The Letter of Intent
Once it is determined who the target is, it is time to nail down some terms. What is the price and what is your client going to be buying—certain assets or the entire business? Some businesses will negotiate the terms of the letter of intent, others see it as a non-binding “we are potentially interested at $x price” kind of thing.
LoIs are kind of funny things because as I said, they are non-binding. The LoI’s job is to outline the agreement in principle—proposed price and other important terms. Whatever is in the letter of intent is allowed to change but it basically provides assurance that you are serious in considering the purchase. It also helps to show expectations for the deal. A LoI is considered important even though it is non-binding because the underlying assumption is that you will not deviate from the terms in the LoI unless there is justification. The justification can be found through the due diligence process or perhaps through other means like a change in the market or the value of the target.
The LoI typically opens the door for due diligence to start.
📖Read Maryann A. Waryjas, Letters of Intent in the Acquisition or Sale of the Privately Held Company. She provides an example of a LoI and the reasons why some LoIs are non-binding and some are binding.
Terms
Depending on the deal, there are different kinds of terms that you will want to include. Some typical ones are:
- Price—what is the price? There are numerous valuation techniques: book value (asset valuation); liquidation value (fmv); income capitalization; using business comparables. (We will discuss these in class.)
- Payment—how/when is the price going to be paid? Will there need to be an escrow for any reason?
- Deal Structure
- Indemnification—one must always include indemnification clauses. Surely your client will not want to take on liability for anything that happened prior to the deal closing. The seller will also want similar protections for after the deal is done.
- Dates—list the important dates. When is closing? When will titles or deeds transfer?
- Employees—will your client want to offer the current employees to stay on or come over? Same questions with management. Do you need the target’s key people to consult to aid in the transition?
While the LoI is non-binding, there are some provisions you will want to include that will be binding in their own right, such as non-disclosure agreements, non-compete agreements, exclusivity provisions to prohibit the seller from shopping their company to others, governing law, and maybe a provision about expenses/costs. The exclusivity clause is the main reason why a buyer wants to have an LoI. Other than that, the buyer really wants provisions to be general. By keeping the language more general, the buyer can wait until due diligence is over to really solidify things. It always helps to have more information on the target before nailing down too much.
Advantages and Disadvantages
The LoI is a sort of road