usually the buyer – starts spending time and money drafting all the legal jargon that the documents needed to acquire a business usually require. An LOI is a document outlining the general understanding between the parties to a transaction and includes statements of intent to formalize that understanding in a legally binding agreement, usually within a certain period of time. When submitting a letter of intent, the buyer usually wants to express its interest in the business in a way that signals a higher level of seriousness on the part of the buyer than the legions of tire kickers that we encounter. But there are other purposes, as well. One is to give the buyer an opportunity to get a “quick look” at the business without fear of another buyer scooping the business up out from under him. This is the purpose of the “no-shop” clause which prohibits the seller from actively marketing the business or entertaining other offers during the “no-shop” period. But there are also potential buyers out there – most notably, private equity groups – that will submit letters of intent to multiple businesses at once thereby tying up the seller of these businesses when their intent is to buy only one.
ContentLetters of Intent in our industry generally include a price to be paid for the purchase of the business as well as any other terms that the buyer considers important. But a letter of intent is a negotiable document. A buyer might submit an LOI for a $4 million business with an offering price of $3 million; or 100% seller financing; or a closing date 12 months away. Our brokers would advise their client, the seller, to counter any terms that are not acceptable with terms more in keeping with what the seller and broker believe to be reasonable. Sellers and brokers have to remember that every item in the LOI is negotiable. As a rule, LOIs are not binding. However, many LOIs contain certain provisions that are binding, such as those governing non-disclosure, governing law, exclusivity or covenants to negotiate in good faith.
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UpsidesIf carefully negotiated, an LOI can serve to protect both parties to a transaction. For example, the seller of a business may incorporate what is known as a non-solicitation provision, which would prohibit the buyer from poaching an employee or client of the seller’s business should the deal not come to fruition. On the other hand, an LOI might protect the buyer of a business by containing a condition that its obligation to complete the transaction is rescinded if the buyer is unable to secure the necessary financing. And both parties should benefit by a well-drafted confidentiality section whereby even the existence of any negotiations – let alone any identities – are kept under wraps.
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