In a business sale, the letter of intent is a vital document, and sellers should thoroughly understand its purpose and scope.

In most business sales, the deal begins with a discussion between a buyer and a business owner (or the owner’s M&A broker) and moves from the “talking” stage to the “serious” stage when the buyer presents the seller with a “letter of intent” to purchase the seller’s company.



After it is signed by both parties, the letter of intent provides a launching pad for everything that follows, through the negotiation and “due diligence” phases to the ultimate sale. To help business owners prepare for its arrival and execution, we offer brief answers to seven fundamental questions that, if not frequently asked, should be.



1. What is a “letter of intent”?



In a business sale, a letter of intent (LOI) is a buyer-originated document through which the buyer expresses its intent to buy the subject business. It should provide:




  • a written expression of the parties’ intent to enter into a deal;

  • an outline of an agreement in principle for the buyer to purchase the seller’s business at an offered price or range and under certain terms;

  • an expression of the type of transaction, e.g., ownership purchase, asset purchase, merger, or reorganization of some type;

  • confidentiality protection for the seller;

  • an outline of the buyer’s financing – whether it will be through third-party financing or the buyer is proposing that the seller carry back some portion of the purchase price;

  • a timeline for the buyer’s due diligence and closing;

  • the buyer’s exclusive right to purchase the company during a specified time period; and

  • a time period within which the parties would strive to enter into a definitive agreement.



2. What is an LOI’s purpose?



In the M&A context, the LOI’s fundamental purpose is to formally acknowledge the parties’:




  • intent to enter into a business purchase or merger, and

  • good-faith desire to proceed in negotiations.



It bridges the temporary gap between a verbal expression of interest and a definitive purchase agreement. While the LOI provides the basic terms and conditions of the eventual contract, it should acknowledge that negotiations are still in progress.



3. Why is an LOI important?



Negotiating the purchase and sale of a business is expensive and time-consuming for both parties, and an LOI can give both parties some assurance that the associated costs and risks are justifiable.




An experienced buyer will not commit time and money to due diligence, analysis, and legal, tax and accounting services unless they believe they have an earnest seller and will have an exclusive right, expressed by a “no shop” clause, to buy the company.



Meanwhile, a prudent seller will not subject its business to the disruption and exposure of the due-diligence process unless the buyer is committed to the deal.



4. Is it legally binding?



By its language and content, an LOI can be either binding or non-binding. Given the uncertainty of how a deal will progress, in most cases neither the buyer nor the seller wants to be ultimately bound by the LOI and will state in the LOI that it is non-binding. In that circumstance, either party should be able to walk away from the deal without legal liability.





In rare cases, courts have ruled that an LOI itself can be a binding contract and enforced by the party that wants to move forward,



if it contains all the material terms of an agreement



and, as one judge wrote, “is complete, clear and unambiguous on its face.” At a minimum, an LOI will usually impose upon the parties at least the obligation to negotiate in good faith toward a definitive agreement.




Also, while the majority of LOIs have provisions that are non-binding (e.g., the buyer must buy the company), other provisions are binding, such as the exclusivity period, confidentiality protection, etc.



5. What should a seller look (and look out) for?



Be on the lookout for “poison pills” that some buyers might try to sneak past an unwary seller. Language stating that the parties have agreed to




anything



should raise a red flag. Also, sellers should be alert to unintended presumptions or default events, such as, “Unless we hear from you to the contrary …”



In addition to vigilance against unwanted language, sellers should expect to see provisions that are common to most well-structured LOIs. In addition to identifying the structure of the transaction, i.e., whether ownership or assets are to be purchased, the parties and their contact information, and the deal’s price and terms, an LOI might address such issues as:



  • whether it is legally binding or non-binding

  • confidentiality and non-disclosure protection

  • exclusivity

  • guidelines for negotiations

  • scope and guidelines for due diligence

  • conditions for closing

  • governing law.



6. What if I want to make changes before I sign it?



An LOI is not a one-way proposition to be dictated by the buyer; rather, it is an agreement between the buyer and seller. It is intended to protect both parties, and the seller has the right to negotiate its terms.




7. What happens after the letter of intent is signed?



The signing of an LOI typically triggers the due-diligence period, during which negotiations occur, the purchase agreement is drafted, and the buyer’s requests for company information are satisfied.




When the parties reach the point where the buyer feels comfortable that the seller has portrayed the business and assets as advertised, the parties will then initiate the bulk of the definitive documents through their attorneys.



Keeping It Simple.



In contrast to the final purchase agreement, a letter of intent should be relatively brief, focusing mostly on the major issues that will help the buyer and seller reach common ground and justify the risk and expense of pursuing the deal.





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